PUBLISHED

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

RICHARD R. ALLEN, SR., a resident

of Fayetteville, NC,

Plaintiff-Appellee,

v.

No. 98-1401

UNITED STATES OF AMERICA, acting

by and through the Internal

Revenue,

Defendant-Appellant.

Appeal from the United States District Court

for the Eastern District of North Carolina, at Raleigh.

James C. Fox, District Judge.

(CA-96-909-5-F2)

Argued: October 27, 1998

Decided: April 20, 1999

Before WILKINSON, Chief Judge, and ERVIN and

WILKINS, Circuit Judges.

_________________________________________________________________

Reversed by published opinion. Judge Ervin wrote the opinion, in

which Chief Judge Wilkinson and Judge Wilkins joined.

_________________________________________________________________

COUNSEL

ARGUED: Charles Bricken, Tax Division, UNITED STATES

DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant.

David D. Dahl, MANNING, FULTON & SKINNER, P.A., Raleigh,
North Carolina, for Appellee. ON BRIEF: Loretta C. Argrett, Assistant Attorney General, Janice McKenzie Cole, United States Attorney, Jonathan S. Cohen, Tax Division, UNITED STATES

DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant.

_________________________________________________________________

OPINION

ERVIN, Circuit Judge:

The Internal Revenue Service (IRS) and taxpayer Allen dispute

whether § 163(h) of the Internal Revenue Code (I.R.C.) of 1986 is

facially ambiguous, and further, whether Temp. Treas. Reg. § 1.163-

9T(b)(2)(i)(A), which prohibits the deduction of individual income

tax deficiency interest, is a valid regulation. See I.R.C. § 163(h)

(1986); Temp. Treas. Reg. § 1.163-9T (1987). The district court

found for Allen, ruling that the language of § 163(h) is clear, unambiguous, and in conflict with Temp. Treas. Reg.§ 1.163-

9T(b)(2)(i)(A).

As the expert agency charged with administering the Internal Revenue Code, the Treasury may promulgate reasonable regulations for

the purpose of implementing ambiguous Code provisions. We find

without doubt that I.R.C. § 163(h) is facially ambiguous; we also find

Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) to be a reasonable construction of I.R.C. § 163(h). Accordingly, we reverse the district court

and hold that an individual taxpayer may not deduct income tax deficiency interest, regardless of the source of the income.

I.

With the Tax Reform Act of 1986, Congress largely eliminated the

deduction for personal interest under the U.S. Tax Code. Pursuant to

a provision of this Act, I.R.C. § 163(h), individual taxpayers may no

longer deduct interest on indebtedness, with the exception of "interest

paid or accrued on indebtedness properly allocable to a trade or business." I.R.C. § 163(h)(2)(A).

The Treasury has issued regulations implementing I.R.C. § 163(h);

one such regulation includes within the scope of non-deductible per-

 2
sonal interest any interest paid "on underpayments of individual Federal, State, or local income taxes ... regardless of the source of the

income generating the tax liability." Temp. Treas. Reg. § 1.163-

9T(b)(2)(i)(A).

In 1995 the IRS denied Taxpayer Allen a deduction for his payment of income tax deficiency interest. Allen subsequently filed a tax

refund suit in district court. The district court ruled that the language

of I.R.C. § 163(h) is so unambiguous on its face that Temp. Treas.

Reg. § 1.163-9T(b)(2)(i)(A) is per se invalid. The Government

appeals from this judgment.

II.

The facts of this case are essentially uncontested. Allen is a real

estate developer; he is also the director and majority shareholder of

D.R. Allen & Son, Inc.( the "Company"), a North Carolina corporation in the business of general contracting. In August of 1983 the

Company found itself in need of additional working capital, which it

sought to borrow from First Union Bank. In his personal capacity as

the owner of valuable real estate, Allen agreed to transfer certain of

his properties to the Company, to provide an injection of equity and

to serve as collateral for the First Union loan.

