James E. Redlark and Cheryl L. Redlark v. Commissioner

106 T.C. No. 2UNITED STATES TAX COURT
JAMES E. REDLARK AND CHERYL L. REDLARK, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4445-94. Filed January 11, 1996.
Ps deducted the amount of interest on the portion
of a deficiency in Federal income tax arising out of
adjustments caused by accounting errors of their
unincorporated business. They claimed that the
interest was properly allocable to business
indebtedness and therefore not personal interest under
sec. 163(h)(2)(A), I.R.C. R disallowed such deduction
on the ground that it was personal interest under sec.
1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs., 52
Fed. Reg. 48409 (Dec. 22, 1987), and limited Ps' total
interest deduction to the amounts allowed by sec.
163(h)(5), I.R.C. Held, sec. 1.163-9T(b)(2)(i)(A),
Temporary Income Tax Regs., is invalid insofar as it
applies under the circumstances involved herein. Held,
further, the amount of the interest so allocated by Ps
is deductible as interest on an "indebtedness properly
allocable to a trade or business" within the meaning of
sec. 163(h)(2)(A), I.R.C.
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Clare Golnick, for petitioners.
Paul L. Dixon, for respondent.
OPINION
TANNENWALD, Judge: Respondent determined deficiencies in
petitioners' 1989 and 1990 Federal income taxes in the amounts of
$46,409 and $6,927, respectively. The issue in dispute is
whether petitioners may deduct certain interest on Federal income
tax deficiencies, paid by petitioners in 1989 and 1990, where the
deficiencies arose in part due to a correction for errors made in
computing petitioners' income from their business.
All the facts have been stipulated. The stipulation of
facts and attached exhibits are incorporated herein by this
reference.
Background
At the time the petition was filed, petitioner James E.
Redlark was a resident of Palm Springs, California, and
petitioner Cheryl L. Redlark was a resident of South Lake Tahoe,
California.
Respondent examined petitioners' Federal income tax returns
for 1979, 1980, 1981, 1982, 1983, 1984, and 1985, following which
respondent and petitioners agreed to adjustments to petitioners'
income for each of the years.
The adjustments were due in part to a correction for errors
made in converting petitioners' revenue from Carrier
Communications, petitioners' unincorporated business, from an
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accrual basis to cash basis for tax purposes. The adjustments
involved the timing of the reporting of business income.
In 1989 and 1990, petitioners paid interest on the Federal
income tax deficiencies for the 1982, 1984, and 1985 years.
On Schedule C of their 1989 and 1990 Federal income tax
returns, petitioners claimed an allocable portion of such
interest as a business expense.
Respondent disallowed a business deduction for the interest
but did allow 20 percent of the interest paid in 1989 and 10
percent of the interest paid in 1990 as a deduction under the
phase-in provisions of section 163(h)(5).1
Petitioners assert that the amount of the interest expense
which they have calculated as being attributable to Carrier
Communications is an ordinary and necessary expense of a trade or
business under section 162, deductible in computing adjusted
gross income under section 62(a), and is therefore not personal
interest under section 163(h).
Respondent argues that petitioners are not entitled to a
deduction because, under section 1.163-9T(b)(2)(I)(A), Temporary
Income Tax Regs., 52 Fed. Reg. 48409 (Dec. 22, 1987), interest on
a Federal individual income tax deficiency is nondeductible
personal interest under section 163(h).
Petitioners reply that section 1.163-9T(b)(2)(I)(A),
Unless otherwise indicated, all section references are to the
Internal Revenue Code in effect for the years in issue, and all
Rule references are to the Tax Court Rules of Practice and
Procedure.
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Temporary Income Tax Regs., is invalid insofar as it disallows a
deduction for interest on a deficiency that is an ordinary and
necessary expense of a trade or business.
Section 62(a) provides in part:
(a) General Rule.--For purposes of this subtitle,
the term "adjusted gross income" means, in the case of
an individual, gross income minus the following
deductions:
(1) Trade and business deductions.--The
deductions allowed by this chapter (other than by
part VII of this subchapter) which are
attributable to a trade or business carried on by
the taxpayer, if such trade or business does not
consist of the performance of services by the
taxpayer as an employee.
Section 162(a) provides in part:
There shall be allowed as a deduction all the ordinary
and necessary expenses paid or incurred during the
taxable year in carrying on any trade or business * * *
Section 163(h) provides in part:
(h) Disallowance of Deduction for Personal Interest.--
(1) In General.--In the case of a taxpayer other
than a corporation, no deduction shall be allowed under
this chapter for personal interest paid or accrued
during the taxable year.
(2) Personal Interest.-- For purposes of this
subsection, the term "personal interest" means any
interest allowable as a deduction under this chapter
other than--
(A) interest paid or accrued on indebtedness
properly allocable to a trade or business (other
than the trade or business of performing services
as an employee),
Before proceeding to a determination of the effect of
pertinent regulations, we must first consider whether the
interest expense involved herein is sufficiently connected to the
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business of Carrier Communications so as to satisfy the "properly
allocable to a trade or business" exception of section
163(h)(2)(A), without regard to the regulations.
Initially, we note that respondent does not question
petitioners' calculation of the amounts of the total interest
payments that are allocable to those portions of the income tax
deficiencies based on adjustments to the income from Carrier
Communications. Moreover, respondent has stipulated that those
adjustments reflected the correction of errors made in converting
the revenue of Carrier Communications giving rise to such income
from the accrual to the cash basis, i.e., the timing of reporting
such income. In this context, petitioners have satisfied some of
the conditions that have thus far enabled us to avoid a decision
as to the impact of section 163(h)(2)(A) and the temporary
regulation thereunder. Tippin v. Commissioner, 104 T.C. 518, 529
(1995) (taxpayer failed to show any relationship between the
interest expense and any business); Crouch v. Commissioner, T.C.
Memo. 1995-289 (record failed to support taxpayer's allocation);
Rose v. Commissioner, T.C. Memo. 1995-75 (investment interest).2
The question remains, however, whether the elements giving rise
In Tippin v. Commissioner, 104 T.C. 518, 529 n.9 (1995), we
specifically stated that we were not deciding the issue, a view
we also articulated in Rose v. Commissioner, T.C. Memo. 1995-75.
The issue was apparently also involved but not reached in True v.
United States, 93-2 USTC par. 50,461, 72 AFTR2d 93-5660 (D. Wyo.
1993), affd. per curiam without published opinion 35 F.3d 574(10th Cir. 1994), because the District Court, in holding for the
Government, ruled that the interest on Federal income tax
deficiencies was attributable to the business of partnerships or
subchapter S corporations of which the taxpayers were partners or
shareholders and not to their businesses as individuals.
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to the deficiencies to which the interest herein relates are of
such a nature as to permit such interest to constitute a business
expense within the meaning of section 162(a), and therefore of
section 62(a), and, as a result, to be characterized as interest
"on indebtedness properly allocable to a trade or business"
within the meaning of section 163(h)(2)(A)3 in the event that the
temporary regulation is not applicable. We think a review of the
cases decided prior to the enactment of section 163(h)(2)(A), in
respect of the deductibility of interest on income tax
deficiencies as a business expense, will throw light on this
question and is therefore a significant element in our analysis
of the impact of that section on petitioners' claimed interest
deduction. It is to that review that we first turn our
attention.
In Standing v. Commissioner, 28 T.C. 789 (1957), affd. 259
Sec. 163(h)(2)(A) was amended by sec. 1005(c)(4) of the
Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100-647,
102 Stat. 3342, 3390.
Sec. 163(h)(2)(A), as originally enacted in 1986, provided:
(A) interest paid or accrued on indebtedness
incurred or continued in connection with the conduct of
a trade or business (other than the trade or business
of performing services as an employee), [Tax Reform Act
of 1986, Pub. L. 99-514, sec. 511(b), 100 Stat. 2085,
2246.]
The amended language, effective for the years in issue, was
intended to conform the definition of personal interest to the
language of the related passive loss and investment interest
limitation provisions, to permit consistent application of a
standard for allocation of interest. See S. Rept. 100-445, at 36
(1988); H. Rept. 100-795, at 35 (1988). There is no indication
that the change in language was intended to make any substantive
change in the meaning of the statutory language.
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F.2d 450 (4th Cir. 1958), we faced the question of whether
interest on a deficiency in Federal income tax resulting in part
from improper reporting of income from a sole proprietorship on
the cash basis instead of the accrual basis, along with related
attorney's and accountant's fees, was deductible as a business
expense. The taxpayers took a deduction under section 22(n)(1)
of the Internal Revenue Code of 1939, the predecessor of section
62(a), in order to arrive at adjusted gross income. While our
analysis was focused on the deductibility of attorney's fees, we
held that the deficiency was based on adjustments "attributable
to the business of the sole proprietorship" and allowed the
deduction for deficiency interest as an ordinary and necessary
business expense. Our reasoning was adopted by the Court of
Appeals.
In Polk v. Commissioner, 31 T.C. 412 (1958), affd. 276 F.2d
601 (10th Cir. 1960), we had to decide whether interest on a
deficiency, arising out of inventory valuation corrections, was a
deductible business expense for purposes of calculating a net
operating loss carryover. Finding that the deficiency arose in
connection with the taxpayer's business, the Court determined
that the case was controlled by Standing v. Commissioner, supra,
and held that the interest was deductible as an ordinary and
necessary business expense and was to be taken into account in
determining the net operating loss carryover. Again, our
reasoning was adopted by the Court of Appeals.
In Reise v. Commissioner, 35 T.C. 571 (1961), affd. 299 F.2d
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380 (7th Cir. 1962), we again had to decide whether certain
expenses, including interest on a Federal income tax deficiency,
stemming from the reporting of sales on a cash basis instead of
an accrual basis, were deductible as business expenses in
computing a net operating loss carryback. Recognizing that prior
to Standing v. Commissioner, supra, and Polk v. Commissioner,
supra, we had denied taxpayers a deduction for deficiency
interest in Aaron v. Commissioner, 22 T.C. 1370 (1954), we
concluded that, in Standing and Polk, we had departed from the
restrictive view of the phrase "attributable to trade or business
carried on by the taxpayer" utilized in Aaron4 and that Aaron
should no longer be followed where net operating losses were
concerned. Reise v. Commissioner, supra at 579. We reaffirmed
the reasoning of Standing and Polk and, finding the factual
situation indistinguishable from those cases, held the deficiency
interest deductible as a business expense in determining the
amount of a net operating loss carryover. Again, our reasoning
was adopted by the Court of Appeals.
To complete our analysis of the pre-section 163(h)
situation, we note that because of explicit legislative history
The standard adopted by Aaron v. Commissioner, 22 T.C. 1370(1954), imported the statement in the legislative history of sec.
22(n)(1) of the Internal Revenue Code of 1939 (the predecessor of
sec. 62(a)(1)) to the effect that expenses deductible under that
section were those "directly incurred in the carrying on of a
trade or business" and that "the connection contemplated by the
statute is a direct one rather than a remote one", giving State
income taxes as an example of a nondeductible expense. Reise v.
Commissioner, 35 T.C. 571, 577 (1961), affd. 299 F.2d 380 (7th
Cir. 1962).
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the deduction of State income taxes on business income, in
computing adjusted gross income under predecessors of section
62(a)(1), has been denied, in contrast to its allowance where net
operating losses were involved and the allowance of a deduction
for interest on Federal income tax deficiencies under
predecessors of section 62(a)(1). Tanner v. Commissioner, 45
T.C. 145 (1965), affd. per curiam 363 F.2d 36 (4th Cir. 1966).5
This treatment has been accepted by respondent insofar as the net
operating loss provisions are concerned but not with respect to
interest on deficiencies as a business expense under sections 162
and 62. See Rev. Rul. 70-40, 1970-1 C.B. 50.
Respondent argues that Polk v. Commissioner, supra, compels
the conclusion that, as a general rule, deficiency interest is
not a business expense, and that the cases recognizing a
deduction are unfounded and wrong. Respondent's argument rests
on the following statement of the Court of Appeals for the Tenth
Circuit:
Unless it can be said that the failure to properly
evaluate inventories, which form a part of a taxpayer's
return, arises because of the nature of the business,
and is ordinarily and necessarily to be expected,
interest on a deficiency assessment does not arise out
of the ordinary operation of the business and may not
be deducted. [Polk v. Commissioner, 276 F.2d at 603;
fn. ref. omitted.]
This statement is rooted in the requirement that deficiency
In Maxcy v. Commissioner, 26 T.C. 526 (1956), and Estate of
Broadhead v. Commissioner, T.C. Memo. 1966-26, affd. 391 F.2d 841(5th Cir. 1968), we sustained the disallowance of the deduction
for State income taxes on the ground of failure of proof as to
the requisite business connection.
