Court Opinion

ID: 4472754
Source: CourtListenerOpinion
Date Created: 2020-01-14 19:34:53.641415+00
Date Added: 2024-06-11T12:01:33.995016
License: Public Domain

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 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 süch 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. 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. Sections 1.163-8T and 1.163-9T, Temporary Income Tax Regs., Are Valid A. Standard of Review The majority sets forth the proper standard for reviewing a regulation. Majority op. pp. 38-39. 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., supra, 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., supra, 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”? NationsBank v. Variable Annuity Life Ins. Co., 513 U.S. at _, 115 S. Ct. 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., supra, is valid and must be given “controlling weight”. NationsBank v. Variable Annuity Life Ins. Co., 513 U.S. at _, 115 S. Ct. 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 subpara-graph (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 — 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., supra. 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., supra. “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). 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)(l) Example, Temporary Income Tax Regs., supra. The bulk of section 1.163-8T, Temporary Income Tax Regs., supra, 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, 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. 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 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 personál 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., supra, 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., supra, is valid. 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., supra. Subdivision (A) of section 1.163-9T(b)(2)(i), Temporary Income Tax Regs., supra, 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., supra, 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., supra. Only if the specific expenditures so identified are business expenditures within the meaning of section 1.163-8T(b)(7), Temporary Income Tax; Regs., supra, 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, 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., supra, 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 ■meáhíng of sec-, tion 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 théir unincorporated business. See secs. 1.163— 8T(a)(4)(i)(A), (b)(7), 1.163-9T(b)(l)(i), Temporary Income Tax Regs., supra. 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, at 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 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., supra, 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 infection 1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs., supra, and invalidated by the majority, is nothing more than a fact-specific application of section 1.163-8T, Temporary Income Tax Regs., supra. It is specific to the fact that Federal taxes are reasonably considered a nondeductible, personal expenditure. Section 1.163-8T, Temporary Income Tax Regs., supra, 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., supra, 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, supra at 11-154, 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. Commissioner, 28 T.C. 789 (1957); affd. 259 F.2d 450 (4th Cir. 1958). Majority op. pp. 44-45. 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-l(a)(l)(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). 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., supra, 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. 43. 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 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., supra, “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. 40-41. 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. 37. 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. p. 47. 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 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, sections 1.163-8T and 1.163-9T, Temporary Income Tax Regs., supra, 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. at _, 115 S. Ct. at 813-814. I would hold for respondent. Hamblen, Cohen, Whalen, and Beghe, JJ., agree with this dissent.   See sec. 275(a)(1) (no deduction for Federal income taxes); Seidman, Seidman’s Legislative History of Federal Income Tax Laws 1938-1861, at 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 expe?ises 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).