CFR > Title 26 - Internal Revenue > CHAPTER I—INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY > SUBCHAPTER A—INCOME TAX (Parts 1–19) > PART 1—INCOME TAXES > 1.446-2—Method of accounting for interest.

1.446-2—Method of accounting for interest.

(a) Effective date. This section is effective for taxable years beginning after December 31, 1975. For taxable years beginning before January 1, 1976, see 26 CFR 1.46-2 (Rev. as of April 1, 1979).
(b) In general. Under section 46(b)(1), unused credit may be carried back and carried over. Carrybacks and carryovers of unused credit are taken into account in determining the amount of credit available and the credit allowed for the taxable years to which they may be carried. In general, the application of the rules of this section to regular and ESOP credits are separate from their application to nonrefundable energy credits. For example, the limitations on carrybacks and carryovers of unused nonrefundable energy credit under section 46(b) (2) and (3), respectively, differ in amount from the limitations on the regular and ESOP credits because the tax liability limitations for those credits differ. See § 1.46-1(h). For a further example, see the special ordering rule in § 1.46-1(m). Section 46(b) does not apply to the refundable energy credit.
(c) Unused credit. If carryovers and credit earned (as defined in § 1.46-1(c)(1)) exceed the applicable tax liability limitation, the excess attributable to credit earned is an unused credit. The taxable year in which an unused credit arises is referred to as the “unused credit year”.
(d) Taxable years to which unused credit may be carried. An unused credit is a carryback to each of the 3 taxable years preceding the unused credit year and a carryover to each of the 7 taxable years succeeding the unused credit year. An unused credit must be carried first to the earliest of those 10 taxable years. An unused credit then must be carried to each of the other 9 taxable years (in order of time) to the extent that the unused credit was not absorbed during a prior taxable year because of the limitations under section 46(b) (2) and (3).
(e) Special rule for pre-1971 years— (1) In general. For unused credit years ending before January 1, 1971, unused credit is allowed a 10-year carryover rather than the 7-year carryover. The principles of paragraph (d) of this section apply to this 10-year carryover.
(2) Cross reference. For limitations on the taxable years to which unused credit from pre-1971 credit years may be carried, see paragraph (g) of this section.
(f) Limitations on carrybacks. Under the FIFO rule to section 46(a)(1), carryovers and credit earned are applied against the tax liability limitation before carrybacks. Thus, carrybacks to a taxable year may not exceed the amount by which the applicable tax liability limitation for that year exceeds the sum of carryovers to and credit earned for that year. Carrybacks from an unused credit year are applied against tax liability before carrybacks from a later unused credit year. To the extent an unused credit cannot be carried back to a particular preceding taxable year, the unused credit must be carried to the next succeeding taxable year to which it may be carried.
(g) Limitations on carryovers— (1) General rule. Carryovers to a taxable year may not exceed the applicable tax liability limitation for that year. Carryovers from an unused credit year are applied before carryovers from a later unused credit year.
(2) Exception. A 10-year carryover from a pre-1971 unused credit year may, under certain circumstances, be postponed to prevent a later-earned 7-year carryover from expiring. This exception does not extend the 10-year carryover period for pre-1971 unused credit. See section 46(b)(1)(D).
(h) Examples. The following examples illustrate paragraphs (a) through (g) of this section.

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Example 1. (a) Corporation M is organized on January 1, 1977 and files its income tax return on a calendar year basis. Assume the facts set forth in columns (1) and (2) of the following table. The determination of the regular credit allowed for each of the taxable years indicated is set forth in the remaining portions of the table.
(1) (2) (3) (4) (5) (6) (7)
Credit available Tax liability Percent Tax liability limitation (remaining from col. (6) on preceding line) Credit allowed (lower of (1) or (4)) Remaining tax liability limitation ((4)-(5)) Unused credit ((1)-(5)) or (amount absorbed)
1977:
A. Credit earned $20,000 $45,000 50 $35,000 $20,000 $15,000 0
B. Carryback from 1978 *15,000 [15,000] 15,000
1978:
A. Credit earned 80,000 55,000 50 40,000 40,000 0 $20,000
Carryback to 1977 (*15,000)
Carryover to 1979 (*5,000)
1979:
A. Carryover from 1978 *5,000 50,000 60 40,000 6,000 35,000
B. Credit earned 50,000 [35,000] 35,000 0 15,000
Carryover to 1980 (*15,000)
1980:
A. Carryover from 1979 *15,000 55,000 70 46,000 15,000 31,000
B. Credit earned 25,000 [31,000] 25,000 6,000 0
*For line “A” each year: Lesser of (1) tax liability or (2) $25,000 (percentage in col. (3) × [col. (2) − $25,000]). See, § 1.46-1(h) . For other lines: Amount in col. (6) on preceding line.