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interest must be attributable to a trade or business to be
deductible, which we found to be the case in Polk v.
Commissioner, supra. Clearly, this statement does not support a
per se denial of the deduction of deficiency interest in view of
the fact that the Court of Appeals affirmed our decision that
such interest was an ordinary and necessary expense for net
operating loss purposes. It may be that the above-quoted
language narrows the types of situations where the ordinary and
necessary business expense requirement of section 162 has been
satisfied. Indeed, we are satisfied that, given the source of
the income tax adjustments herein, i.e., accounting errors in
applying cash and accrual methods, petitioners have satisfied any
such narrow standard. Reise v. Commissioner, supra (cash versus
accrual changes); cf. Polk v. Commissioner, supra (involving
inventory valuations). We reject respondent's attack to the
extent that it goes beyond the above quotation from Polk and is
directed against the pre-section 163(h) decided cases generally.
Concededly there is some confusion in the reasoning of the
decided cases, but the thrust of their bottomline conclusions is
clear. Exceptions will be accorded to the ordinary and necessary
provision of section 162 only when there is explicit legislative
indication that such a result was intended. Thus, we agree with
petitioners that there is a consistent body of pre-section 163(h)
case law holding that, at least under limited circumstances such
as were involved in Standing v. Commissioner, supra, Polk v.
Commissioner, supra, and Reise v. Commissioner, supra, deficiency
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interest is a deductible business expense under section 162 and
therefore under section 62(a)(1). See Brennan & Megaard,
"Deducting Interest on Noncorporate Trade or Business Tax
Deficiencies: Uncertainty Exists Under the New Temporary
Regulations," 13 Rev. of Taxation of Individuals 22 (1989).
With the foregoing as background, we address the critical
issue before us, namely, the effect of section 163(h)(2)(A) and
section 1.163-8T, Temporary Income Tax Regs., 52 Fed. Reg. 24999(July 2, 1987), and section 1.163-9T(b)(2)(I)(A), Temporary
Income Tax Regs., which specifically denies the deduction herein
claimed. This case is one of first impression in this Court on
this issue. See supra pp. 5-6. We note, however, that the Court
of Appeals for the Eighth Circuit in Miller v. United States, 65
F.3d 687 (1995), although agreeing without conclusion as to the
pre-section 163(h) state of the law, has accepted respondent's
position and held the temporary regulation a reasonable
interpretation of the statute and therefore valid.6
The judicial history of Miller v. United States, 65 F.3d 687(8th Cir. 1995), affg. 95-1 USTC par. 50,068, 76 AFTR2d 95-5162
(D.N.D. 1994), revg. 841 F. Supp. 305 (D.N.D. 1993), shows that
the District Court initially entered an order, on cross motions
for summary judgment, holding that sec. 1.163-9T(b)(2)(I)(A),
Temporary Income Tax Regs., 52 Fed. Reg. 48409 (Dec. 22, 1987),
was invalid. Miller v. United States, 841 F. Supp. 305 (D.N.D.
1993). After further discovery, the District Court entered a
decision for the Government on the ground that the deficiency
interest could not be found to constitute an ordinary and
necessary business expense. Miller v. United States, 95-1 USTC
par. 50,068, 76 AFTR2d 95-5162 (D.N.D. 1994). The court found
the taxpayer "chose to operate what is an obviously improper
income deferral scheme in order to defer the reporting of
substantial amounts of money as taxable income." Id. 95-1 USTC
at 87,232, 76 AFTR2d at 95-5166. The Court of Appeals for the
(continued...)
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Initially, we note that temporary regulations are accorded
the same weight as final regulations. Peterson Marital Trust v.
Commissioner, 102 T.C. 790, 797 (1994). The regulations involved
herein were promulgated pursuant to the general authority granted
to the Secretary of the Treasury by section 7805(a) and not
pursuant to specific legislative authority, T.D. 8168, 1988-1
C.B. 80, 83; they are therefore interpretative. An
interpretative regulation is owed "'less deference than a
regulation issued under a specific grant of authority to define a
statutory term or prescribe a method of executing a statutory
provision.'" United States v. Vogel Fertilizer Co., 455 U.S. 16,
24 (1982) (quoting Rowan Cos. v. United States, 452 U.S. 247, 253
(1981)). An interpretative regulation will be upheld if it is
found to "'implement the congressional mandate in some reasonable
manner'". United States v. Vogel Fertilizer Co., 455 U.S. at 24(quoting United States v. Correl., 389 U.S. 299, 307 (1967)).
Recently, the Supreme Court summarized the standard of
review as follows:
Under the formulation now familiar, when we confront an
expert administrator's statutory exposition, we inquire
first whether "the intent of Congress is clear" as to
"the precise question at issue." Chevron U.S.A. Inc. v.
Natural Resources Defense Council, Inc., 467 U.S. 837,
842 (1984). If so, "that is the end of the matter."
(...continued)
Eighth Circuit then held that, contrary to the conclusion of the
District Court, the regulation was valid, and as such,
dispositive of the taxpayers' claimed interest deduction. Miller
v. United States, 65 F.3d 687 (8th Cir. 1995). Because the
District Court's ultimate conclusion was that the interest at
issue was nondeductible personal interest, the Court of Appeals
affirmed.
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Ibid. But "if the statute is silent or ambiguous with
respect to the specific issue, the question for the
court is whether the agency's answer is based on a
permissible construction of the statute." Id., at 843.
If the administrator's reading fills a gap or defines a
term in a way that is reasonable in light of the
legislature's revealed design, we give the
administrator's judgment "controlling weight." Id., at
844. [NationsBank v. Variable Annuity Life Ins. Co.,
513 U.S. , , 115 S.Ct. 810, 813-814 (1995);
citations omitted.]
Section 163(h)(2)(A) was added to the Internal Revenue Code
by the Tax Reform Act of 1986, Pub. L. 99-514, sec. 511(b), 100
Stat. 2085, 2246. The key phrase that governs the disposition of
this case involves the exception from personal interest of
"interest paid or accrued on indebtedness properly allocable to a
trade or business". We have previously noted that the original
version of this provision was different but that the language
change was not intended to make any substantive change. See
supra note 3. Arguably, this language in and of itself is
sufficient to enable petitioners to prevail, since such interest
on Federal income tax deficiencies was considered, at least in
situations such as that involved herein, as an ordinary and
necessary business expense under predecessors of section 162 and
therefore of section 62(a)(1) by the pre-section 163(h) cases, a
view also adopted with respect to net operating loss carryovers
and carrybacks. Reise v. Commissioner, supra; Polk v.
Commissioner, supra; Standing v. Commissioner, supra. We note,
however, that, in a comparable situation dealing with the
deduction of State income taxes in computing adjusted gross
income, we found sufficient ambiguity to cause us to look at the
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legislative history and approve a regulation denying such a
deduction. See Tanner v. Commissioner, 45 T.C. at 148-149, 151.
Against the foregoing background, we consider the regulatory
framework and legislative history that relate to the
deductibility of interest on income tax deficiencies. Section
1.163-9T(b)(1)(I), Temporary Income Tax Regs., 52 Fed. Reg. 48409(Dec. 22, 1987), specifically references section 1.163-8T,
Temporary Income Tax Regs., by providing that interest is not
personal interest if it is "paid or accrued on indebtedness
properly allocable (within the meaning of § 1.163-8T) to the
conduct of a trade or business". Additionally, paragraph (b)(3)
of section 1.163-9T, Temporary Income Tax Regs., 52 Fed. Reg.
48410, further references section 1.163-8T, Temporary Income Tax
Regs., "for rules for determining the allocation of interest
expense to various activities". Such being the case, we deal
first with the impact of section 1.163-8T, Temporary Income Tax
Regs., noting that respondent makes only a passing reference to
the regulation without advancing any argument as to its
application to this case, and that petitioners completely ignore
it.
Section 1.163-8T, Temporary Income Tax Regs., establishes an
allocation method based on the expenditure, i.e., the use, of the
debt proceeds. It provides in paragraph (c)(1):
(c) Allocation of debt and interest expense--(1)
Allocation in accordance with use of proceeds. Debt is
allocated to expenditures in accordance with the use of
the debt proceeds and, * * *. * * * debt proceeds and
related interest expense are allocated solely by
reference to the use of such proceeds, and the
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allocation is not affected by the use of an interest in
any property to secure the repayment of such debt or
interest. * * * [52 Fed. Reg. 25000 (July 2, 1987).]
On this basis, it can be argued that the proceeds of an
individual's income tax indebtedness cannot be considered as
expended in a trade or business. From this it would follow that
section 1.163-9T(b)(2)(I)(A), Temporary Income Tax Regs., which
treats interest on income tax deficiencies as personal interest
(see infra p. 19), simply represents a specific example of the
application of the expenditure method of allocation of
indebtedness set forth in section 1.163-8T, Temporary Income Tax
Regs., and is therefore valid.
The question to be resolved is whether section 7805(a)
provides a sufficient basis to justify the application of the
expenditure method of allocation set forth in section 1.163-
8T(c), Temporary Income Tax Regs., to the factual situation
involved herein. Whatever the merits of such method of
allocation may be in other contexts, we do not think that the
Secretary of the Treasury should be entitled to use the authority
conferred by section 7805(a) to construct a formula which
excludes an entire category of interest expense in disregard of a
business connection such as exists herein. Such a result
discriminates against the individual who operates his or her
business as a proprietorship instead of in corporate form where
the limitations on the deduction of "personal interest" would not
apply. See Brennan & Megaard, supra at 33. We are not persuaded
that we should view the category of income tax deficiencies as
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simply an incidental example, which unfortunately falls within
the broad spectrum of indebtedness to which the application of
the expenditure method of allocation would be appropriately
applied, a situation which, in and of itself, might not be
sufficient to invalidate the regulation. See Associated
Telephone & Telegraph Co. v. United States, 306 F.2d 824, 833 (2d
Cir. 1962); Brunswick Corp. v. Commissioner, 100 T.C. 6, 16
(1993).
Nor do we think that the reasonableness of the expenditure
method of allocation, as applied to the facts herein, can be
supported by the fact that the Secretary chose the expenditure
method after considering a pro rata apportionment method of
allocation that might have produced a different result in respect
of interest on business-related income tax deficiencies but which
the Secretary viewed as involving "practical and theoretical
problems", at the same time conceding that such problems would
not necessarily preclude the adoption of a pro rata apportionment
method in the future. T.D. 8145, 1987-2 C.B. 47, 50. The fact
of the matter is that any method of allocation would present
similar problems in its application (sections 1.163-8T and 1.163-
9T, Temporary Income Tax Regs., are themselves stark testimony as
to the validity of this observation), but this factor should not,
in and of itself, justify the selection of a method, at least to
the extent that its application produces an unreasonable result.
Moreover, we are not convinced that the reach of section
1.163-8T, Temporary Income Tax Regs., necessarily provides a
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sufficient basis for validating, under all circumstances, the
specific provision of section 1.163-9T, Temporary Income Tax
Regs. Thus, section 1.163-8T(b)(5), Temporary Income Tax Regs.,
52 Fed. Reg. 25000 (July 2, 1987), defines personal expenditure
to mean "an expenditure that is not a business expenditure" and
section 1.163-8T(c)(3)(ii), Temporary Income Tax Regs., 52 Fed.
Reg. 25001 (July 2, 1987), provides:
(ii) Debt assumptions not involving cash
disbursements. If a taxpayer incurs or assumes a debt
in consideration for the sale or use of property, for
services, or for any other purpose, or takes property
subject to a debt, and no debt proceeds are disbursed
to the taxpayer, the debt is treated for purposes of
this section as if the taxpayer used an amount of the
debt proceeds equal to the balance of the debt
outstanding at such time to make an expenditure for
such property, services, or other purpose.
Under this provision, it would appear permissible to analyze
the elements of the income tax indebtedness to determine whether
its imputed expenditure is properly allocable to business
activity. Indeed, such an interpretation would be consistent
with the overall legislative purpose in enacting section 163(h),
namely to end the deduction for interest incurred to fund
consumption expenditures. S. Rept. 99-313 at 804 (1985), 1986-3
C.B. (Vol. 3) 804; H. Conf. Rept. 99-841 at II-154 (1986), 1986-3
C.B. (Vol. 4) 154. To conclude that an income tax deficiency is
ipso facto a consumption expenditure begs the issue. Thus, aside
from our conclusion that the regulatory provisions contained in
section 1.163-8T, Temporary Income Tax Regs., are unreasonable as
applied to the facts herein, it is possible to conclude that the
provisions are sufficiently elliptical so that the validity of
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section 1.163-9T, Temporary Income Tax Regs., can, in any event,
be appropriately independently determined. Accordingly, we turn
our attention to that task.
