Flood v. U.S., 93-35429

• Citation: 33 F.3d 1174
• Decision Date: 31 August 1994
• Docket Number: No. 93-35429,93-35429
• Parties: -6122, 94-2 USTC P 50,454 James J. FLOOD; Joan L. Flood, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

Page 1174

33 F.3d 1174

74 A.F.T.R.2d 94-6122, 94-2 USTC P 50,454

James J. FLOOD; Joan L. Flood, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.

No. 93-35429.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Aug. 4, 1994.

Decided Aug. 31, 1994.

Gilbert S. Rothenberg, Tax Div., U.S. Dept. of Justice, Washington, DC, for defendant-appellant.

John D. Hollinrake, Jr., Bogle & Gates, Seattle, WA, for plaintiffs-appellees.

Appeal from the United States District Court for the District of Alaska.

Before: PREGERSON, CANBY, and BOOCHEVER, Circuit Judges.

PREGERSON, Circuit Judge:

The United States appeals from the decision of the district court granting summary judgment in favor of James and Joan Flood in their claim for an income tax refund. The sole issue before us is whether the amount of investment interest that could be carried forward under Sec. 163(d) of the Internal Revenue Code in effect between 1983 and 1986, ¹ 26 U.S.C. Sec. 163(d), was limited by the taxpayer's taxable income in the year that the investment interest was paid or accrued. We have jurisdiction under 28 U.S.C. Sec. 1291. We hold that the amount that may be carried forward is not limited by the amount of taxable income. We therefore affirm.

BACKGROUND

"Investment interest" is defined, generally, as "interest paid or accrued on indebtedness incurred ... to purchase or carry property held for investment." I.R.C. Sec. 163(d)(3)(i). It is a deductible expense under I.R.C. Sec. 163(a).

In 1969, Congress amended the tax code to limit the amount of investment interest that could be deducted in any taxable year. See Pub.L. No. 91-172, tit. II, Sec. 221(a), 83 Stat. 574 (1969). As amended in 1976, the Sec. 163(d)(1) limitation on deduction of investment interest was equal to the taxpayer's net investment income during the taxable year plus $10,000. ² When Congress imposed a limit on the investment interest deduction, it also for the first time allowed taxpayers to carry forward to following years "the amount not allowable as a deduction solely by reason of [this] limitation." I.R.C. Sec. 163(d)(1).

During the four tax years from 1983 through 1986, the Floods paid or accrued a total of about $2 million in investment interest but earned only about $800,000 in investment In their 1987 joint return, the Floods for the first time reported a surplus of net investment income earned over investment interest paid. The surplus was approximately $900,000. Thereafter, they filed an amended return in which they claimed a $900,000 deduction, derived from carrying forward, under Sec. 163(d)(2), a portion of the $1.2 million excess investment interest which they had carried forward during the tax years 1983-1986. The IRS allowed the deduction, although the government now claims that the IRS erred in doing so.

income. Because their investment income did not exceed their investment interest in any single year, Sec. 163(d)(1) capped the total amount of investment interest that the Floods could deduct during the four years at $800,000. This left about $1.2 million in interest that was not allowable because of Sec. 163(d)(1).

The Floods' 1988 tax return also showed a surplus of net investment income over investment interest. They again filed an amended return, this time claiming as a deduction the remaining $300,000 of excess investment interest that they had not claimed as a deduction the year before. This time the IRS disallowed the deduction. The IRS reasoned that the carryover provided in Sec. 163(d)(2) was limited in any given tax year to the amount of taxable income (adjusted gross income minus itemized deductions and exemptions) reported during that year, and that any excess could not be carried forward. ³

Over the four years in question (1983-86), the IRS calculated that the Floods were entitled to carry forward about $490,000. The IRS noted that the Floods had already been permitted to carry forward and deduct more than this the previous year, through what it characterized as its error. IRS therefore concluded that there was no more investment interest carryover from previous years to deduct in the 1988 tax year, which is the year in question.

The Floods appealed the IRS's ruling to the district court. The parties stipulated to the above facts and submitted the matter for summary judgment. The district court found in favor of the Floods, and the government now appeals the district court's decision, 845 F.Supp. 1367.

