Case Name: James E. Redlark and Cheryl L. Redlark, Petitioners v. Commissioner of Internal Revenue, Respondent
Court: United States Tax Court
Jurisdiction: United States
Decision Date: 1996-01-11
Citations: 106 T.C. 31
Docket Number: Docket No. 4445-94
Parties: James E. Redlark and Cheryl L. Redlark, Petitioners v. Commissioner of Internal Revenue, Respondent
Judges: Swift, Jacobs, Wright, Parr, Wells, Chiechi, and Vasquez, JJ., agree with this majority opinion.
Reporter: Reports of the Tax Court of the United States
Volume: 106
Pages: 31–75

Head Matter:
James E. Redlark and Cheryl L. Redlark, Petitioners v. Commissioner of Internal Revenue, Respondent
Docket No. 4445-94.
Filed January 11, 1996.
Clare Golnick, for petitioners.
Paul L. Dixon, for respondent.

Opinion:
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 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).
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), Temporary Income Tax Regs., supra, 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:
SEC. 62(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:
SEC. 163(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 tp a trade or business (other than the trade or business of performing serv- ices 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 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). The question remains, however, whether the elements giving rise 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) in the event tfiat 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 ques tion 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 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)(l) 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 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 Aaron 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 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). 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. Rui. 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 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 sé 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 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 Taxn. 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), Tern- porary Income Tax Regs., supra, which specifically denies the deduction herein claimed. This case is one of first impression in this Court on this issue. See supra p. 33. 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.
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., supra at 24 (quoting United States v. Correll, 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 Con gress 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." 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, 35 T.C. 571 (1961); Polk v. Commissioner, 31 T.C. 412 (1958); Standing v. Commissioner; 28 T.C. 789 (1957). 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 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)(l)(i), Temporary Income Tax Regs., 52 Fed. Reg. 48409 (Dec. 22, 1987), specifically references section 1.163-8T, Temporary Income Tax Regs., supra, 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". Addition ally, 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., supra, "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., supra, 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., supra, 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 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., supra, which treats interest on income tax deficiencies as personal interest (see infra pp. 42-43), 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., supra, 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., supra, 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 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., supra, 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., supra, necessarily provides a sufficient basis for validating, under all circumstances, the specific provision of section 1.163-9T, Temporary Income Tax Regs., supra. 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) 1, 804; H. Conf. Rept. 99-841, at 11-154 (1986), 1986-3 C.B. (Vol. 4) 1, 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., supra, are unreasonable as applied to the facts herein, it is possible to conclude that the provisions are sufficiently elliptical so that thé validity of section 1.163-9T, Temporary Income Tax Regs., supra, 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., 52 Fed. Reg. 48409 (Dec. 22, 1987), provides:
(2) Interest relating to taxes — (i) In general. Except as provided in paragraph (b)(2)(iii) of this section, personal interest inclúdes 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, supra at II— 154, 1986-3 C.B. (Vol. 4) at 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.
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 Consol., 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 11-154, 1986-3 C.B. (Vol. 4) at 154; see also S. Rept. 99-313, supra at 804-806, 1986-3 C.B. (Vol. 3) at 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., supra, is reasonable and that additional proof of reasonableness is provided by the statement in the Joint Committee Staff Explanation. See supra p. 43. 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) (describing "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. 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, etei,-taxes in order to account for the use of 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., supra.
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 Poly. 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. 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); 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, Inc. 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 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, 31 T.C. 412 (1958). It would constitute an unrealistic 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., supra, 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 AFTR 2d 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.
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.
Unless otherwise indicated, ail 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.
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 AFTR 2d 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 subch. S corporations of which the taxpayers were partners or shareholders and not to their businesses as individuals.
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.
The standard adopted by Aaron v. Commissioner, 22 T.C. 1370 (1954), imported the statement in the legislative history of sec. 22(n)(l) 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).
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.
The judicial history of Miller v. United States, 65 F.3d 687 (8th Cir. 1995), affg. 95-1 USTC par. 50,068, 76 AFTR 2d 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 AFTR 2d 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 AFTR 2d a.t 95-5166. The Court of Appeals for the Eighth Circuit then held that, contrary to the conclusion of the District Court, the regulation was valid, and as such, disposi-tive 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.
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 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).]
In this connection, wo also note that the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, was enacted on Oct. 22, 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.