Section 1.163-9T(b)(2)(I)(A), Temporary Income Tax Regs.,
provides:
(2) Interest relating to taxes--(I) In general.
Except as provided in paragraph (b)(2)(iii) of this
section, personal interest includes interest--
(A) Paid on underpayment of individual Federal,
State or local income taxes * * * regardless of the
source of the income generating the tax liability;
The only legislative history of section 163(h) which
directly addresses the issue involved herein is the conference
committee report which states:
Under the conference agreement, personal interest
is not deductible. Personal interest is any interest,
other than interest incurred or continued in connection
with the conduct of a trade or business (other than the
trade or business of performing services as a[n]
employee), investment interest, or interest taken into
account in computing the taxpayer's income or loss from
passive activities for the year. Personal interest
also generally includes interest on tax deficiencies.
[H. Conf. Rept. 99-841 at II-154 (1986), 1986-3 C.B.
(Vol. 4) 1, 154.]
The General Explanation of the Tax Reform Act of 1986,
elaborates on this statement by providing as follows:
Personal interest also includes interest on
underpayment of individual Federal, State or local
income taxes notwithstanding that all or a portion of
the income may have arisen in a trade or business,
because such taxes are not considered derived from the
conduct of a trade or business.60 * * *
_______
60
Personal interest does not include interest on
taxes, other than income taxes, that are incurred in
connection with a trade or business. (For the rule
that taxes on net income are not attributable to a
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trade or business, see Treas. Reg. sec. 1.62-1(d),
relating to nondeductibility of State income taxes in
computing adjusted gross income.) * * * [Staff of
Joint Comm. on Taxation, General Explanation of the Tax
Reform Act of 1986, at 266 (J. Comm. Print 1987).]
Were it not for the foregoing, we would have been inclined
to conclude that the provisions of section 163(h)(2)(A) standing
alone would not have provided a sufficient basis for upholding
the regulation. We so state because we have consistently been
reluctant to conclude that Congress overruled existing case law
when the statutory language does not compel such a conclusion and
Congress has not otherwise expressly indicated that such a result
should ensue. See Santa Anita Consolidated, Inc. v.
Commissioner, 50 T.C. 536, 560 n.13 (1968); cf. Stephenson Trust
v. Commissioner, 81 T.C. 283, 298-299 (1983); see also Reise v.
Commissioner, 35 T.C. at 578. Compare Marquis v. Commissioner,
49 T.C. 695, 699 (1968), discussing the situation where, after
Congress imposed a specific limitation on the amount of
deductible charitable contributions, Congress made clear, by
statutory provision, that such limitation applied as well to the
nondeductibility of charitable contributions as ordinary and
necessary business expenses under section 23(a)(2) of the
Internal Revenue Code of 1939. Our reluctance is reinforced by
the fact that the conference committee report makes it clear, at
the outset, that personal interest does not include "interest
incurred or continued in connection with a trade or business".
H. Conf. Rept. 99-841, supra at II-154, 1986-3 C.B. (Vol. 4) at
154; see also S. Rept. 99-313 at 804-806 (1986), 1986-3 C.B.
- 20 -
(Vol. 3) 1, 804-806. This provides a broad context in which to
evaluate the impact of the exception for interest on an
indebtedness allocable to the business. Id.
We first address the language of the conference committee
report. Respondent argues that the word "generally" was intended
only to permit deduction of interest on past-due business taxes,
such as sales and excise taxes which the regulations specifically
exclude from the definition of personal interest. See sec.
1.163-9T(b)(2)(iii)(A), Temporary Income Tax Regs., 52 Fed. Reg.
48409 (Dec. 22, 1987). On this basis, respondent concludes that
section 1.163-9T(b)(2)(I)(A), Temporary Income Tax Regs., is
reasonable and that additional proof of reasonableness is
provided by the statement in the Joint Committee Staff
Explanation. See supra p. 19. This approach is also articulated
by the Court of Appeals for the Eighth Circuit in Miller v.
United States, 65 F.3d 687 (8th Cir. 1995), holding the temporary
regulation valid.
We think both respondent and the Court of Appeals for the
Eighth Circuit overlook the use of the word "deficiencies" in the
sentence in the conference committee report. That word has had a
long-established and well-known meaning. It has been described
as a "term of art". Bregin v. Commissioner, 74 T.C. 1097, 1101-
1102 (1980), which describes "deficiency" as a term of art
represented by statutory definition as "the amount by which the
income, gift, or estate tax due under the law exceeds the amount
of such tax shown on the return"; see also Estate of Mueller v.
- 21 -
Commissioner, 101 T.C. 551, 568 (1993) (Chabot, J., dissenting).
Moreover, in cases too numerous to cite, the word "deficiency"
has been treated as embodying such a definition and has
consequently acquired a fixed and settled meaning. Such being
the case, we have every reason to assume that the conference
committee used the word in that sense. See United States v.
Merriam, 263 U.S. 179, 187 (1923); Norfolk S. Corp. v.
Commissioner, 104 T.C. 13, 37 (1995), supplemented by 104 T.C.
417 (1995); cf. St. Paul Fire & Marine Ins. Co. v. Barry, 438
U.S. 531, 541 (1978) ("Congress thus employed terminology that
evokes a tradition of meaning").
In short, we think that when the conference committee used
the phrase "tax deficiencies", it was referring to amounts due by
way of income, estate, and gift taxes. In this context, the word
"generally" in the conference committee report takes on a
significant meaning. It signals that not all interest relating
to income tax, etc., deficiencies are included in "personal
interest". The logical explanation for what is excluded by
"generally" is such interest that constitutes an ordinary and
necessary business expense and is therefore "allocable to an
indebtedness of a trade or business" within the meaning of the
exception clause of section 163(h)(2)(A). To adopt respondent's
position would require us to substitute the word "always" for
"generally" and to expand the interpretation of the word
"deficiencies" beyond its accepted meaning to encompass taxes
other than income, etc., taxes in order to account for the use of
- 22 -
the word "generally". By way of contrast, our interpretation
accepts the established meaning of "deficiencies" and gives
effect to "generally" without modification. Nor do we think our
view is negated by the rationale advanced by both respondent and
the Court of Appeals for the Eighth Circuit that, in the case of
an individual, income tax, etc., the payment of deficiencies and
therefore of the interest thereon is always a "personal
obligation". That is equally true of the obligation to pay
interest on sales and excise taxes imposed upon a business
conducted as a sole proprietorship--interest that is excluded by
regulation. Sec. 1.163-9T(b)(2)(iii)(A), Temporary Income Tax
Regs.
Nor can respondent's position be salvaged by the Joint
Committee Staff Explanation. Such a document is not part of the
legislative history although it is entitled to respect. E.g.,
Condor International, Inc. v. Commissioner, 98 T.C. 203, 227
(1992); see also Estate of Hutchinson v. Commissioner, 765 F.2d
665, 669-670 (7th Cir. 1985), affg. T.C. Memo. 1984-55;
Livingston, "What's Blue and White and Not Quite as Good as a
Committee Report: General Explanations and the Role of
'Subsequent' Tax Legislative History," 11 Amer. J. Tax Policy 91
(1994). Where there is no corroboration in the actual
legislative history, we shall not hesitate to disregard the
General Explanation as far as congressional intent is concerned.7
In this connection, we also note that the Tax Reform Act of
1986, Pub. L. 99-514, 100 Stat. 2085, was enacted on Oct. 22,
(continued...)
- 23 -
See Estate of Wallace v. Commissioner, 965 F.2d 1038, 1050-1051
n.15 (11th Cir. 1992), affg. 95 T.C. 525 (1990); Zinniel v.
Commissioner, 89 T.C. 357, 367 (1987), affd. 883 F.2d 1350 (7th
Cir. 1989);8 see also Livingston, supra at 93 ("The Blue Book is
on especially weak ground when it adopts anti-taxpayer positions
not taken in the committee reports."). Given the clear thrust of
the conference committee report, the General Explanation is
without foundation and must fall by the wayside. To conclude
otherwise would elevate it to a status and accord it a deference
to which it is simply not entitled.
Respondent further argues that Congress has failed to
express dissatisfaction with the regulation in subsequent
legislative actions in 1988 and 1990. According to National
Muffler Dealers Association v. United States, 440 U.S. 472, 477
(1979), this is one element to consider in determining the
reasonableness of a regulation. However, we do not believe the
legislative action discussed by respondent is the type
contemplated by the Supreme Court. The first action is the
enactment of the amendment to section 163(h)(2)(A) on
November 10, 1988, which was less than a year after the issuance
of the regulation on December 22, 1987, and which, as we have
(...continued)
1986, during the 99th Congress, whereas the General Explanation
was published on May 4, 1987, during the 100th Congress. Thus,
the General Explanation is not even entitled to the respect it
might otherwise be accorded if it had been prepared for the
Congress which enacted sec. 163(h).
See also Lawson v. Commissioner, T.C. Memo. 1994-286, at n.8.
- 24 -
previously pointed out, see supra note 3, made no substantive
change. Besides the implication from the fact that the
regulation was only temporary, 11 months is a relatively short
period of time for considering its impact.
The second action is a 1990 proposal of the Senate Finance
Committee to amend section 163, by eliminating the deduction for
corporate taxpayers of interest on income tax deficiencies. In
explaining the proposed change of law, the Committee states:
Individuals are not permitted to deduct personal
interest. For this purpose, personal interest includes
interest on underpayment of the individual's income taxes,
even if all or a portion of the individual's income is
attributable to a trade or business. [136 Cong. Rec. S15711
(Oct. 18, 1990).]
First, this statement is not reliable evidence of
Congressional approval considering that it is only a proposal
entered into the Senate record, and that the provision was not
approved by Congress, nor is there any indication that the House
of Representatives even reviewed the proposal. Furthermore, the
proposed amendment contains an express restriction on the
deductibility of deficiency interest, which shows that Congress
knew how to restrict the deductibility of interest if it so
intended.
One final comment. Suppose that the only income reported on
the return of petitioners had been Schedule C income from Carrier
Communications and that the entire deficiency related to the type
of errors that the courts have previously concluded were expected
to occur in the ordinary course of business. E.g., Polk v.
Commissioner, supra. It would constitute an unrealistic
- 25 -
application of our tax laws to conclude that the interest on such
deficiency is not attributable to an indebtedness properly
allocable to a trade or business under section 163(h)(2)(A), in
the absence of clear legislative intent that such a result is
required. Yet, such is the inescapable consequence of adopting
respondent's position.
In light of the foregoing, and with all due respect to the
Court of Appeals for the Eighth Circuit, we hold that, as applied
to the circumstances involved herein, section 1.163-
9T(b)(2)(I)(A), Temporary Income Tax Regs., constitutes an
impermissible reading of the statute and is therefore
unreasonable. Accordingly, we further hold that the interest
involved herein is interest "on indebtedness properly allocable
to a trade or business" and therefore excluded from personal
interest under section 163(h)(2). In so holding, we emphasize
that there will be situations where a Federal income tax
deficiency will not be as narrowly focused as is the case herein
and therefore interest paid on the deficiency may not be said to
constitute an ordinary and necessary business expense allocable
within the meaning of section 163(h)(2)(A). Indeed, the
situation in Miller v. United States, 95-1 USTC par 50,068, 76
AFTR2d 95-5162 (D.N.D. 1994), affd. 65 F.3d 687 (8th Cir. 1995),
which the District Court described as "an obviously improper
income deferral scheme", see supra note 6, can be said to fall
within the latter category.
- 26 -
In order to take into account mathematical corrections
encompassed by the stipulation of the parties,
Decision will be entered
under Rule 155.
Reviewed by the Court.
SWIFT, JACOBS, WRIGHT, PARR, WELLS, CHIECHI, and VASQUEZ,
JJ., agree with this majority opinion.
FOLEY, J., concurs in the result only.
- 27 -
SWIFT, J., concurring: Two significant facts are clear and
undisputed in this case: (1) Under the express language of
section 163(h)(2)(A), if an interest expense is properly
allocable to a trade or business, then under that statute the
interest expense is deductible; and (2) the interest expense at
issue herein arose from, in connection with, and is allocable to,
petitioners’ business. Accordingly, the interest expense should
be deductible.
Under respondent’s regulation and position herein,
petitioners’ interest expense is not deductible “regardless” of
the fact that it was clearly incurred by petitioners in
connection with, and that it is undisputably allocable to,
petitioners’ business. Respectfully, respondent’s regulation and
position herein should be rejected as an erroneous attempt to
redefine the substantive provision of section 163(h)(2)(A).
