Robinson v. Comm'r of Internal Revenue, 9574–99.

• Decision Date: 05 September 2002
• Docket Number: No. 9574–99.,9574–99.
• Citation: 119 T.C. No. 4,119 T.C. 44
• Parties: Edward A. ROBINSON III and Diana R. Robinson, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

119 T.C. 44
119 T.C. No. 4

Edward A. ROBINSON III and Diana R. Robinson, Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 9574–99.

United States Tax Court.

Sept. 5, 2002.

Taxpayers petitioned for redetermination of deficiencies arising from disallowance of deduction for interest paid on tax deficiency allocable to sole proprietorship. Abrogating Redlark v. Comm., 1996 WL 10243, the Tax Court, Chabot, J., held that interest paid on underpayment of tax was nondeductible personal interest.

Decision for IRS.

Ruwe, J., filed concurring opinion.

Thornton, J., filed concurring opinion, in which Gerber and Gale, JJ. joined.

Wells, C.J., filed dissenting opinion, in which Swift, Colvin, Laro, and Vasquez, JJ., joined.

Swift, J., filed dissenting opinion, in which Colvin, Laro, Vasquez, JJ., and Wells, C.J., joined.

Vasquez, J., filed dissenting opinion, in which Swift, Colvin, Laro, JJ., and Wells, C.J., joined.

[119 T.C. 44]

P–H operated a law practice as a sole proprietorship at all relevant times. R audited Ps' 1987 joint tax return and made several adjustments to the Schedules A and C attached to this tax return. Ps agreed to R's adjustments and the resulting deficiencies and additions to tax. In 1994, R seized real property that Ps owned; in 1995, R sold the property and applied the proceeds to Ps' underpayment of their 1987 income tax liability and interest thereon. On Schedule C of their 1995 joint tax return, Ps deducted the 1987 underpayment interest that had been thus paid.1. Held: Insofar as sec. 1.163–8T, Temporary Income Tax Regs., 52 Fed.Reg. 24999 (July 2, 1987), and sec. 1.163–9T(b)(2)(i)(A), Temporary Income Tax Regs., 52 Fed.Reg. 48409 (Dec. 22, 1987), apply under the circumstances herein to characterize the 1987 underpayment interest thus paid in 1995 as not being “interest * * * on indebtedness properly

[119 T.C. 45]

allocable to a trade or business” within the meaning of sec. 163(h)(2)(A), I.R.C.1986, and therefore as not being deductible under ch. 1, I.R.C.1986, these regulations are valid.2. Held, further, Redlark v. Commissioner, 106 T.C. 31, 1996 WL 10243 (1996), revd. and remanded 141 F.3d 936 (9th Cir.1998), will no longer be followed.3. Held, further, Ps are not entitled to deduct the interest they paid in 1995 on account of the underpayment of their 1987 income tax liability.Charles B. Sklar¹, for petitioners.

Joseph Ineich, for respondent.

CHABOT, J.

Respondent determined a deficiency in Federal individual income tax for 1995 against petitioners in the amount of $29,879.² The issue for decision is whether petitioners may deduct for 1995 the interest they paid in 1995 on their 1987 Federal individual income tax underpayment.³

FINDINGS OF FACT

Some of the facts have been stipulated; the stipulations and the stipulated exhibits are incorporated herein by this reference.

Petitioners Edward A. Robinson III (hereinafter sometimes referred to as Edward), and Diana R. Robinson resided in Louisiana when they filed their petition in the instant case.

A. Edward's Background

In 1970, Edward was graduated from Grambling State University, cum laude, with a double major in political science and

[119 T.C. 46]

English. In 1971, Edward received a master's degree in criminal jurisprudence from the State University of New York at Albany. In 1975, Edward received his law degree from Rutgers University. Edward also was awarded an honorary LL.D. from World University, in Tucson, Arizona.

After his Rutgers graduation, Edward worked as the chief administrator of the Louisiana Justice Department. Edward resigned from this position and opened his own law practice in 1979. Edward's law practice focused almost exclusively on personal injury cases. At all relevant times; Edward's law practice was operated as a sole proprietorship.

B. 1987 Return and Audit Thereof

During 1989, respondent audited petitioners' 1986 and 1987 joint tax returns. ⁴

On their 1987 tax return, petitioners reported $6,274 interest income and $60,677 net profit from Edward's law practice. On the 1987 Schedule C, petitioners reported $388,000 gross receipts, $18,500 cost of goods sold, and $308,823 deductions, leading to the $60,677 net profit. On the 1987 Form 1040, petitioners reported $3,866 chapter 1 income tax, $5,387 chapter 2 self-employment tax, $502 addition for underpayment of estimated tax, and no withholding or other payments, for a total of $9,755 owed. Petitioners timely paid this $9,755.

Respondent proposed adjustments to petitioners' 1987 taxable income, and a deficiency and additions to tax as shown in table 1.