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Example 2. (a) Assume the same facts as in Example 1 except for 1979 M earns a $35,000 nonrefundable energy credit. The following table shows the determinations for each year.
(1) Credit available (2) Tax liability (a) Regular (b) Energy ((2)(a)-(5)(R)) (3) Percent (4) Tax liability limitation* (remaining from col. (6) on preceding line) (5) Credit allowed (lower of (1) or (4)) (6) Remaining tax liability limitation ((4)-(5)) (7) Unused credit ((1)-(5)) or (amount absorbed)
1977:
Regular:
A. Credit earned $20,000 $45,000 50 $35,000 $20,000R $15,000 0
B. Carryback from 1978 *15,000 [15,000] 15,000R 0
1978:
Regular:
A. Credit earned 60,000 55,000 50 40,000 40,000R 0 $20,000
Carryback to 1977 (*15,000)
Carryover to 1979 (*5,000)
Energy:
A. Carryback from 1979 *15,000 $15,000 100 15,000 15,000E 0
1979:
Regular:
A. Carryover from 1978 *5,000 50,000 60 40,000 5,000R 35,000
B. Credit earned 50,000 [35,000] 35,000R 0 15,000
Carryover to 1980 (*15,000)
Energy:
A. Credit earned 35,000 10,000 100 10,000 10,000E 0 25,000
Carryback to 1978 (*15,000)
Carryover to 1980 (*10,000)
1980:
Regular:
A. Carryover from 1979 *15,000 55,000 70 46,000 15,000R 31,000
B. Credit earned 25,000 [31,000] 25,000R 6,000 0
Energy:
A. Carryover from 1979 *10,000 15,000 100 15,000 10,000E 5,000
*See footnote to the chart in Example 1.
(b) Although, in general, a nonrefundable energy credit may be carried back to taxable years ending before October 1, 1978, in this example the unused nonrefundable energy credit from 1979 may not be absorbed in 1977. The 1977 tax liability limitation for the nonrefundable energy credit is the same as it is for the regular credit, reduced by regular credit previously allowed for 1977. See §§ 1.46-1(h)(3) and 1.46-1(m) .

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Example 3. (a) Assume the same facts as in Example 2 except M has regular credit of $37,000 for 1981 and M's tax liability for 1981 is $32,500. The determinations for 1980 and 1981 are set forth in the following table.
(1) Credit available (2) Tax liability (a) Regular (b) Energy ((2)-(5)(R)) (3) Percent (4) Tax liability limitation* (remaining from col. (6) on preceding line) (5) Credit allowed (lower of (1) or (4)) (6) Remaining tax liability limitation ((4)-(5)) (7) Unused credit ((1)-(5)) or (amount absorbed)
1979 (restated):
Energy:
To be carried over $10,000
Carryover to 1980 (*9,000)
Carryover to 1981 (*1,000)
1980 (restated):
Regular:
A. Carryover from 1979 $15,000 $55,000 70 $46,000 $15,000R $31,000
B. Credit earned *25,000 [31,000] 25,000R 6,000 0
C. Carryback from 1981 *6,000 [6,000] 6,000R 0
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Energy:
A. Carryover from 1979 *9,000 $9,000 100 9,000 9,000E
1981: Regular:
A. Credit earned 37,000 32,500 80 31,000 31,000R 0 6,000
Carryback to 1980 (*6,000)
Energy:
A. Carryover from 1979 *1,000 1,500 100 1,500 1,000E 500 0
*See footnote to chart under Example 1.
(b) Allowance of the regular carryback in 1980 from 1981 requires that the computations for 1980 be restated. The energy tax liability limitation for 1980 is reduced from $15,000 (as determined in Example 2) to $9,000. Thus, $1,000 of the $10,000 energy credit allowed for 1980 is displaced by the regular carryback. That amount may not be carried back because there is no remaining energy tax liability limitation for the prior 3 years (see table in Example 2). It may be carried over to 1981 and allowed in full in that year.
(i) [Reserved]
(j) Electing small business corporation. A shareholder of an electing small business corporation (as defined in section 1371(b)) may not take into account unused credit of the corporation attributable to unused credit years for which the corporation was not an electing small business corporation. However, a taxable year for which the corporation is an electing small business corporation is counted as a taxable year for determining the taxable years to which that unused credit may be carried.
(k) Periods of less than 12 months. A fractional part of a year that is considered a taxable year under sections 441(b) and 7701(a)(23) is treated as a preceding or succeeding taxable year for determining under section 46(b) the taxable years to which an unused credit may be carried.
(l) Corporate acquisitions. For carryover of unused credits in the case of certain corporate acquisitions, see section 381(c)(23).