I reiterate and emphasize that the statute speaks for
itself. Thereunder, at the least, if an interest expense clearly
relates to and is allocable to a taxpayer’s business, it is
deductible. Respondent’s regulation may provide reasonable
methods for allocating interest between a taxpayer’s business and
personal activities. But if there is no question as to what an
item of interest expense relates to, and is allocable to, then
the statute is clear and, if the expense relates to the
taxpayers’ business, the statute allows the deduction. Because
section 1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs., 52 Fed.
Reg. 48409 (Dec. 22, 1987), in the context of a sole
- 28 -
proprietorship, provides that regardless of that fact, an
interest expense is not deductible, respondent’s regulation
should be considered invalid.
The statute mandates an allocation and allows a deduction
for interest expense related to a taxpayer’s business.
Respondent’s regulation, in the situation of a sole proprietor,
would leave nothing to be allocated.
Further, respondent’s position herein and her regulation
under section 1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs.,
52 Fed. Reg. 48409 (Dec. 22, 1987), is inconsistent with the
specific allocation rule provided under section
1.163-8T(c)(3)(ii), Temporary Income Tax Regs., 52 Fed. Reg.
25001 (July 2, 1987), with regard to the frequent situations
where no loan proceeds are involved in the underlying transaction
or activity (namely, where the seller or provider of goods or
services provides the financing to the taxpayer or where the
transaction involves interest expenses associated with the mere
extension of credit, not the provision of funds). Section 1.163-
8T(c)(3)(ii), Temporary Income Tax Regs., provides as follows:
If a taxpayer incurs or assumes a debt in consideration
for the sale or use of property, for services, or for
any other purpose, or takes property subject to a debt,
and no debt proceeds are disbursed to the taxpayer, the
debt is treated for purposes of this section as if the
taxpayer used an amount of the debt proceeds equal to
the balance of the debt outstanding at such time to
make an expenditure for such property, services, or
other purpose. [Emphasis added.]
- 29 -
The above regulation simply provides that in the many
situations where financing or credit transactions do not involve
the disbursement of any loan proceeds but do involve the
extension of credit and interest charges or expenses therefor,
the interest expenses are to be allocated between the taxpayer’s
business and personal activity based on the nature of the
particular underlying activity giving rise to the extension of
credit.
Under section 1.163-8T(c)(3)(ii), Temporary Income Tax
Regs., even though no loan proceeds were disbursed to petitioners
by the Government, credit was extended to petitioners by the
Government, and petitioners were charged interest with regard
thereto.
Because the underlying activity in question in this case
(giving rise to the tax deficiency and to the Government’s
extension of credit to petitioners) undisputedly relates to
petitioners’ business, under section 1.163-8T(c)(3)(ii),
Temporary Income Tax Regs., the interest expense in question
should be treated as allocable to petitioners’ business and as
deductible under the statute.
COLVIN and LARO, JJ., agree with this concurring opinion.
LARO, J., concurring: I agree with the majority opinion.
I write separately, however, to emphasize the invalidity of
section 1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs., 52 Fed.
Reg. 48409 (Dec. 22, 1987), for reasons additional to those
stated by the majority.
- 30 -
Before the Tax Reform Act of 1986 (TRA), Pub. L. 99-514,
100 Stat. 2085, this and other courts allowed an individual to
deduct interest on his or her income tax liability as a business
expense under sections 62(a)(1) and 162(a), see, e.g., Standing
v. Commissioner, 28 T.C. 789, 795 (1957), affd. 259 F.2d 450(4th Cir. 1958), or a nonbusiness itemized deduction, sec.
163(a).1 Thus, the courts allowed an individual to compute
adjusted gross income (AGI) under section 62(a)(1) by deducting
deficiency interest that was an ordinary and necessary expense
under section 162(a), irrespective of the provisions of section
163 and independent of whether the individual itemized his or her
deductions. See generally Bittker & Lokken, Federal Taxation Of
Income, Estates And Gifts, par. 31.1.1, at 31-2 (2d ed. 1990)
("Since, even in the absence of §163(a), interest attributable to
business or profit-oriented transactions would be deductable
under §162 * * * or §212 * * *, the principal function of §163(a)
is to permit the deduction of interest on consumer debt"). The
Courts also allowed an individual to deduct deficiency interest
that was an ordinary and necessary business expense under section
162(a) in order to compute a net operating loss (NOL) under
section 172(d)(4). Polk v. Commissioner, 31 T.C. 412, 415
(1958), affd. 276 F.2d 601 (10th Cir. 1960).
The Commissioner disagrees with the Courts' view. According
to her, interest on an income tax liability attributable to a
1
Whether the interest was deductible as a business expense
or a nonbusiness itemized deduction depended on the character of
the income tax liability.
- 31 -
business is not deductible by an individual in computing AGI.
In Rev. Rul. 58-142, 1958-1 C.B. 147, the Commissioner stated
that an individual's payment of State income taxes, interest on
State and Federal income taxes, and litigation expenses related
to these taxes was "not attributable to a trade or business",
even if these expenses were related to business income or
deductible under section 212. The Commissioner ruled that these
State income taxes, interest on State and Federal income taxes,
and litigation expenses were not deductible from gross income in
computing AGI under former section 62(a)(1). The Commissioner
also ruled that these State income taxes, interest on State and
Federal income taxes, and litigation expenses did not generate an
NOL under section 172(d)(4).
The Commissioner's ruling in Rev. Rul. 58-142, supra, with
respect to AGI, was based on former section 1.62-1(d), Proposed
Income Tax Regs., 21 Fed. Reg. 8403 (Nov. 2, 1956), which
provides:
To be deductible for the purposes of determining
adjusted gross income, expenses must be those directly,
and not those merely remotely, connected with the
conduct of a trade or business. For example, taxes are
deductible in arriving at adjusted gross income only if
they constitute expenditures directly attributable to a
trade or business or to property from which rents or
royalties are derived. Thus, property taxes paid or
incurred on real property used in a trade or business
are deductible, but State taxes on net income are not
deductible even though the taxpayer's income is derived
from the conduct of a trade or business.
The Commissioner's ruling with respect to the NOL was primarily
based on this Court's decisions in Maxcy v. Commissioner, 26 T.C.
526 (1956), and Aaron v. Commissioner, 22 T.C. 1370 (1954). In
- 32 -
Maxcy v. Commissioner, supra at 527, the Court held that the
taxpayer failed to prove that he could compute an NOL by
deducting from his gross income a claimed business expense of
interest on underpayments of personal income tax. In Aaron v.
Commissioner, supra at 1376, the Court sustained the
Commissioner's determination that the taxpayer could not compute
an NOL by deducting the State income taxes that he claimed were
related to his business income. According to the Court, the
phrase "attributable to" meant that an expense had to bear a
"direct relation" to the individual's business. Id.
In Rev. Rul. 70-40, 1970-1 C.B. 50, the Commissioner
reconsidered and reversed her position in Rev. Rul. 58-142,
supra, insofar as it held that State income taxes, deficiency
interest, and litigation expenses related to a taxpayer's
business income were nondeductible nonbusiness expenses for
purposes of determining an NOL.2 Prior to her reconsideration,
this and other Courts had consistently rejected that position.
First, in Standing v. Commissioner, supra at 795, this Court held
that the taxpayer's deficiency interest and professional fees
were deductible as business expenses under sections 22(n)(1) and
2
At the same time, the Commissioner reaffirmed her view
that these expenses were not deductible in computing AGI. The
Commissioner explained her inconsistency in these two views by
noting that the legislative history of sec. 172(d)(4) contained
no language comparable to the language in the legislative history
of former sec. 62(a)(1) which stated that expenses deductible in
arriving at AGI must be "directly incurred" in carrying on a
trade or business, and that State income taxes are not directly
incurred. Rev. Rul. 70-40, 1970-1 C.B. 50, 50-51.
- 33 -
23(a)(1)(A) of the 1939 Code, in arriving at AGI.3 In Standing,
the taxpayer was the sole proprietor of two businesses. The
Commissioner audited the taxpayer's 1945 through 1949 individual
income tax returns, and the taxpayer retained an attorney and an
accountant to assist him in the audit. The taxpayer and the
Commissioner settled the matter; substantially all of the
agreed-upon deficiencies were proximately related to the
taxpayer's businesses. The taxpayer later claimed a business
deduction for the deficiency interest and the professional fees
incurred with respect to the deficiencies. The Commissioner
disallowed these expenses as business deductions from gross
income mainly because the expenses had no connection with the
taxpayer's business. We disagreed. We held that the interest
and the fees were "ordinary and necessary expenses paid or
incurred during the taxable year in carrying on * * * [the
taxpayer's] trade or business" within the meaning of section
23(a)(1)(A) of the 1939 Code. Standing v. Commissioner, supra at
793. The Court of Appeals for the Fourth Circuit affirmed our
decision allowing these deductions. Commissioner v. Standing,
259 F.2d at 456.
3
Sec. 22(n)(1) of the 1939 Code provides that AGI equals
gross income less "deductions allowed by section 23 which are
attributable to a trade or business carried on by the taxpayer,
if such trade or business does not consist of the performance of
services by the taxpayer as an employee". Sec. 23(a)(1) of the
1939 Code allows for the deduction of "All the ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business". The language of secs.
22(n)(1) and 23(a)(1) is essentially verbatim with the language
of secs. 62(a)(1) and 162(a), respectively.
- 34 -
Subsequently, in Polk v. Commissioner, supra at 414-415,
this Court held that interest on an income tax deficiency
stemming from the Commissioner's revaluation of the taxpayer's
livestock inventory was deductible as a business expense for
purposes of computing an NOL. In so holding, this Court stated
that the case was "clearly controlled" by Standing. Polk v.
Commissioner, supra at 415. We also stated that the deficiency
interest was deductible as a business expense because the
deficiency "arose in connection with * * * [the taxpayer's]
business, and was proximately related thereto, and that the same
must be said of the interest paid thereon." Id. at 415. We
distinguished Maxcy v. Commissioner, 26 T.C. 526 (1956), on which
the Commissioner relied, by concluding:
The Opinion in that case includes the following (p.
527): “The burden is on * * * [the taxpayer] to
demonstrate the clear allowability of the deduction.
This burden he has failed to carry.”
In the instant case, however, as in Standing,
supra, * * * [the taxpayer's] burden is clearly and
fully met. We have carefully reexamined the problem,
and we see no occasion to depart from the reasoning and
principles established by the Court of Appeals for the
Fourth Circuit, and by this Court, in Standing. [Polk
v. Commissioner, supra at 415.]
On appeal, the Court of Appeals for the Tenth Circuit agreed
that these amounts were deductible. Commissioner v. Polk,
276 F.2d at 604. According to the court, a taxpayer may compute
an NOL by deducting deficiency interest from gross income as a
business expense if the interest is an ordinary and necessary
expense incurred in the operation of the business. The court
stated that the assessment of additional income taxes related to
- 35 -
the valuation of livestock is ordinary and necessary to the
conduct of a livestock business because people may disagree on
the value of livestock. Id. at 603.
Shortly thereafter, this Court reached a result consistent
with Polk and Standing in our Court-reviewed opinion in Reise v.
Commissioner, 35 T.C. 571 (1961), affd. 299 F.2d 380 (7th Cir.
1962). We held in Reise that State income taxes, deficiencies in
State income taxes, interest on State and Federal income taxes,
and litigation expenses relating primarily to an individual's
business income were deductible as ordinary and necessary
business expenses in computing an NOL carryback. We carefully
reviewed the relevant statutes, the legislative history, the
administrative interpretations of these provisions, and the
caselaw (including Polk, Standing, Maxcy, and Aaron). We
concluded that Standing and Polk are "sound and correct", and
Aaron is not. Id. at 579. We applied the rationale of Polk and
Standing, and we overruled Aaron as an improper and incorrect
construction of section 122(d)(5) of the 1939 Code.4 Id. at 579.
This and other Courts have steadfastly followed the judicial
reasoning that we enunciated in Reise, Polk, and Standing.
Indeed, in Estate of Broadhead v. Commissioner, T.C. Memo
1966-26, affd. 391 F.2d 841 (5th Cir. 1968), we were obliged to
distinguish Standing, in holding that the taxpayer could not
claim a business expense deduction for interest on his Federal
4
The text of sec. 122(d)(5) of the 1939 Code is virtually
identical to the text of sec. 172(d)(4).
