Alfaro v. C.I.R.

• Citation: 349 F.3d 225
• Decision Date: 06 November 2003
• Docket Number: No. 03-60261 Summary Calendar.,03-60261 Summary Calendar.
• Parties: Daniel V. ALFARO; Irma L. Alfaro, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (5th Circuit)

349 F.3d 225

Daniel V. ALFARO; Irma L. Alfaro, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 03-60261 Summary Calendar.

United States Court of Appeals, Fifth Circuit.

November 6, 2003.

Howard P. Newton, Matthews & Branscomb, San Antonio, TX, Kenton E. McDonald, Matthews & Branscomb, Corpus Christi, TX, for Petitioners-Appellants.

Randolph Lyons Hutter, Jonathan S. Cohen, U.S. Dept. of Justice, Tax Div., Charles Casazza, Clerk, U.S. Tax Court, B. John Williams, Jr., IRS, Eileen J. O'Connor, Asst. Atty. Gen., U.S. Dept. of Justice, Washington, DC, for Respondent-Appellee.

Appeal from the United States Tax Court.

Before JOLLY, SMITH, and WIENER, Circuit Judges.

WIENER, Circuit Judge:

Petitioners-Appellants Daniel V. Alfaro and Irma L. Alfaro, husband and wife ("Taxpayers") appeal the ruling of the United States Tax Court ("Tax Court") in its Memorandum Opinion,¹ upholding the notice of deficiency issued by the Internal Revenue Service ("IRS") on behalf of Respondent-Appellee, Commissioner of Internal Revenue ("CIR"). That notice of deficiency disallowed the Taxpayer's claim of a 1996 interest expense deduction of $1,527,695, the amount that they paid in accrued statutory interest that year on an income tax deficiency for a prior year. None dispute that the interest had been paid in 1996 in connection with a compromise between the parties under which the Taxpayers remitted additional taxes on income earned by Daniel Alfaro in his law practice during prior years. Neither is it disputed that this law practice was Mr. Alfaro's principal trade or business. In this issue of first impression in this circuit,² we affirm the Tax Court's validation of the Treasury regulation relied on by the Commissioner for the proposition that statutory interest paid by an individual taxpayer on prior income tax deficiencies is not the kind of interest that is deductible. We do so even though the tax deficiency that produced the liability for statutory interest was the result of underpayment of tax on income generated by the principal trade or business of one of the individual taxpayers.

I. FACTS AND PROCEEDINGS

Based entirely on stipulations, the Tax Court found that, from at least 1982 through 1996, Attorney Alfaro was the sole proprietor of his law practice. The IRS audited the Taxpayers' joint income tax returns for the years 1982-88 and assessed deficiencies related entirely to Taxpayers' income from that law practice. In 1995 the Taxpayers and the IRS settled all matters related to the years in question, and in 1996, the Taxpayers paid $1,527,695 in accrued statutory interest on their agreed income tax deficiencies for the subject years. The income that was the subject of the tax deficiency and in turn gave rise to the statutory interest at issue here was produced by Mr. Alfaro's law practice and thus arose from his principal trade or business for purposes of reporting on Schedule C. For 1996, the year in which the Taxpayers paid the statutory interest, they claimed an interest expense deduction on Schedule C of their joint return.

As reflected in a notice of deficiency issued to the Taxpayers in 2000 as a result of an audit of their 1996 return, the IRS disallowed that interest expense deduction. The Taxpayers challenged the deficiency determination in the Tax Court, arguing that the interest was deductible because the underlying income on which the taxes had been owed was from Mr. Alfaro's trade or business in the practice of law and thus not "personal interest" for purposes of § 163(h) of the Internal Revenue Code ("I.R.C."). The gravamen of the Taxpayers' argument in the Tax Court was that the Commissioner's reliance on Temporary Treasury Regulation § 1.163-9T(b)(2)(i)(A) (the "Regulation") was misplaced. They insist that the Regulation is invalid because, according to Taxpayers, it conflicts with I.R.C. § 163(h). In rejecting the Taxpayer's argument, the Tax Court relied in large part on its recent opinion in Robinson v. Commissioner³ which held this kind of interest to be non-deductible personal interest, relying on the Regulation as authority. Taxpayers timely filed a notice of appeal.