The two transfers at issue occurred in 1984. The first involved a

partnership, Clarendon House, that held among its assets a tract of

land upon which apartments were subsequently built. On January 1,

1984, Allen transferred his interest in the Clarendon House partnership to the Company. The Company sold the Clarendon House tract

in May of 1984.

The second transfer involved a 52-acre parcel of land (the "Belk

tract") upon which stood the Belk Service Center and the D.R. Allen

& Son office building. In July of 1984 Allen entered a contract to sell

the parcel for nearly $3.7 million. The closing date, originally scheduled for September of 1984, was later extended. Allen then transferred his interests in the land, the improvements, and the contract of

sale to the Company. In October of 1984 the Company sold the tract

pursuant to the modified contract of sale.

 3
The Company reported the gain on the sale of the Clarendon House

tract and the Belk tract on its corporate income tax return for 1984.

The IRS eventually audited Allen and determined that he should have

reported the gain on the sale of both properties on his own 1984 individual return. In September of 1992 the IRS assessed Allen an additional $833,664 of income tax due for the year 1984, with the

deficiency arising primarily from the unreported gain on the sale of

the Belk and Clarendon House tracts.

Allen petitioned the Tax Court for a redetermination of the deficiency. While the Tax Court proceeding was pending, Allen paid the

government $1,000,000 toward his potential 1984 income tax liability, directing that $500,000 of this sum should be applied to interest

on his as-yet undetermined deficiency. In 1993 the parties settled the

Tax Court case, with Allen agreeing to an increase in his 1984 income

tax liability of $541,882. The following year Allen filed an amended

1992 return and claimed a refund of $159,650 in 1992 income tax,

based on a deduction from his 1992 income of the $500,000 paid to

the IRS as interest on his 1984 deficiency.

In January of 1995 the IRS disallowed Allen's refund claim, noting

in a letter of explanation that income tax deficiency interest is considered nondeductible personal interest pursuant to Temp. Treas. Reg.

§ 1.163-9T(b)(2)(i)(A). Allen challenged the IRS determination by

filing the instant case in district court.

Following a bench trial the district court ruled in Allen's favor. The

court concluded that Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) contradicts the plain and unambiguous meaning of I.R.C.§ 163(h). See

Allen v. United States, 987 F.Supp. 460, 468 (E.D.N.C. 1997). Given

its view of the plain meaning of § 163(h), the district court declined

to undertake any analysis of the statute's legislative history. See Allen,

987 F.Supp. at 466; see also Chevron U.S.A. v. Natural Res. Def.

Council, Inc., 467 U.S. 837, 842-843 (1984) ("[i]f the intent of Congress is clear, that is the end of the matter; for the court, as well as

the agency, must give effect to the unambiguously expressed intent

of Congress").

Having invalidated Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A), the

district court proceeded to find that Allen's $500,000 interest payment

 4
was deductible as an ordinary and necessary expense of his real estate

business. See Allen, 987 F.Supp. at 468.

III.

The validity of Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) appears

to be an issue of first impression in the Fourth Circuit, although taxpayers have litigated the issue elsewhere. We note that a sharply

divided United States Tax Court refused to uphold the regulation in

1996, see Redlark v. Commissioner, 106 T.C. 31, 46 (1996); however,

the Ninth Circuit later reversed this decision. See Redlark v.

Commissioner, 141 F.3d 936, 941 (9th Cir. 1998). The Eighth Circuit

has also judged Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) to be a permissible construction of I.R.C. § 163(h). See Miller v. United States,

65 F.3d 687 (8th Cir. 1995).

We begin our own inquiry by asking whether the statute is facially

ambiguous. Ordinarily we give great deference to the Commissioner's

interpretation of ambiguous Code provisions; thus when a statute is

ambiguous we must uphold any Treasury regulation that implements

the statutory purpose in some reasonable manner. See Rowan Cos. v.

United States, 452 U.S. 247, 252 (1981). Yet, on those occasions

when Congress speaks unambiguously, we must overturn a regulation

that clearly conflicts with the plain text of the statute. See

NationsBank of N.C., N.A. v. Variable Annuity Life Ins. Co., 513 U.S.

251, 257 (1995) (citing Chevron, 467 U.S. at 843).