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(Secs. 7805 (68A Stat. 917, 26 U.S.C. 7805 ) and 38(b) (76 Stat. 962, 26 U.S.C. 38 ))

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[T.D. 7751, 46 FR 1679, Jan. 7, 1981]
(a) Applicability— (1) In general. This section provides rules for determining the amount of interest that accrues during an accrual period (other than interest described in paragraph (a)(2) of this section) and for determining the portion of a payment that consists of accrued interest. For purposes of this section, interest includes original issue discount and amounts treated as interest (whether stated or unstated) in any lending or deferred payment transaction. Accrued interest determined under this section is taken into account by a taxpayer under the taxpayer's regular method of accounting (e.g., an accrual method or the cash receipts and disbursements method). Application of an exception described in paragraph (a)(2) of this section to one party to a transaction does not affect the application of this section to any other party to the transaction.
(2) Exceptions— (i) Interest included or deducted under certain other provisions. This section does not apply to interest that is taken into account under—
(A) Sections 1272(a), 1275, and 163(e) (income and deductions relating to original issue discount);
(B) Section 467(a)(2) (certain payments for the use of property or services);
(C) Sections 1276 through 1278 (market discount);
(D) Sections 1281 through 1283 (discount on certain short-term obligations);
(E) Section 7872(a) (certain loans with below-market interest rates); or
(F) Section 1.1272-3 (an election by a holder to treat all interest on a debt instrument as original issue discount).
(ii) De minimis original issue discount. This section does not apply to de minimis original issue discount (other than de minimis original issue discount treated as qualified stated interest) as determined under § 1.1273-1(d). See § 1.163-7 for the treatment of de minimis original issue discount by the issuer and §§ 1.1273-1(d) and 1.1272-3 for the treatment of de minimis original issue discount by the holder.
(b) Accrual of qualified stated interest. Qualified stated interest (as defined in § 1.1273-1(c)) accrues ratably over the accrual period (or periods) to which it is attributable and accrues at the stated rate for the period (or periods).
(c) Accrual of interest other than qualified stated interest. Subject to the modifications in paragraph (d) of this section, the amount of interest (other than qualified stated interest) that accrues for any accrual period is determined under rules similar to those in the regulations under sections 1272 and 1275 for the accrual of original issue discount. The preceding sentence applies regardless of any contrary formula agreed to by the parties.
(d) Modifications— (1) Issue price. The issue price of the loan or contract is equal to—
(i) In the case of a contract for the sale or exchange of property to which section 483 applies, the amount described in § 1.483-2(a)(1)(i) or (ii), whichever is applicable;
(ii) In the case of a contract for the sale or exchange of property to which section 483 does not apply, the stated principal amount; or
(iii) In any other case, the amount loaned.
(2) Principal payments that are not deferred payments. In the case of a contract to which section 483 applies, principal payments that are not deferred payments are ignored for purposes of determining yield and adjusted issue price.
(e) Allocation of interest to payments— (1) In general. Except as provided in paragraphs (e)(2), (e)(3), and (e)(4) of this section, each payment under a loan (other than payments of additional interest or similar charges provided with respect to amounts that are not paid when due) is treated as a payment of interest to the extent of the accrued and unpaid interest determined under paragraphs (b) and (c) of this section as of the date the payment becomes due.
(2) Special rule for points deductible under If a payment of points is deductible by the borrower under section 461(g)(2), the payment is treated by the borrower as a payment of interest.
(3) Allocation respected in certain small transactions. [Reserved]
(4) Pro rata prepayments. Accrued but unpaid interest is allocated to a pro rata prepayment under rules similar to those for allocating accrued but unpaid original issue discount to a pro rata prepayment under § 1.1275-2(f). For purposes of the preceding sentence, a pro rata prepayment is a payment that is made prior to maturity that—
(i) Is not made pursuant to the contract's payment schedule; and
(ii) Results in a substantially pro rata reduction of each payment remaining to be paid on the contract.
(f) Aggregation rule. For purposes of this section, all contracts calling for deferred payments arising from the same transaction (or a series of related transactions) are treated as a single contract. This rule, however, generally only applies to contracts involving a single borrower and a single lender.
(g) Debt instruments denominated in a currency other than the U.S. dollar. This section applies to a debt instrument that provides for all payments denominated in, or determined by reference to, the functional currency of the taxpayer or qualified business unit of the taxpayer (even if that currency is other than the U.S. dollar). See § 1.988-2(b) to determine interest income or expense for debt instruments that provide for payments denominated in, or determined by reference to, a nonfunctional currency.
(h) Example. The following example illustrates the rules of this section.