- 36 -
income tax deficiencies because he failed to show that the
deficiencies were related to his business income. Similarly, in
Tanner v. Commissioner, 45 T.C. 145, 149-150 (1965), affd. per
curiam 363 F.2d 36 (4th Cir. 1966), we were obliged to
distinguish Standing, in refusing to allow a deduction for State
income taxes under former section 62(a)(1). We reasoned that,
whereas former section 62(a)(1) was silent on the deductibility
of interest and legal expenses attributable to the underpayment
of business income, former section 62(a)(1) and its legislative
history clearly barred an individual from deducting the State
income taxes on business income.
It is with this backdrop that I proceed to address the
validity of the regulations at hand. The Commissioner claims
that she validly prescribed section 1.163-9T(b)(2)(i)(A),
Temporary Income Tax Regs., 52 Fed. Reg. 48409 (Dec. 22, 1987),
based on the legislative history of section 163(h) and the Staff
of Joint Comm. on Taxation, General Explanation of the Tax Reform
Act of 1986, at 266 (J. Comm. Print 1987) (the 1986 Bluebook).5
5
The Joint Committee of Taxation for the 100th Congress
(Joint Committee) consisted of five Senators and five members of
the House of Representatives. The 1986 Bluebook, at II. The
1986 Bluebook was prepared by the Staff of the Joint Committee,
in consultation with the staffs of the House Ways and Means
Committee and the Senate Finance Committee. Letter from David H.
Brockway, Chief of Staff, to the Hon. Dan Rostenkowski, Chairman,
and the Hon. Lloyd Bentsen, Vice-Chairman, id. at XVII.
According to Mertens, Law of Federal Income Taxation, sec. 3.20,
at 31 (1994):
The purpose of the Blue Book is to provide, in one
volume, a compilation of the legislative history of a
piece of tax legislation. While the document is most
(continued...)
- 37 -
According to her, the Congress enacted section 163(h), in part,
to prohibit an individual from deducting interest on an income
tax liability attributable to his or her trade or business. I
disagree.
First, there is no reason to resort to the legislative
history of section 163(h). A statute speaks for itself, and its
legislative history should be sought to embellish the text only
when the meaning of the words therein are "inescapably
ambiguous". Garcia v. United States, 469 U.S. 70, 76 n.3 (1984);
see also Ex parte Collett, 337 U.S. 55 (1949). The relevant text
of section 163(h) reads:
In the case of a taxpayer other than a corporation, no
deduction shall be allowed under this chapter for
personal interest paid or accrued during the taxable
year.
* * * the term "personal interest" means any interest
* * * other than--
* * * interest paid or accrued on
indebtedness properly allocable to a trade or
business * * * [Sec. 163(h)(1) and (2)(A).]
This text is not ambiguous. Interest paid on a debt that is
properly allocable to a trade or business is not personal
interest under section 163(h). Given the clarity of this text,
the beginning and end of our inquiry should be the statutory
text, and we should apply the plain and common meaning of the
(...continued)
helpful as a handy reference volume it also gives some
guidance. Where the Blue Book's explanation differs
from that in a conference report it may serve to alert
the reader that a technical correction is needed to
reconcile the views. [Emphasis added.]
- 38 -
statute.6 TVA v. Hill, 437 U.S. 153 (1978); United States v.
American Trucking Associations, 310 U.S. 534, 543-544 (1940). As
the United States Supreme Court has said:
canons of construction are no more than rules of thumb
that help courts determine the meaning of legislation,
and in interpreting a statute a court should always
turn first to one, cardinal canon before all others.
We have stated time and time again that courts must
presume that a legislature says in a statute what it
means and means in a statute what it says there. * * *
When the words of a statute are unambiguous, then, this
first canon is also the last: judicial inquiry is
complete. [Connecticut Natl. Bank v. Germain, 503 U.S.
249, 253-254 (1992); citations and quotation marks
omitted.]
Although a plain reading of the statute is ordinarily
conclusive, I recognize that a clear legislative intent that is
contrary to the text may sometimes lead to a different result.
6
Indeed, the Commissioner has done just that with respect
to the term “properly allocable”. The Commissioner prescribed
sec. 1.163-8T, Temporary Income Tax Regs., to determine the
amount of interest that is properly allocable to a trade or
business. Sec. 1.163-9T(b)(1)(i), Temporary Income Tax Regs.,
52 Fed. Reg. 48409 (Dec. 22, 1987). Sec. 1.163-8T(a)(3),
(4)(i)(A), (b)(7), and (c)(3)(ii), Temporary Income Tax Regs.,
52 Fed. Reg. 24999-25001 (July 2, 1987), provides that interest
is properly allocable to a trade or business to the extent that
the proceeds of the underlying debt are traceable to an
"expenditure * * * in connection with the conduct of any trade or
business". But for sec. 1.163-9T(b)(2)(i)(A), Temporary Income
Tax Regs., 52 Fed. Reg. 48409 (Dec. 22, 1987) there should be no
dispute that petitioners may deduct their deficiency interest
because the interest is connected to the Federal income taxes
that they must pay on their business income. Fort Howard Corp.
and Subs. v. Commissioner, 103 T.C. 345, 352 (1994) (an expense
is incurred "in connection with" the conduct of a trade or
business if it is associated with or logically related); Polk v.
Commissioner, 31 T.C. 412, 415 (1958) (deficiency interest
deductible as a business expense because the deficiency "arose in
connection with * * * [the taxpayer's] business, and was
proximately related thereto, and that the same must be said of
the interest paid thereon"), affd. 276 F.2d 601 (10th Cir. 1960);
see also Reise v. Commissioner, 35 T.C. 571 (1961), and the cases
cited therein, affd. 299 F.2d 380 (7th Cir. 1962).
- 39 -
Consumer Product Safety Commn. v. GTE Sylvania, Inc., 447 U.S.
102, 108 (1980); see also Halpern v. Commissioner, 96 T.C. 895,
899 (1991) (only "unequivocal evidence" of legislative purpose in
the history to a statute may override the plain meaning of the
words therein). I find no clear and unequivocal legislative
intent that would support the Commissioner's taking a position in
section 1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs., that is
inconsistent with the statute. The conference report to the TRA
states that "Personal interest is any interest, other than
interest incurred or continued in connection with the conduct of
a trade or business (other than the trade or business of
performing services as an employee), investment interest, or
interest taken into account in computing the taxpayer's income or
loss from passive activities for the year." H. Conf. Rept.
99-841, at II-154 (1986), 1986-3 C.B. (Vol. 4) at 154; see also
S. Rept. 99-313, at 804-806, 1986-3 C.B. (Vol. 3) at 804-806.
Although the conference report further states that "Personal
interest also generally includes interest on tax deficiencies",
H. Conf. Rept. 99-841, at II-154, 1986-3 C.B. (Vol. 4) at 154,
I agree with the majority that this reference is to tax
deficiencies that are not business related. I do not believe
that the Congress meant to change sub silentio the pre-existing
judicial view that interest on income tax deficiencies
attributable to a trade or business is deductible. I conclude
that the disallowance for personal interest in section 163(h)(2)
relates only to interest not qualifying as a trade or business
- 40 -
expense under sections 62(a)(1) or 162(a).
My conclusion is not changed by the broad interpretation
given to section 163(h)(2) by the Joint Committee in the 1986
Bluebook. I give little weight to this broad interpretation.
Flood v. United States, 33 F.3d 1174, 1178 (9th Cir. 1994);
Slaven v. BP America, 973 F.2d 1468, 1475 (9th Cir. 1992).
The 1986 Bluebook is not legislative history; it was written
after the enactment of the TRA. See Flood v. United States,
supra at 1178; McDonald v. Commissioner, 764 F.2d 322, 336-337
n.25 (5th Cir. 1985), affg. T.C. Memo. 1983-197; Mertens, Law of
Federal Income Taxation, sec. 3.20, at 31 (1994). It was not
approved by the Congress before its release. See Estate of
Hutchinson v. Commissioner, 765 F.2d 665, 669-670 (7th Cir.
1985), affg. T.C. Memo. 1984-55. It does not comport with the
text of section 163(h) or the legislative history thereunder.
I recognize that both the United States Supreme Court and this
Court have relied on the Blue Book, see, e.g., FPC v. Memphis
Light, Gas & Water Div., 411 U.S. 458, 471-472 (1973); Estate of
Sachs v. Commissioner, 88 T.C. 769, 775 (1987), affd. in part and
revd. in part 856 F.2d 1158 (8th Cir. 1988), and that it is
entitled to great respect, Estate of Hutchinson v. Commissioner,
supra at 669-670; McDonald v. Commissioner, supra at 336-337
n.25. All the same, we should not be bound by statements in the
1986 Bluebook that are unsupported by and contrary to section 163
and its legislative history.
The nuts and bolts of this case is that the Commissioner
- 41 -
continues to disagree with the pre-TRA judicial view that an
individual engaged in a trade or business may deduct from gross
income the amount of interest on a Federal income tax liability
that is attributable to his or her business. Thus, the
Commissioner prescribed her position into section
1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs., under the
guise of the TRA's amendments to section 163. Section
1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs., is inconsistent
with section 163(h). The nondeductibility of personal interest
does not apply to interest on a Federal income tax liability that
is properly allocable to a trade or business. Sec. 163(h)(2)(A).
Interest on a Federal income tax liability that is properly
allocable to a trade or business is deductible under section
162(a) if the incurrence of the interest is ordinary and
necessary to the trade or business. If the Congress had intended
to disallow any deduction for deficiency interest that was an
ordinary and necessary business expense under section 162(a), the
Congress would have said so. Instead, the Congress clearly
stated that personal interest does not include "interest paid or
accrued on indebtedness properly allocable to a trade or business
(other than the trade or business of performing services as an
employee)". Sec. 165(h)(2)(A). Because the Commissioner's
prescription of section 1.163-9T(b)(2)(i)(A), Temporary Income
Tax Regs., is inconsistent with the statute (and is not within
the "legislature's revealed design" for the TRA's amendments to
section 163, Nationsbank v. Variable Annuity Life Ins. Co., 513
- 42 -
U.S. , , 115 S.Ct. 810, 813-814 (1995)), I concur in the
majority's holding that it is outside the bounds of her
regulatory authority under section 7805(a).7 Section
1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs., is invalid.
Accord Professional Equities, Inc. v. Commissioner, 89 T.C. 165(1987); Stephenson Trust v. Commissioner, 81 T.C. 283 (1983); see
RLC Industries Co. v. Commissioner, 58 F.3d 413, 418 (9th Cir.
1995), affg. 98 T.C. 457 (1992).
SWIFT, WRIGHT, PARR, and VASQUEZ, JJ., agree with this
concurring opinion.
7
I note that the Commissioner's position in the instant
case is inconsistent with a recent administrative position of
hers. In Rev. Rul. 92-29, 1992-1 C.B. 20, the Commissioner
modified Rev. Rul. 70-40, 1970-1 C.B. 50, to state that sec.
62(a)(1) allows an individual to deduct litigation expenses
incurred in determining State and Federal income taxes on income
derived from his or her trade or business. The recent ruling
also states that an individual may deduct the portion of a tax
preparation fee that is attributable to his or her
sole-proprietor business. Given the Commissioner's position with
respect to these litigation expenses and tax preparation fees, I
am unable to fathom why she continues to believe that the
interest on a tax deficiency that is allocable to a trade or
business is not also deductible.
- 43 -
RUWE, J., dissenting: I disagree with the majority for
reasons already well stated by the Court of Appeals for the
Eighth Circuit in Miller v. United States, 65 F.3d 687 (8th Cir.
1995). Since there is no need to repeat those reasons, I shall
confine myself to addressing several aspects of the majority
opinion not addressed in Miller.
First, I do not believe that the conference committee's use
of the word "generally" supports the majority's reasoning. The
conference committee report states: "Personal interest also
generally includes interest on tax deficiencies". H. Conf. Rept.
99-841, at II-154 (1986), 1986-3 C.B. (Vol. 4) 1, 154. The
majority seizes upon the word "generally" and reasons that
Congress could not have intended to declare that all interest on
"income" tax deficiencies is personal interest. However, in the
conference committee report, the word "generally" modifies "tax
deficiencies", not "income tax deficiencies". The term "tax
deficiencies", which also includes estate and gift tax
deficiencies, is obviously broader than the term "income tax
deficiencies". Congress statutorily excluded some interest on
tax deficiencies from the "personal interest" definition by
specifically providing in section 163(h)(2)(E) that interest on
estate taxes imposed by section 2001 is, in certain
circumstances, not personal interest. Therefore, the use of the
word "generally" in the conference committee report was both
technically correct and consistent with the regulation's holding
that all interest on individual income tax deficiencies is
- 44 -
personal interest. Indeed, use of the word "generally" indicates
that allowing interest on a "tax deficiency" would be an
exception to the norm, such as provided for by section
163(h)(2)(E), and would not include the very common situation
where an "income tax deficiency" is based on adjustments to items
reported on an individual's Schedule C.