This is not such an occasion. As enacted, § 163(h) permits a deduction for personal interest only if such interest is deemed "properly

allocable" to a trade or business. Congress did not see fit to define the

term "properly allocable" in the context of personal interest, so in the

absence of a statutory directive we conclude that§ 163(h) is manifestly ambiguous.1 As evidence that § 163 lacks a plain meaning, we

need look no further than the sharply divergent opinions of the United

_________________________________________________________________

1 The Ninth Circuit has voiced a similar opinion, describing as "untenable" the assertion that the words "properly allocable" unambiguously render business-related income tax deficiency interest deductible. Redlark,

141 F.3d at 940.

 5
States Tax Court, which could not agree upon a single reading of the

statute. See Redlark, 106 T.C. at 31.

Taxpayer Allen persuaded the district court that§ 163(h) must be

harmonized with an antecedent line of cases in which courts classed

deficiency interest as a business expense for the purpose of calculating either adjusted gross income, see Standing v. Commissioner, 28

T.C. 789 (1957), aff'd, 259 F.2d 450 (4th Cir. 1958), or net operating

loss. See Polk v. Commissioner, 31 T.C. 412 (1958), aff'd, 276 F.2d

601 (10th Cir. 1960). See also Reise v. Commissioner, 35 T.C. 571

(1961), aff'd, 299 F.2d 380 (7th Cir. 1962). In the opinion of the district court, these few cases "clearly establish[ed] that interest on a tax

deficiency could be a deductible business expense." Allen, 987

F.Supp. at 465.

We decline to adopt the view that the Standing line controls the

meaning of § 163(h), because those cases do not concern whether

income tax deficiency interest is deductible per se. Under pre-1986

tax law, most forms of interest, including personal interest, were

deductible. Standing, Polk, and Reise addressed how the taxpayer

should treat an otherwise-permissible deduction when making specific line item computations.2

The holding of Standing must be limited to the calculation of

adjusted gross income; the holdings of Polk and Reise to the calculation of net operating loss. We shall not attempt to distill from these

three cases more comprehensive decision rules for interest allocation.

As Judge Halpern of the Tax Court concluded in his Redlark dissent,

to do so would be to allow a small tail to wag a very large dog. See

Redlark, 106 T.C. at 73.

The 1986 Tax Reform Act fundamentally altered the tax character

of personal interest, creating the presumption that such interest is non-

_________________________________________________________________

2 These cases do not establish that deficiency interest is always deductible when computing adjusted gross income or net operating loss; rather,

the cases erect a high threshold for proof of a connection between the

underlying indebtedness and the taxpayer's business. See Melinda L.

Reynolds, Redlark v. Commissioner: A "Bird in the Hand" for NonCorporate Taxpayers? 47 Case. W. Res. L. Rev. 751, 759 (1997).

 6
deductible. This sweeping change in the tax law casts doubt upon the

contemporary relevance of the Standing cases.3 Additionally, after the

Treasury promulgated Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A),

Congress re-wrote § 163(h) in less precise terms. As first enacted,

§ 163(h) had permitted a deduction for interest "incurred or continued

in connection with the conduct of a trade or business." In 1988 Congress deleted the words "incurred or continued in connection with"

and substituted the more general "properly allocable" language. See

Technical and Miscellaneous Revenue Act of 1988, Pub.L. No. 100-

647, 102 Stat. 3342, 3390. This retroactive amendment, whatever its

purpose, rendered the meaning of § 163(h) even less certain.

IV.

Because we find that § 163(h) is ambiguous on its face, we next

examine whether Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) is a permissible construction of the statute. See Chevron, 467 U.S. at 843. In

so doing, we need not conclude that the regulation in question is the

only, or even the best possible means of implementing the statute. See

id. at 843 n.11. Instead, we simply ask whether the administrative

interpretation embodied in Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A)

is reasonable. See Chevron, 467 U.S. at 845.

Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) must be read in conjunction with Temp. Treas. Reg. § 1.163-8T, which provides tracing rules

for the allocation of interest expenditures. Under§ 1.163-8T, interest

is allocated in the same manner as the debt to which it relates; the

underlying debt is allocated based upon the taxpayer's use of the debt

proceeds. See Temp. Treas. Reg. § 1.163-8T(a)(3). In cases where the

taxpayer does not actually receive the debt proceeds (e.g., deficiency

interest), the IRS looks to the expenditure that gave rise to the debt,

and subjects interest on the debt to any limitations governing the

expenditure. See Temp. Treas. Reg. § 1.163-8T(c)(3)(iii).

_________________________________________________________________

3 As the Ninth Circuit observed in Redlark, "[c]ontrary to the Redlarks'

assertions, the fact that courts consistently allowed the type of deduction

they are now seeking before the enactment of the Tax Reform Act of

1986 and its implementing regulations does not lend support to the argument that such a deduction must continue to be allowable under the new

statute." 141 F.3d at 940.

 7
Pursuant to these allocation rules, deficiency interest is allocable to

the payment of income taxes, an expenditure that is purely personal

in nature. Income taxes are a personal expenditure because an individual's income tax obligation arises from all sources of income, not

merely business income, and because the payment of income taxes is

regarded, in an economic sense, as personal consumption, not as a

cost of earning income.4 It follows, therefore, that individual income

tax deficiency interest is not "properly allocable" to a trade or business. In plain English, interest on an unpaid income tax debt is never

a cost of doing business, because no taxpayer may claim that he or

she is in the business of not paying taxes.

We find Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) to be an eminently reasonable and easily administrable construction of § 163(h).

No mention of § 163(h) in the legislative history of the Tax Reform

Act would suggest otherwise. The authoritative history of the 1986

Tax Reform Act contains only a single reference to§ 163(h) as it concerns tax deficiencies: a line in the Conference Committee report that

states, "[p]ersonal interest also generally includes interest on tax deficiencies." H.R. Conf. Rep. No. 841, 99th Cong., 2nd Sess. II-154

(1986). This statement, otherwise unembellished, does not support the

conclusion that Congress intended to exclude income tax deficiency

interest allocable to a trade or business from the broader category of

non-deductible personal interest.

The General Explanation of the Tax Reform Act of 1986 more

directly contradicts the position of taxpayer Allen. This document,

created after the enactment of the statute it explains, provides in pertinent part: "[p]ersonal interest also includes interest on underpayments

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 trade

or business." Staff of the Joint Committee on Taxation, 100th Cong.,

1st Sess., General Explanation of the Tax Reform Act of 1986 (266

Comm. Print 1987).

_________________________________________________________________

4 Personal consumption includes spending for the necessities and luxuries of life. Under the I.R.C., such costs are presumptively nondeductible. See Marvin A. Chirelstein, Federal Income Taxation 96

(1997).

 8
We recognize that the General Explanation is not controlling

authority, but, in the absence of any clearer statement of legislative

intent, this explanation of the statute, prepared by the joint committee

staff, may nonetheless shed some light on the matter. The definition

of "personal interest" in the General Explanation explicitly includes

deficiency interest; this interpretation of the statute supports the position that the Treasury has taken in Temp. Treas. Reg. § 1.163-

9T(b)(2)(i)(A).

Lastly, Allen reminds this Court that the Treasury's interpretation

of § 163(h) disadvantages all taxpayers who operate their businesses

as sole proprietors. If Allen is correct and the negative impact of

Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) is widespread, the failure of

Congress to address the status of income tax deficiency interest, once

the IRS had explicitly classed such interest as non-deductible, suggests, albeit indirectly, that legislators do not view Temp. Treas. Reg.

§ 1.163-9T(b)(2)(i)(A) as inconsistent with the statute.

V.

Section 163(h) of the Internal Revenue Code is facially ambiguous

and in obvious need of interpretation. This unenviable task falls to the

Department of the Treasury, not to the federal courts. Because we

find that Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) is a permissible,

indeed, a reasonable construction of the statute, we reverse the decision of the district court and hold that individual income tax deficiency interest is a non-deductible personal expenditure.

REVERSED

 9