Table 1

+------------------------------------------------+
                ¦Item ¦Amount ¦
                +------------------------------------------------¦
                ¦ ¦
                +------------------------------------------------¦
                ¦Unreported income 1 ¦$25,377.81¦
                +------------------------------------------------¦
                ¦ ¦
                +------------------------------------------------¦
                ¦Sched. C adjustments—net ¦195,715.95¦
                +------------------------------------------------¦
                ¦ ¦
                +------------------------------------------------¦
                ¦Sched. A adjustment—consequential 2 ¦6,389.00 ¦
                +------------------------------------------------¦
                ¦ ¦
                +------------------------------------------------¦
                ¦Sched. A adjustments—other ¦(658.59) ¦
                +------------------------------------------------¦
                ¦ ¦
                +------------------------------------------------¦
                ¦Deficiency ¦83,632.30 ¦
                +------------------------------------------------¦
                ¦ ¦
                +------------------------------------------------¦
                ¦Addition—sec. 6653(a)(1)(A) ¦4,181.62 ¦
                +------------------------------------------------¦
                ¦ ¦
                +------------------------------------------------¦
                ¦Addition—sec. 6653(a)(1)(B) ¦3 ¦
                +------------------------------------------------¦
                ¦ ¦
                +------------------------------------------------¦
                ¦Addition—sec. 6661 ¦20,908.08 ¦
                +------------------------------------------------+
                

Petitioners agreed to these proposed changes, and the appropriate amounts were assessed.

Respondent seized certain of petitioners' property in 1994, sold the property in 1995, and in 1995 applied $69,617 of the proceeds to petitioners' interest on the underpayment of their 1987 tax liability.

The $69,617 interest payment was not related to any liability on petitioners' 1987 tax return as originally filed, as all such liability had been timely paid. This interest payment was applied only to interest assessed as a result of the 1987 audit deficiency in tax and additions. Petitioners deducted this $69,617 as “Interest: * * * Other” on line 16b of the Schedule C (Edward's law practice) on their 1995 tax return.

On their 1995 tax return, petitioners reported $359,915 net profit from Edward's law practice (Sched.C), $1,410 royalty income (Sched.E), and a $1,702 loss on sales of business property (Form 4797). On the 1995 Schedule C, petitioners reported $523,480 gross receipts, $26,340 cost of goods sold, and $137,225 deductions (including the disputed $69,617 other interest item), leading to the $359,915 net profit. On the 1995 Form 1040, petitioners reported $108,735 chapter 1 income tax, $17,228 chapter 2 self-employment tax, $59 addition for underpayment of estimated tax, and $110,000 estimated tax payments, for a total of $16,022 owed.

The $69,617 was interest paid in 1995, but it was not on indebtedness properly allocable to Edward's law practice, petitioners' only relevant trade or business.

OPINION A. The Parties' Contentions

The parties focus their dispute on whether section 163 prohibits allowance of petitioners' claimed $69,617 Schedule C interest deduction; in particular whether the interest is “on indebtedness properly allocable to a trade or business”, within the meaning of section 163(h)(2)(A), and therefore exempt from the general disallowance rule of section 163(h).

[119 T.C. 48]

Petitioners contend that the $69,617 interest qualifies for the exemption from the disallowance rule and that a regulation to the contrary is invalid, relying on this Court's opinions to that effect. In the alternative, they contend that the regulation is not an authoritative interpretation of the applicable statutory language, the regulation having been issued before the statutory language was enacted.

Respondent relies on the regulation as an authoritative interpretation of an ambiguous statute and notes that the Courts of Appeals of five different circuits have come to the same conclusion. As to the prior opinions on which we relied in invalidating the regulation, respondent's brief states that “It is therefore respondent's position that pre-section 163(h) case law is irrelevant to the resolution of the instant case.” In the alternative, respondent contends that, if we were to conclude “that deficiency interest attributable to a trade or business is deductible, then an allocation of the deficiency interest in this case to the Schedule C adjustments and to the Schedule A adjustments for the 1987 year, will be required.”

Neither side contends that we should distinguish between the factual settings presented in our two prior opinions on this subject. Apart from respondent's alternative contention as to the 1987 Schedule A adjustments, respondent apparently accepts that, if the regulations are not valid, then the interest expense resulting from the 1987 Schedule C adjustments is properly a 1995 Schedule C deduction.

B. Summary of Conclusions

We agree with respondent's primary position and much of respondent's analysis.

Section 162(a) allows a deduction for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business”; this includes interest. Section 163(a) allows a deduction for “all interest paid or accrued within the taxable year on indebtedness”; this is allowed even if the interest would not be deductible under section 162(a). Notwithstanding this broad allowance language there are statutory limitations on amounts (e.g., sec.163(d), relating to investment interest) and prohibitions (e.g., sec.163(f), relating to...