Second, the body of case law relied upon by the majority
found its genesis to a large extent in the failure of section
22(n) of the Internal Revenue Code of 1939 to directly address
whether an individual was entitled to deduct interest on an
income tax deficiency attributable to a trade or business and the
lack of legislative history and regulations on the subject. See
Commissioner v. Standing, 259 F.2d 450 (4th Cir. 1958), affg. 28
T.C. 789 (1957). However, in Tanner v. Commissioner, 45 T.C.
145, 150 (1965), affd. 363 F.2d 36 (4th Cir. 1966), where we held
that an individual taxpayer was not allowed to deduct State
individual income taxes as a business expense, we observed:
In reaching its conclusion [in Standing], the court
pointed out that neither the committee reports nor the
regulations with respect to section 22(n)(1)
specifically mentioned interest on tax deficiencies
with respect to business income or legal expenses
incurred in contesting such deficiencies. The same
cannot be said, of course, with respect to State income
taxes. As pointed out hereinabove, both the committee
reports and the regulations specifically state that
State income taxes, even though incurred as a result of
business profits, are not deductible in computing
adjusted gross income.
Like the situation presented to us in Tanner, both the
legislative history and contemporaneous regulations support a
- 45 -
holding that the interest paid on petitioners' late income tax
payment constitutes nondeductible "personal interest".
Third, the majority expresses concern that the regulation in
issue "discriminates against the individual who operates his or
her business as a proprietorship instead of in corporate form
where the limitations on the deduction of 'personal interest'
would not apply." See majority op. p. 15. The short answer to
this is that Congress, when it enacted section 163(h) disallowing
personal interest, excluded corporate taxpayers from its
provisions. Surely, the majority does not question Congress'
authority to allow corporations, which are treated as separate
taxable entities, to deduct items that individuals may not. But
if the majority is concerned about discrimination, it should
observe that the result it reaches produces an even greater
disparity of treatment between individual taxpayers. While the
majority would allow a business deduction for interest on income
tax deficiencies attributable to adjustments to proprietorship
income, interest on individual tax deficiencies attributable to
businesses operated as partnerships and subchapter S corporations
is not deductible as a business expense. Thus, even for taxable
years ending prior to the effective date of section 163(h), it
has been held that interest on an individual's income tax
deficiency attributable to adjustments to the income of a
partnership or an S corporation was not deductible as a business
expense by an individual partner or shareholder. True v. United
States, 35 F.3d 574 (10th Cir. 1994), affg. without published
- 46 -
opinion1 93-2 USTC par. 50,461, 72 AFTR2d 93-5660 (D. Wyo. 1993).
Consistent treatment of individual taxpayers can be best achieved
by recognizing that interest on individual income tax
deficiencies is personal interest regardless of whether the
adjustment giving rise to the deficiency pertains to a
proprietorship, a partnership, or an S corporation.
An individual’s income tax liability is based on an
amalgamation of income derived from all sources and deductions,
credits, exclusions, exemptions, filing status, income bracket,
and other considerations. Income from an unincorporated business
is merely one of the many components necessary to determine what
is still in essence a tax on an individual's personal accessions
to wealth from whatever source derived. See James v. United
States, 366 U.S. 213, 219 (1961). Interest on a individual's
income tax liability represents a personal expense because the
underlying tax obligation is personal. See Miller v. United
States, supra at 691.
HAMBLEN, CHABOT, COHEN, GERBER, HALPERN, and BEGHE, JJ.,
agree with this dissent.
1
A copy of the unpublished opinion of the Court of Appeals
for the Tenth Circuit in True v. United States that appears at 74
AFTR2d 94-6253, is appended. Although citation of unpublished
opinions of the Court of Appeals for the Tenth Circuit remains
unfavored, unpublished opinions may now be cited if the opinion
has persuasive value on a material issue, and a copy is attached
to the citing document. See General Order of Nov. 29, 1993,
suspending 10th Cir. Rule 36.3.
- 47 -
APPENDIX
JEAN D. TRUE; H.A. TRUE, JR.; H.A. TRUE, III;
KAREN S. TRUE; DIEMER D. TRUE; SUSAN L. TRUE;
DAVID L. TRUE; MELANIE A. TRUE, PLAINTIFFS-
APPELLANTS v. U.S., DEFENDANT-APPELLEE. U.S. Court of Appeals,
Tenth Circuit, No. 93-8092, Aug. 26, 1994. District Court, 72
AFTR 2d 93-5660, affirmed. Decision for Govt.
MOORE, Circuit Judge:
Order and Judgment
Before MOORE, SETH, and TACHA, Circuit Judges:**
Plaintiffs in these consolidated cases appeal from a summary
judgment motion in favor of the government. They seek an income
tax refund claiming the IRS improperly calculated their
alternative minimum tax. They contend the correct computation
permits them to fully deduct as a business expense interest paid
on income tax deficiencies relating to their various business
entities. According to their treatment of the interest,
plaintiffs owe no alternative minimum tax. Finding no legal
support for that position, we affirm.
H.A. True, Jr.,1 his wife, and three of their children are
owners of numerous ranching and energy-related businesses
operated as partnerships and S corporations. In 1986, the IRS
advised taxpayers to pay disputed tax deficiencies and associated
interest because, after 1986, interest on most tax deficiencies
would not be fully deductible. Accordingly, in 1986, plaintiffs
(the business owners and their spouses) paid, for various
previous tax years, contested taxes and penalty interest relating
"nearly exclusively" to their businesses. On their 1986
**
This order and judgment is not binding precedent, except
under the doctrines of law of the case, res judicata, and
collateral estoppel. The court generally disfavors the citation
of orders and judgments; nevertheless, an order and judgment may
be cited under the terms and conditions of the court's General
Order filed November 29, 1993. 151 F.R.D. 470.
1
Mr. True died during the course of this litigation. As
personal representatives of his estate, his wife and the three of
his children involved in this case have been substituted as
parties for Mr. True.
- 48 -
individual income tax returns, plaintiffs fully deducted these
interest payments from gross income as a business expense. The
IRS disallowed these "above the line" deductions, but allowed
plaintiffs to deduct the interest "below the line" from their
adjusted gross incomes. The IRS's treatment of the 1986 interest
payments did not change plaintiffs' regular tax liability but
created alternative minimum tax liability which plaintiffs
believed they did not owe. Plaintiffs paid the disputed
alternative minimum tax and associated interest. They sought a
refund of this money from the IRS, which denied the claim, and
then filed this action in the district court. On cross-motions
for summary judgment, the district court granted judgment to the
government.
The district court determined the tax code classifies the
1986 interest payments as a personal rather than a business
expense. The court asserted a sole proprietor could deduct this
interest as a personal business expense. However, unlike the
situation with sole proprietorships, partnerships and S
corporations are separate entities from partners and shareholders
for the purpose of characterizing income and deducting business
expenses. Therefore, if the interest payments are a business
expense, the deduction would occur on the partnership or
corporate level before the determination of the distributive
shares of the businesses' incomes.2 Plaintiffs must endure the
consequences of their choice of business form. Because they own
shares of partnerships and S corporations, their 1986 interest
payments are personal deductions.
Plaintiffs argue they have no alternative minimum tax
liability. They claim the interest payments represent a business
expense because the complexity of income tax laws creates
legitimate disputes about the amount of tax owed, and, thus,
deficiency interest is an ordinary and necessary expense of
operating a business. They argue when deficiency interest is
deducted as a business expense from gross income to arrive at
adjusted gross income, the staring point for calculating
alternative minimum tax, no alternative minimum tax liability
occurs. To support their contention the interest constitutes a
business expense, plaintiffs argue a sole proprietor could deduct
this interest as a business expense; therefore, equity demands
partners and S corporation shareholders receive the same tax
treatment. Pointing to cases involving legal fees and employee
benefits, plaintiffs assert partners may deduct personally-paid
partnership-related expenses as business expenses. Furthermore,
because partnerships and S corporations pass their tax liability
2
The court noted the irony that the corporations and
partnerships cannot deduct the 1986 interest payments because
they have no obligation to pay taxes or interest on tax
deficiencies.
- 49 -
onto their owners rather than pay taxes themselves, plaintiffs
point out these entities cannot account for deficiency interest
in determining distributable income. The partners and
shareholders, therefore, may deduct deficiency interest
attributable to the entities as a business expense on their
individual returns.
The government argues the interest payments are a personal
rather than a business expense. Partnerships and S corporations
are entities separate from their owners for the purposes of
calculating income and deductions. Therefore, if the 1986
interest represents a business expense, the expense and deduction
belong to the partnership or corporate entities. However,
because partnerships and S corporations have no federal income
tax liability, they bear no responsibility for interest on unpaid
taxes and, thus, they cannot consider penalty interest a business
expense. The government adds, contrary to the district court's
conclusion, sole proprietors generally cannot deduct deficiency
interest as a business expense because deficiency interest does
not constitute an ordinary and necessary expense of operating a
business.3 Penalty interest constitutes the cost of not paying
the correct amount of taxes and not the cost of producing the
taxable income. Therefore, a sole proprietor, like an employee,
cannot deduct this interest as a business expense and neither can
partners and S corporation shareholders.
We review de novo a grant of summary judgment. Phillips
Petroleum Co. v. Lujan, 4 F.3d 858, 860 (10th Cir. 1993)
(citation omitted). Summary judgment is appropriate if no
genuine issue of material fact exists and the moving party is
entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c).
The alternative minimum tax imposes additional income taxes
on individual taxpayers for whom a portion of their alternative
minimum taxable income exceeds their regular tax liability.
I.R.C. section 55(a).4 Adjusted gross income serves as the
starting point for calculating alternative minimum taxable income
and, thus, the alternative minimum tax. I.R.C. section 55(b).
To determine adjusted gross income, a taxpayer lessens gross
income by several "above the line" deductions including allowable
deductions "attributable to a trade or business carried on by the
taxpayer" if the trade or business does not amount to the
taxpayer's services as an employee. I.R.C. section 62(l). The
code defines business expenses as "all the ordinary and necessary
3
The government goes on to contend an individual taxpayer
can never deduct deficiency interest from gross income as a
business expense.
4
Citations to the tax code refer to the amended provisions
of the 1954 code effective in 1986.
- 50 -
expenses paid or incurred during the taxable year in carrying on
any trade or business." I.R.C. section 162(a). An individual
taxpayer reduces adjusted gross income by enumerated items,
including a limited amount of qualified interest, as part of the
computation of alternative minimum taxable income. I.R.C.
section 55(b)(1), (e)(1)(D), (e)(3). The denouement of these
statutory machinations is a taxpayer calculating alternative
minimum tax liability can fully deduct interest that constitutes
a business expense. However, he or she cannot fully deduct any
other interest to the extent it exceeds the cap on qualified
interest.
The deficiency interest paid by plaintiffs exceeded the
amount they were entitled to deduct as qualified interest; thus,
plaintiffs may only fully deduct the deficiency interest if it
constitutes a business expense. We conclude the penalty interest
represents a personal expense because the obligation to pay taxes
is personal to plaintiffs.
With a few exceptions inapplicable to this controversy,
partnerships and S corporations calculate and report their
taxable income in the same manner as individual taxpayers, but
these entities do not incur tax liability.5 I.R.C. sections 701,
703, 1363(a), 1363(b), 6031(a), 6037(a). Instead, the partners
and shareholders pay taxes on their shares of the partnerships'
and S corporations' various items of income, gain, loss,
deduction and credit. I.R.C. sections 701, 702(a), 1366(a).6 A
5
Certain circumstances not relevant here will result in tax
liability for an S corporation. See I.R.C. section 1363(a).
6
The Supreme Court has noted a partnership is a separate
entity from its partners for the purpose of calculating and
reporting its income but has no bearing on the partners'
individual tax liability for the partnership's income. United
States v. Basye, 410 U.S. 441, 448 (1973).
In advocating their opposing arguments, plaintiffs and the
government have suggested Commissioner v. Polk, 276 F.2d 601(10th Cir. 1960), disposes of this controversy. In Polk, we
considered whether interest paid on a tax deficiency arising from
an individual's livestock business qualified as a deduction
"attributable to the operation of a trade or business" to compute
a net operating loss under 122(d)(5) of the 1939 tax code. To
determine the interest's deductibility, the court examined
whether the interest fell within the category of ordinary and
necessary business expenses deductible from gross income as
provided in 23(a)(1)(A) of the 1939 code, the precursor to
section 162(a). Polk, 276 F.2d at 602. The court noted the
facts of each case determine whether penalty interest qualifies
(continued...)