DISCUSSION

A number of courts, including two federal appellate courts, have addressed the precise question before us today. ⁴ Of these, only one tax court decision--the first to rule upon the issue--ruled in favor of the government. Beyer v. Commissioner, 92 T.C. 1304, 1989 WL 66555 (1989), rev'd, 916 F.2d 153 (4th Cir.1990). All other courts have agreed that the amount of investment interest that a taxpayer may carry forward under Sec. 163(d) is not limited by the amount of the taxpayer's taxable income in the year that the full amount of investment interest was not allowed as a deduction. The single tax court case that found otherwise was reversed by the Fourth Circuit, and the tax court's conclusion was later explicitly disapproved of by an en banc panel of the tax court. Lenz v. Commissioner, 101 T.C. No. 17 Prentiss Hall 101-133, 1993 WL 393870 (Sept. 30, 1993) (en banc). The government in the case at bar presents no new evidence or arguments that have not previously been addressed by the other courts.

When interpreting a statute we begin by seeking to determine its meaning based on its plain language. Where the statute's language is unambiguous, its plain meaning controls except in those "rare cases where literal application 'will produce a result demonstrably at odds with the intentions of the drafters.' " Almero v. INS, 18 F.3d 757, 760 (9th Cir.1994) (quoting Griffin v. Oceanic Contractors, Inc., 458 U.S. 564, 571, 102 S.Ct. 3245, 3250, 73 L.Ed.2d 973 (1982)). Here, the language of the statute is unambiguous, and its legislative history does not require us to reach a result contrary to its plain meaning.

(1) Plain Meaning.

The dispute between the IRS and the taxpayers centers on the meaning of the definition of "disallowed investment interest" that may be carried forward under Sec. 163(d)(2) to subsequent years. Section 163(d)(3)(E) provides that "[t]he term 'disallowed investment interest' means with respect to any taxable year, the amount not allowable as a deduction solely by reason of the limitation in [Sec. 163(d)(1) ]." (Emphasis added.)

This definition tells us that the amount of "disallowed investment interest" does not qualify for the carryover unless the "sole" reason that it is not allowable as a deduction is because of the limitation in Sec. 163(d)(1). The IRS argues that the limitation in Sec. 163(d)(1) is not the sole reason why the amount by which investment interest exceeds taxable income in a given year is "not allowable as a deduction" in that year. Rather, the IRS contends that this excess amount also is not allowable as a deduction because there happens to be no taxable income for it to offset: a deduction in a given tax year in excess of taxable income would provide no tax benefit in the year taken.

The problem with the IRS's position is that it misconstrues the meaning of "allowable as a deduction." Although not explicitly defined in the tax code, these words are a term of art, with a fixed meaning in the tax arena. Lenz v. Commissioner, 101 T.C. 17, 1993 WL 393870. A deduction is "allowable" if it is "permitted and not otherwise forbidden or limited by the [code], whether or not [the deduction is] actually used and regardless of [its] lack of tax benefit." Sharp, 14 F.3d at 588.

There are two elements to this definition. First, the deduction must be "permitted" by the tax code. Other than the limitation contained in Sec. 163(d)(1), the full amount of investment interest paid or accrued in a given year would clearly be permitted under Sec. 163(a) as a deduction. Second, the deduction must not be otherwise limited or forbidden in the tax code. The only limitation on the deductibility of investment interest in the tax code is that contained in Sec. 163(d)(1). Therefore, the full amount of investment interest paid or accrued in a given year would be "allowable as a deduction" in that year, limited only by the provisions of Sec. 163(d)(1). It is of no avail for the IRS to point out that such a deduction, if it exceeded taxable income in the year accrued or paid, would not produce a tax benefit in that tax year. While that is so, the amount still may be "allowable as a deduction." An expense may be "allowable as a deduction" even if it would produce no tax benefit. Sharp, 14 F.3d at 588.

Therefore, contrary to the IRS's position, the Sec. 163(d)(1) limitation is the "sole" reason that the full amount of investment interest is not "allowable as a deduction" in the taxable year in which it is paid or accrued. It follows that under Sec. 163(d)(2) the full amount of such investment interest disallowed because of Sec. 163(d)(1) in a given year may be carried forward to subsequent tax years, without regard to taxable income.

(2) Purpose and Legislative History.

Against this argument, the government counterpoises its interpretation of the purpose and legislative history of Sec. 163(d). All of the courts to examine the issue have concluded that the purpose of Sec. 163(d) was to prevent a mismatching of investment income and the related expenses of earning that income. See, e.g., Lenz, 101 T.C. 17, 101-133, at 101-137, 1993 WL 393870 (citing, Hearings on H.R. 13270 Before the Senate Comm. on Finance, 91st Cong., 1st Sess., 637-640 (1969)). This purpose does not conflict with the interpretation we adopt here, which permits taxpayers to deduct exactly as much investment interest as they eventually may earn in investment income.

Nevertheless, the government argues...