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Example. Allocation of unstated interest to deferred payments—(i) Facts. On July 1, 1996, A sells his personal residence to B for a stated purchase price of $1,297,143.66. The property is not personal use property (within the meaning of section 1275(b)(3)) in the hands of B. Under the loan agreement, B is required to make two installment payments of $648,571.83 each, the first due on June 30, 1998, and the second due on June 30, 2000. Both A and B use the cash receipts and disbursements method of accounting and use a calendar year for their taxable year. (ii) Amount of unstated interest. Under section 483, the agreement does not provide for adequate stated interest. Thus, the loan's yield is the test rate of interest determined under § 1.483-3 . Assume that both A and B use annual accrual periods and that the test rate of interest is 9.2 percent, compounded annually. Under § 1.483-2 , the present value of the deferred payments is $1,000,000. Thus, the agreement has unstated interest of $297,143.66. (iii) First two accrual periods. Under paragraph (d)(1) of this section, the issue price at the beginning of the first accrual period is $1,000,000 (the amount described in § 1.483-2(a)(1)(i) ). Under paragraph (c) of this section, the amount of interest that accrues for the first accrual period is $92,000 ($1,000,000×.092) and the amount of interest that accrues for the second accrual period is $100,464 ($1,092,000×.092). Thus, $192,464 of interest has accrued as of the end of the second accrual period. Under paragraph (e)(1) of this section, the $648,571.83 payment made on June 30, 1998, is treated first as a payment of interest to the extent of $192,464. The remainder of the payment ($456,107.83) is treated as a payment of principal. Both A and B take the payment of interest ($192,464) into account in 1998. (iv) Second two accrual periods. The adjusted issue price at the beginning of the third accrual period is $543,892.17 ($1,092,000 $100,464-$648,571.83). The amount of interest that accrues for the third accrual period is $50,038.08 ($543,892.17×.092) and the amount of interest that accrues for the final accrual period is $54,641.58, the excess of the amount payable at maturity ($648,571.83), over the adjusted issue price at the beginning of the accrual period ($593,930.25). As of the date the second payment becomes due, $104,679.66 of interest has accrued. Thus, of the $648,571.83 payment made on June 30, 2000, $104,679.66 is treated as interest and $543,892.17 is treated as principal. Both A and B take the payment of interest ($104,679.66) into account in 2000.
(i) [Reserved]
(j) Effective date. This section applies to debt instruments issued on or after April 4, 1994, and to lending transactions, sales, and exchanges that occur on or after April 4, 1994. Taxpayers, however, may rely on this section for debt instruments issued after December 21, 1992, and before April 4, 1994, and for lending transactions, sales, and exchanges that occur after December 21, 1992, and before April 4, 1994.

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[T.D. 8517, 59 FR 4804, Feb. 2, 1994]