- 51 -
partner or shareholder's individual obligation to pay taxes also
includes the personal responsibility to pay any tax deficiency
arising from incorrect returns and the associated penalty
interest. Because the duty to pay penalty interest is personal
to the individual partner or shareholder, penalty interest cannot
constitute a business expense.7
Plaintiffs, having chosen to operate their businesses as
partnerships and S corporations, bear personal responsibility for
tax deficiencies and the associated interest attributable to
their businesses. As a result, they cannot deduct the penalty
interest they paid in 1986 from gross income as a business
expense pursuant to I.R.C. section 62(l). Plaintiffs, therefore,
are not entitled to a refund of their alternative minimum tax.
The judgment of the district court is AFFIRMED.
(...continued)
as ordinary business expenses. Id. at 603. Generally, interest
on a deficiency assessment is not an ordinary by product of
business operations and is not deductible. Id. However,
deficiency interest may be deducted where the nature of the
business leads to the expectation that on numerous occasions a
taxpayer acting in good faith to evaluate inventories, which form
a part of his or her return, will nevertheless fail to evaluate
them properly. Id. at 603 & n.1. The court concluded the
taxpayer's livestock business fit this exception because
"qualified minds" may differ over the valuation of livestock.
Id. at 603.
We believe, as did the panel presiding in Polk, that Polk
settled a unique controversy. The parties have not presented any
facts nor can we imagine another situation in which penalty
interest would be an ordinary and necessary expense of operating
a trade or business. Furthermore, Polk has no relevance here
because it involved a taxpayer operating a sole proprietorship
rather than a partnership or S corporation.
7
This liability is in addition to, and separate from, the
direct liability of a corporate employer. Section 6672 is not in
issue in this case.
- 52 -
HALPERN, J., dissenting:
I. Introduction
Section 163(h)(2)(A) exempts from the category of personal
interest (which is nondeductible for individuals): "interest
paid or accrued on indebtedness properly allocable to a trade or
business (other than the trade or business of performing services
as an employee)".
The majority finds that a reasonable interpretation of that
exemption includes the interest here in question. The majority
holds that, if the tracing rules of section 1.163-8T, Temporary
Income Tax Regs., require a contrary conclusion, then, to that
extent, the tracing rules are invalid. If the tracing rules of
section 1.163-8T, Temporary Income Tax Regs., 52 Fed. Reg. 24999(July 2, 1987), do not require a contrary conclusion, but the
specific rule of section 1.163-9T(b)(2)(i)(A), Temporary Income
Tax Regs., 52 Fed. Reg. 48409 (Dec 22, 1987), does, then the
majority holds that that specific rule is invalid.
In so holding, the majority departs from the Supreme Court's
teachings in Chevron, U.S.A., Inc. v. Natural Resources Defense
Council, Inc., 467 U.S. 837, 842-844 (1984), and NationsBank v.
Variable Annuity Life Ins. Co., 513 U.S. ___, 115 S. Ct. 810,
813-814 (1995). I believe that application of those decisions
leads to the conclusion that the temporary regulations at issue
are valid, which leads to a decision for respondent.
II. In the Absence of Regulations
I agree that, in the absence of temporary regulations, a
- 53 -
reasonable interpretation of section 163(h)(2)(A) would include
the interest here in question. First, it is reasonable to treat
a deficiency in tax as giving rise to an indebtedness to the
Government in the amount of the deficiency and to treat the
interest allocable to the deficiency as interest paid or accrued
on that indebtedness. See discussion infra sec. III.C.2.a.
Second, any tax paid with respect to income is an expense
associated with that income, at least in the sense that the
income is causal of the expense. Interest on a deficiency in
income tax (hereafter, deficiency interest), or interest on a
borrowing to pay an income tax, likewise is an expense associated
with the income subject to tax. With respect to both such tax
and such interest, only the after-tax-after-interest amount is
available for consumption or as an addition to savings. Whether
such aftercosts themselves constitute consumption is the real
question here at issue. In the absence of any exposition in the
statute of the term "properly allocable", and in light of
Congress' history (explained infra) of treating Federal income
taxes as not a consumption expense, I think that it is reasonable
to conclude that deficiency interest attributable to nonemployee
trade or business income (hereafter, simply trade or business
income) is properly allocable to such income and, thus, is not
personal interest. However, because Congress changed its mind,
and now treats Federal income taxes as a consumption expense
(i.e., Federal income taxes are not deductible), I think that it
is equally reasonable to conclude that deficiency interest
attributable to trade or business income is personal interest.
- 54 -
Because a reasonable case can be made for the proposition that
all deficiency interest is personal interest, the temporary
regulations are valid, and we must sustain them. See Chevron,
U.S.A., Inc. v. Natural Resources Defense Council, Inc., supra;
NationsBank v. Variable Annuity Life Ins. Co., supra.
III. Section 1.163-8T and 9T, Temporary Income Tax Regs.,
Is Valid
A. Standard of Review
The majority sets forth the proper standard for reviewing a
regulation. Majority op. pp. 12-13. The majority, I submit,
misapplies that standard.
The narrow question before us is whether section 1.163-
9T(b)(2)(i)(A), Temporary Income Tax Regs., is valid, insofar as
it applies to the facts of the instant case. Therefore, in order
to properly decide that issue, we must, in accordance with the
teaching of NationsBank v. Variable Annuity Life Ins. Co., supra,
answer two questions. First, is section 163(h) silent or
ambiguous with respect to either: (a) The standard for
determining which items of indebtedness are "properly allocable"
to a trade or business, or (b) "the specific issue at hand",
which is whether interest paid with respect to an individual's
Federal income tax liability is deductible? NationsBank v.
Variable Annuity Life Ins. Co., 513 U.S. at __, 115 S. Ct. at
813-814. Second, is section 1.163-9T(b)(2)(i)(A), Temporary
Income Tax Regs., a permissible interpretation of section 163(h)
in that it "fills a gap or defines a term in a way that is
reasonable in light of the legislature's revealed design"?
- 55 -
NationsBank v. Variable Annuity Life Ins. Co., supra at 813-814.
In this case, my answer to each of the above questions is
yes. Therefore, section 1.163-9T(b)(2)(i)(A), Temporary Income
Tax Regs., is valid and must be given "controlling weight".
NationsBank v. Variable Annuity Life Ins. Co., supra at 813-814.
B. An Ambiguous Statute
Section 163(h) was added to the Code by the Tax Reform Act
of 1986, Pub. L. 99-514, sec. 511(b), 100 Stat. 2085, 2246. In
the case of individual taxpayers, section 163(h)(1) disallows a
deduction for all personal interest paid or accrued during the
taxable year. Section 163(h)(2) then provides that all interest
is personal interest unless that interest falls into one of the
five exceptions listed in paragraph (2). The only relevant
exception for our purposes is contained in subparagraph (A),
which provides that the term "personal interest" does not include
"interest paid or accrued on indebtedness properly allocable to a
trade or business”. Sec. 163(h)(2)(A) (emphasis added).
The term "properly allocable" is ambiguous, because Congress
has not indicated the method by which, or the assumptions under
which, taxpayers, the Service, and the courts are to decide
whether a particular indebtedness is "properly allocable" to a
trade or business. Clearly, there is more than one way to
allocate interest. Compare, for example, the asset based
apportionment method found in section 265(b)(2) with the tracing
method outlined in section 1.163-8T(a)(3), Temporary Income Tax
Regs., 52 Fed. Reg. 24999 (July 2, 1987). More importantly, the
statute is silent with respect to the specific issue at hand--
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whether interest with respect to an individual's Federal income
tax liability is deductible. For the foregoing reasons, the
first requirement of the NationsBank teaching is satisfied.
C. The Temporary Regulations Promulgated Under
Section 163(h) Are Permissible Agency Interpretations
1. Section 1.163-8T, Temporary Income Tax Regs.
Is Valid
In order to give meaning to the term "properly allocable",
and thereby implement section 163(h)(2)(A), the Secretary has
promulgated section 1.163-8T, Temporary Income Tax Regs. The
focus of the temporary regulations is on the relationship between
an individual's debts and her activities. That is because, under
section 163(h)(2)(A), interest piggybacks on indebtedness, and it
is the allocation of a particular indebtedness to a trade or
business that establishes the deductibility of the related
interest: "interest paid or accrued on indebtedness properly
allocable to a trade or business". Sec. 163(h)(2)(A) (emphasis
added). The general rule of the temporary regulations is that
interest on indebtedness is allocated in the same manner in which
the underlying debt is allocated. Sec. 1.163-8T(a)(3), Temporary
Income Tax Regs. "Debt", the temporary regulations prescribe,
"is allocated by tracing the disbursements of the debt proceeds
to specific expenditures." Id. Thus, for interest to be
deductible pursuant to section 163(h)(2)(A), the interest must be
traceable to a debt-financed trade or business expenditure (i.e.,
an expenditure made in connection with the conduct of a trade or
business). See sec. 1.163-8T(a)(4)(ii), (b)(7), and (c),
Temporary Income Tax Regs., 52 Fed. Reg. 25000 (July 2, 1987).
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For example, if an individual borrows money to take a vacation in
Spain, securing her debt with a mortgage on her business, the
interest on the borrowed funds is personal interest
notwithstanding that the debt is secured by business property.
See sec. 1.163-8T(c)(1) Example, Temporary Income Tax Regs. The
bulk of section 1.163-8T, Temporary Income Tax Regs., is devoted
to prescribing rules for tracing debt to specific expenditures.
The tracing approach selected by the Secretary may at times
appear wooden and mechanical. Thus, an individual with $100 in
savings and two obligations, one to pay $100 to her employees and
one to pay $100 towards her vacation in Spain, can dictate the
tax result of borrowing $100 to pay one of those obligations by
deciding which one to pay with the borrowed $100. Nevertheless,
the tracing approach leaves little room for ambiguity as to
whether an indebtedness is business related, at least in the case
of debt financed expenditures that are clearly business or
personal.
The legislative history of section 163(h) indicates a
Congressional purpose to end the deduction for interest on debt
incurred to fund consumption, or personal, expenditures.
S. Rept. 99-313 (1985), 1986-3 C.B. (Vol. 3) 804; H. Conf. Rept.
99-841 (1986), 1986-3 C.B. (Vol. 4) 154. By requiring the manner
in which borrowed funds are expended to determine whether the
interest on those funds is deductible, the Secretary has defined
the term "properly allocable" in a way that is "reasonable in
light of the legislature's revealed design". NationsBank v.
Variable Annuity Life Ins. Co., 513 U.S. at __, 115 S. Ct. at
- 58 -
813-814. Indeed, in developing the tracing method of interest
allocation in the temporary regulations, the Secretary seriously
considered an alternative of requiring an allocation method based
on pro rata apportionment of interest expense among a taxpayer's
assets. T.D. 8145, 1987-2 C.B. 47, 50. The Secretary rejected
that approach, at least for the present, because of "the
practical and theoretical problems that a comprehensive pro rata
apportionment system would present". Id. No doubt, those
problems included the allocation of deficiency interest among
personal and business assets. Clearly, the problem facing the
Secretary in determining how properly to allocate interest is
very much larger than the narrow question addressed by the
majority. Moreover, nothing in the majority's opinion suggests
that, on an overall basis, the tracing method of allocation
adopted by the Secretary is other than an acceptable choice among
permissible interpretations of the statute: "The choice among
reasonable interpretations is for the Commissioner, not the
courts." National Muffler Dealers Association Inc. v. United
States, 440 U.S. 472, 488 (1979). The majority’s quarrel is not
with the Secretary’s choice of a method of allocation, which goes
only so far as to allocate deficiency interest to a borrowing to
pay taxes. The majority’s quarrel is with the further
conclusion, expressed in section 1.163-9T(b)(2)(i)(A), Temporary
Income Tax Regs., that income taxes on business income are not an
expenditure made in connection with a trade or business. Section
1.163-8T, Temporary Income Tax Regs. is valid.
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2. Section 1.163-9T(b)(2)(i)(A), Temporary Income Tax
Regs., Also Is Valid
a. Are Petitioners' Tax Payments Made in Connection
With Their Trade or Business?
The majority invalidates section 1.163-9T(b)(2)(i)(A),
Temporary Income Tax Regs. Subdivision (A) of section 1.163-
9T(b)(2)(i), Temporary Income Tax Regs., provides that personal
interest includes interest:
Paid on underpayments of individual Federal, State or
local income taxes and on indebtedness used to pay such
taxes (within the meaning of §1.168-8T), regardless of
the source of the income generating the tax liability;
The obligation to pay deficiency interest arises if a
taxpayer fails to make a timely payment of her tax liability, as
finally determined. See sec. 6601(a). For there to be any
possibility that deficiency interest is deductible under section
163(h)(2)(A), we must assume that the underpayment giving rise to
deficiency interest is an indebtedness of the taxpayer. See sec.