II. ANALYSIS

A. Standard of Review

If the Regulation is valid, the Tax Court must be affirmed. We review de novo the Tax Court's legal determination of the validity of a Treasury regulation.⁴

B. Contentions of Taxpayers

In their appellate brief, counsel for Taxpayers present a strong and cogent argument for reversing the Tax Court. As summarized in that brief, Taxpayers begin by noting that Congress is presumed to have known the case law that was in existence when it enacted the Tax Reform Act of 1986, adding I.R.C. § 163(h) to the Code to abolish the deductibility of specified types of interest. The Taxpayers advance that the prior jurisprudence made clear that interest paid on an individual taxpayer's income tax deficiency is deductible when the underlying deficiency was on income from the trade or business of such taxpayer. And, urge the Taxpayers, given the absence of an unmistakable showing of congressional intent to reverse or depart from such pre-existing case law, it must be presumed to continue in effect. Furthermore, argue the Taxpayers, the language of the 1986 Tax Reform Act reflects a congressional intent for this species of interest to remain deductible.

The Taxpayers continue by insisting that, by characterizing all interest payments on an income tax deficiency of an individual as non-deductible, without excepting interest on a deficiency properly allocable to income from a trade or business, the Regulation is inconsistent with the plain wording of I.R.C. § 163(h). And a regulation that contradicts the plain meaning of the statute that it addresses, assert the Taxpayers, is invalid. Taxpayers further contend that the Treasury's issuance of the Regulation without following routine notice and comment procedures eschews the usual deference to which regulations promulgated by a federal agency are entitled under Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc.⁵ Finally, Taxpayers urge that it would be bad policy to allow a corporation to deduct interest paid on tax deficiencies related to income from a trade or business without affording non-corporate taxpayers the same privilege.

C. Contentions of the Commissioner

The Commissioner supports the Tax Court's ruling in reliance on its own opinion in Robinson,⁶ in which that court upheld the validity of the Regulation. The Commissioner first notes that all five courts of appeal that have addressed the Regulation have upheld it.⁷ Next, the Commissioner takes issue with the Taxpayers' position on deference. The Commissioner reiterates the well-known Chevron maxim that agency regulations are valid and must be upheld if they implement the related statute in some reasonable way or if they are "based on a permissible construction of the statute."⁸ The Commissioner's deference argument continues to the effect that the Taxpayers' reliance on United States v. Mead Corp.⁹ for the proposition that the Regulation is not entitled to Chevron deference because of its promulgation without formal notice or comment, is misplaced.¹⁰ The Commissioner urges us to apply the factors listed by the Supreme Court in Barnhart v. Walton¹¹ in considering the deference issue presented here.

The Commissioner notes that I.R.C. § 163(h) eliminates deductions of "personal interest" by non-corporate taxpayers, emphasizing that non-deductible "personal interest" includes "interest paid or accrued on indebtedness properly allocable to a trade or business."¹² The Commissioner observes that I.R.C. § 163(h) fails to specify a method of "properly" allocating interest and does not purport to answer the question whether interest paid on an underpayment of individual income tax is deemed to be "properly allocable to a trade or business" when the interest is paid on tax liability arising from adjustments to reported income from an individual's non-corporate trade or business. Thus, concludes the Commissioner, I.R.C. § 163(h) is ambiguous because the undefined term "properly allocable to a trade or business" is susceptible of more than one reasonable interpretation.

In contrast, notes the Commissioner, the regulations implementing I.R.C. § 163(h) do address the precise issue now before us. The Regulation provides that interest "[p]aid on underpayments of individual Federal, State, or local income taxes ... regardless of the source of the income generating the tax liability" is included in the category of non-deductible personal interest.¹³ The Commissioner asserts that the Regulation does not conflict with the language of the Code section; on the contrary, the Regulation constitutes a reasonable position, because the duty to pay one's individual income tax is not a business obligation but a personal one. As such, reasons the Commissioner, the payment of interest resulting from a failure to pay such taxes in full when due is likewise personal, regardless of the origin of the underlying income.

As for pre-1986 jurisprudence, the Commissioner points out that the cases cited by the Taxpayers did not address whether an item of interest was deductible per se. In addition, urges the Commissioner, the pre- § 163(h) case law did not contain any reasoned, persuasive analysis that would support the Taxpayers' position that interest on underpayments of personal income tax is a business expense when the individual taxpayer's income tax liability arose from income derived from his principal trade or business. And, not surprisingly, the Commissioner finds comfort in Robinson and all prior federal appellate cases on point.

The Commissioner's argument that we perceive to be most compelling is grounded in the General Explanation of the Tax Reform Act of 1986, the so-called "Blue Book," which was prepared by the staff of Congress's Joint Committee on Taxation. This...