163(h)(2)(A). Moreover, the tracing rules of section 1.163-8T,
Temporary Income Tax Regs., require the taxpayer to identify
(1) the proceeds resulting from any indebtedness and (2) the
disbursement of those proceeds to specific expenditures.
Sec. 1.163-8T(a)(3), Temporary Income Tax Regs. Only if the
specific expenditures so identified are business expenditures
within the meaning of section 1.163-8T(b)(7), Temporary Income
Tax Regs., would the related deficiency interest be deductible
under section 163(h)(2)(A). Sec. 1.163-8T(a)(4)(i)(A), Temporary
Income Tax Regs., 52 Fed. Reg. 25000 (July 2, 1987). Of course,
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an underpayment of income tax does not give rise to identifiable
proceeds received from the Government. The temporary regulations
address the situation of unidentifiable debt proceeds under the
heading "Debt assumptions not involving cash disbursements."
Section 1.163-8T(c)(3)(ii), Temporary Income Tax Regs., provides:
If a taxpayer incurs or assumes a debt in consideration
for the sale or use of property, for services, or for
any other purpose, or takes property subject to a debt,
and no debt proceeds are disbursed to the taxpayer, the
debt is treated for purposes of this section as if the
taxpayer used an amount of the debt proceeds equal to
the balance of the debt outstanding at such time to
make an expenditure for such property, services, or
other purpose. [Emphasis added.]
An individual making an underpayment of tax is thus treated as if
she incurred an indebtedness equal to the amount of such
underpayment and used the proceeds of the indebtedness to
eliminate the underpayment. Such an individual is treated the
same as an individual who avoided any underpayment by borrowing
from a third party the funds necessary to make a full payment.
Indeed, it is difficult to see a tracing system distinguishing
between those two cases without getting into the type of
apportionment that tracing is designed to avoid. The majority
does not distinguish between those two cases.
The real question, of course, is whether interest on
borrowed funds expended to discharge an individual's income tax
liability is personal interest within the meaning of section
163(h)(2)(A). It is not, on the facts of our case, if
petitioners' payments of their 1989 and 1990 Federal income taxes
are expenditures made in connection with the conduct of their
unincorporated business. See sec. 1.163-8T(a)(4)(i)(A), (b)(7),
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and -9T(b)(1)(i), Temporary Income Tax Regs.
b. A Conclusion Either Way Is Reasonable
Prior to the War Revenue Act, ch. 63, 40 Stat. 300 (1917),
Federal income taxes were deductible. See, e.g., sec. 5(a) of
the Revenue Act of 1916, ch. 463, 39 Stat. 756, 759; Seidman,
Seidman's Legislative History of Federal Income Tax Laws 1938-
1861, 943-944 (1938) (re: 1917 Act). Before 1917, Federal income
taxes allocable to a business reasonably could be considered a
cost of that business, and both any deficiency interest allocable
to such taxes and any interest on indebtedness incurred to pay
such taxes likewise could be considered a cost of business.
Congress, however, has not allowed a deduction for Federal income
taxes since such deduction was eliminated by the War Revenue Act,
ch. 63, sec. 1201(1), 40 Stat. 300, 330 (1917).1 By not allowing
a deduction, Congress has signaled that money expended for
Federal income taxes constitutes a consumption expenditure, and
not a cost of earning income.
Congress’ present treatment of Federal income taxes is
1
See sec. 275(a)(1) (no deduction for Federal income
taxes); Seidman, Seidman's Legislative History of Federal Income
Tax Laws 1938-1861, 943-944 (1938) (re: 1917 Act). Sec.
275(a)(1) was added to the Code by section 207 of the Revenue Act
of 1964, Pub. L. 88-272, 78 Stat. 19, 40. Sec. 275(a)(1) merely
restates preexisting law (which was contained in sec. 164(b)(1)).
Both the Committee on Ways and Means and the Committee on Finance
had the following to say about preexisting law: "Under present
law, certain taxes, largely Federal taxes, may not be deducted in
any case either as taxes, or as business expenses or as expenses
incurred in the production of income.” (Emphasis added.)
H. Rept. 749, 88th Cong., 1st Sess. (1963), 1964-1 C.B. (Part 2)
125, 174 (that report accompanied H.R. 8363, 88th Cong.,
1st. Sess., which was enacted as the Revenue Act of 1964, Pub. L.
88-272, 78 Stat. 19); S. Rept. 830, 88th Cong., 2d Sess. (1964),
1964-1 C.B. (Part 2) 505, 560 (similar).
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reasonable. Plainly, an expenditure made for Federal income
taxes is not an expenditure made in consideration of any specific
property or service received by the taxpayer. The payment of
Federal income taxes is a civic duty, not a matter of business
contract or investment advantage. All taxpayers, as well as
others (citizens and noncitizens) receive benefits on account of
the funding of the Federal Government. The payment of Federal
income taxes reduces a taxpayer's wealth otherwise available for
consumption. Thus, Federal income tax payments exhibit
characteristics not common to business (or investment)
expenditures. Justice Holmes made a point that serves nicely to
emphasize the nonbusiness aspect to tax payments: "Taxes are
what we pay for civilized society". Compania General de Tabacos
de Filipinas v. Collector of Internal Revenue, 275 U.S. 87, 100
(1927) (Holmes, J., dissenting).
If Federal income taxes constitute consumption, and not a
trade, business, or investment expense, then, under a tracing
rule, such as the rule of section 1.163-8T, Temporary Income Tax
Regs., the inescapable, and reasonable, conclusion is that any
deficiency interest, or interest on a borrowing to pay income
taxes, is personal interest. The taxpayer's purpose for
borrowing the money, or the reason the deficiency arose (e.g.,
"my accountant made a mistake!") simply is irrelevant. Though
that approach may appear wooden, it is unambiguous.
The rule found in section 1.163-9T(b)(2)(i)(A), Temporary
Income Tax Regs., and invalidated by the majority, is nothing
more than a fact-specific application of section 1.163-8T,
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Temporary Income Tax Regs. It is specific to the fact that
Federal taxes are reasonably considered a nondeductible, personal
expenditure. Section 1.163-8T, Temporary Income Tax Regs., is a
valid regulation and must be given "controlling weight".
NationsBank v. Variable Annuity Life Ins. Co., 513 U.S. at __,
115 S. Ct. at 813-814. Accordingly, section 1.163-9T(b)(2)(A),
Temporary Income Tax Regs., also is valid.
D. The Majority's Other Points
The above analysis is sufficient to convince me that the
majority has improperly invalidated portions of the temporary
regulations. Nonetheless, I will address certain of the
majority's other points.
1. The Legislative History of Section 163(h)
In reaching its holding, the majority relies in part on the
scant legislative history behind section 163(h). The majority's
main concern lies in the fact that the conference committee
report cryptically states that, after the enactment of section
163(h), personal interest will "generally" include interest on
tax deficiencies. H. Conf. Rept. 99-841 at II-154 (1986), 1986-3
C.B. (Vol. 4) at 154. The majority asserts that the term
"deficiencies" is a term of art and concludes that the word
"generally" must mean that Congress intended to carve out from
the term “personal interest” the interest on tax deficiencies
that are allocable to a trade or business within the meaning of
the decisions in Reise v. Commissioner, 35 T.C. 571 (1961), affd.
299 F. 2d 380 (7th Cir. 1962); Polk v. Commissioner 31 T.C. 412(1958), affd. 276 F.2d 601 (10th Cir. 1960); and Standing v.
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Commissioner, 28 T.C. 789 (1957); affd. 259 F.2d 450 (4th Cir.
1958). Majority op. pp. 20-22.
The majority's conclusion does not necessarily follow from
the language in the committee report. First, whether or not the
term “deficiency” has an established meaning for purposes of
statutory construction, I am unconvinced that we ought to ascribe
to the drafters of a conference report the same care that is
supposed in the drafting of statutes. Moreover, there is at
least one instance consistent with the temporary regulations in
which deficiency interest paid by an individual is not personal
interest. Prior to the disallowance of a deduction for personal
interest, courts held that a transferee under section 6901 (tax
liability resulting from transferred assets) could deduct
interest on an income tax deficiency that accrued after the
transfer of the assets to which the tax related. Haden Co. v.
Commissioner, 165 F.2d 588, 591 (5th Cir. 1948), affg. a
Memorandum Opinion of this Court; Merritt v. Commissioner, T.C.
Memo. 1964-164. Although perhaps not technically a deficiency of
the transferee, the deficiency and interest collected from a
transferee are collected pursuant to the usual deficiency
procedures. See sec. 301.6901-1(a)(1)(iii), Proced. & Admin.
Regs. Section 1.163-9T(b)(2) (iii)(C), Temporary Income Tax
Regs., 52 Fed. Reg. 48410 (Dec. 22, 1983), excludes from the
definition of personal interest any interest paid with respect to
a C corporation's underpayment of income tax. I assume that is
because the interest is regarded as investment interest within
the meaning of section 163(h)(2)(C).
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Thus, the conference committee report does not exclusively
support the majority's interpretation of the statute. The aspect
of the report relied on by the majority is ambiguous and should
be given little weight in determining what deficiency interest is
personal interest. The ambiguity of the report only supports the
conclusion that the regulation at issue here is valid, because
the statute, itself, is ambiguous.
2. And What About Reise, Polk, and Standing?
In reaching its conclusion that section 1.163-
9T(b)(2)(i)(A), Temporary Income Tax Regs., is invalid, the
majority relies on Reise v. Commissioner, supra; Polk v.
Commissioner, supra; and Standing v. Commissioner, supra, for the
proposition that certain deficiency interest has been interpreted
to constitute a trade or business expense for various purposes,
e.g., for applying section 62(a)(1) in determining adjusted gross
income. The majority apparently believes that those
interpretations have been woven into the fabric of the Code in
such a way that only a specific act of Congress could remove
them. Majority op. p. 15. In the context in which those
interpretations were made (e.g., a question arising under what is
now section 62(a)(1), when the distinction between business and
personal interest was otherwise unimportant), perhaps the
majority has a point. The majority's focus, I submit, is too
narrow. The proper allocation of indebtedness for purposes of
section 163(h)(2)(A) is not limited to indebtedness giving rise
to deficiency interest. Congress left it to the Secretary to
interpret the statutory command--"properly allocable”--for all
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categories of debt. The tracing method of interest allocation
settled on by the Secretary is applicable across the board, not
just in the case of an indebtedness arising on account of an
underpayment. Indeed, it is difficult to discern a coherent
scheme of interest allocation from the three cited cases. It
would be a very small tail wagging a very large dog if we were to
let those cases determine what is a proper method of interest
allocation for all classifications of indebtedness.
3. Discrimination as to Form of Doing Business
The majority postulates that (1) the expenditure method of
allocation found in section 1.163-8T, Temporary Income Tax Regs.,
"excludes an entire category of interest expense in disregard of
a business connection such as exists herein" and (2) "Such a
result discriminates against the individual who operates his or
her business as a proprietorship instead of in corporate form
where the limitations on the deduction of 'personal interest'
would not apply." Majority op. pp. 16-17.
As a preliminary matter, the majority has not identified
the business connection here. The majority relies on cases whose
reasoning it concedes is confusing. Majority op. p. 11.
Moreover, the majority has warned that, to satisfy section
163(h)(2)(A), it is insufficient simply to show that the cause of
the deficiency interest is an underpayment of income tax
attributable to a trade or business. Majority op. pp. 26-27.
The majority has not specified the principles to be used in
deciding future cases. Assuming that there are such principles,
however, the majority does not explain why Congress may not
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discriminate between individuals doing business as
proprietorships and in corporate form. Granted, section 163(h)
applies only to individuals. Congress has been of two minds as
to the deductibility of Federal income taxes, and perhaps the
distinction reflects some residual ambiguity. Perhaps Congress
views corporate deficiency interest as properly an investment
expense of shareholders. We do not know. In any event, the
majority has not convinced me that the inconsistency is
unconstitutional.
E. Conclusion
Again, the temporary regulations in question, section 1.163-
8T and 9T, Temporary Income Tax Regs., resolve ambiguities and
fill gaps in the statute in a permissible fashion, and for that
reason, must be upheld. NationsBank v. Variable Annuity Life
Ins. Co., 513 U.S. __, 115 S. Ct. at 813-814.
I would hold for respondent.
HAMBLEN, COHEN, WHALEN, and BEGHE, JJ., agree with this
dissent.