Davis v. U.S.

• Decision Date: 30 July 1999
• Docket Number: No. MO-98-CA-121.,MO-98-CA-121.
• Citation: 71 F.Supp.2d 622
• Parties: W.R. and Joann DAVIS, Plaintiffs, v. UNITED STATES of America, Defendants.
• Court: U.S. District Court — Western District of Texas

71 F.Supp.2d 622

W.R. and Joann DAVIS, Plaintiffs, v. UNITED STATES of America, Defendants.

No. MO-98-CA-121.

United States District Court, W.D. Texas, Midland-Odessa Division.

July 30, 1999.

Donald P. Lan, Jr., Kroney, Silverman, Mincey, Inc., Dallas, TX, for plaintiffs.

Gregg D. Stevens, Dept. of Justice, Dallas, TX, for defendant.

ORDER GRANTING MOTION FOR SUMMARY JUDGMENT

BUNTON, Senior District Judge.

BEFORE THE COURT is Plaintiffs' Motion for Summary Judgment filed April 15, 1999 and the United States' Cross Motion for Summary Judgment filed May 13, 1999, and the parties' responses and memoranda of law. The Court, having considered the parties' respective motions, the responses, the materials submitted by the parties in support of their respective positions, the pleadings of record, the applicable law, finds that the United States' motion for summary judgment should be granted.

Background

The material facts of this case are not in dispute. Plaintiffs, W.R. Davis and JoAnn Davis, taxpayers in this case, were involved in numerous business transactions as unincorporated participants: W.R. Davis owned an interest in barges and tugs used for petroleum transport; was a partner in a various partnerships involving gas transportation pipelines, crude oil refining, financing, and oil and gas operations; maintained a crude oil investment trading account; was a shareholder in several subchapter S corporations involved in processing of crude oil and transportation, storage and marketing of refined products, and other oil and gas operations. JoAnn Davis was a shareholder in a power company. The Davises use the cash receipts and disbursements method of accounting.

The Davises filed a joint federal income tax return for 1986 which was audited by the Internal Revenue Service (IRS). The IRS issued a 30-day letter dated February 21, 1991, with a revenue agent's report, proposing an income tax deficiency for 1986 based on numerous adjustments. As a result of agreed audit adjustments for 1986, the Davises paid to the United States additional tax of $822,025.00 and deficiency interest of $221,587.00 which accrued on the agreed deficiency. The agreed adjustments related directly to income and/or expenses which were allocable to property, held by the Davises for investment. The Davises paid both the tax deficiency and the interest on the tax deficiency in 1992. On their 1992 joint federal income tax return (Form 1040), Schedule E, the Davises claimed the $221,587.00 interest that was due as the result of their 1986 tax deficiency as a nonpassive activity loss deduction. The IRS audited the Davises' 1992 return and disallowed the $221,587.00 tax deficiency interest expense deduction. The Davises appealed this and other adjustments to the IRS Office of Appeals in Dallas, Texas.

The Davises settled their 1992 federal income tax audit with the IRS Office of Appeals by signing a Form 870 in late 1997. As part of that settlement, the Davises consented to the disallowance of the $221,587.00 tax deficiency interest expense adjustment. The settlement did not preclude the Davises from later filing a claim for refund to contest that adjustment. The Davises paid the agreed audit tax liability as reflected on the Form 870, plus interest resulting from the 1992 deficiency in the amount of $27,414.03 on or about November 24, 1997. On or about December 16, 1997, the Davises timely filed a claim for refund in the form of a Form 1040X Amended Income Tax Return with the IRS in Austin, Texas to contest the Form 870 agreement. On the Davises' 1992 amended federal income tax return (Form 1040X), they reclassified the $221,587.00 tax deficiency interest expense deduction. Originally claimed as an "above the line" nonpassive activity loss of their 1992 Form 1040, Schedule E, concerning income and losses from partnerships and S corporations, the Form 1040X Amended Return for 1992 claimed the deduction amount as a "below the line," Schedule A itemized investment interest deduction.

On their 1992 Form 1040X, the Davises state that the $221,587.00 of interest paid per a prior year federal income tax deficiency is deductible as investment interest for the following reasons:

(1) Interest on a tax deficiency that arises in connection with an unincorporated business is trade or business interest under a plain reading of section 163(h)(2)(A) of the Internal Revenue Code. Temporary Treasury Regulation section 1.163-9T(b)(2)(i)(A), which provides that all interest paid on federal income tax deficiencies constitutes personal interest regardless of the source of the income generating the tax deficiency is invalid.

(2) Section 163(h)(2)(B) of the Code excludes investment interest from the definition of nondeductible personal interest. Investment interest is any interest which is paid or incurred on indebtedness properly allocable to property held for investment. The tax deficiency on which interest was paid is allocable to investment assets: taxpayers' interest in partnerships and Subchapter S corporations. Consequently, the interest on that deficiency is investment interest and is deductible subject to the limitations of section 163(d).

The Davises now bring this action seeking a redetermination of the IRS's decision to disallow the claimed deduction of interest paid on federal tax deficiencies as investment interest.

Standard of Review

Summary judgment is appropriate if there is no genuine issue as to any material fact and the moving party is entitled to judgment as a matter of law. Fed. R.Civ.P. 56(c); Celotex Corp. v. Catrett, 477 U.S. 317, 322, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986); Guthrie v. Tifco Industries, 941 F.2d 374 (5th Cir.1991). The moving party bears the initial burden of showing that there is no genuine issue for trial; it may do so by pointing out the absence of evidence supporting the nonmoving party's case. Skotak v. Tenneco Resins, Inc., 953 F.2d 909, 913 (5th Cir.), cert. denied, 506 U.S. 832, 113 S.Ct. 98, 121 L.Ed.2d 59 (1992) citing Latimer v. Smithkline & French Laboratories, 919 F.2d 301, 303 (5th Cir.1990); Celotex, 477 U.S. at 325, 106 S.Ct. 2548. The court may only grant the motion after drawing all inferences from the facts in favor of the party resisting the motion. Boazman v. Economics Laboratory, Inc., 537 F.2d 210, 213-14 (5th Cir.1976); Lavespere v. Niagara Machine & Tool Works, Inc., 910 F.2d 167, 178 (5th Cir.1990), cert. denied, 510 U.S. 859, 114 S.Ct. 171, 126 L.Ed.2d 131 (1993).

Summary judgment is appropriate in cases "where the underlying facts are undisputed and the record reveals no evidence from which reasonable persons might draw conflicting inferences about these facts." Smith v. Mobil Corp., 719 F.2d 1313, 1315 (5th Cir.1983), quoting Bertrand v. Int'l Mooring and Marine, Inc., 700 F.2d 240, 244 (5th Cir.1983). Because there is no dispute as to the underlying facts in this case, the court resolves the issue presented by the application of legal principles to specific underlying facts. Bertrand, 700 F.2d at 244 (additional citations omitted).

Crux of this Case

The sole issue to be determined in this case, as stipulated by the parties, is whether interest arising on Plaintiffs' federal income tax deficiency for 1986 is nondeductible personal interest, regardless of whether the tax deficiency relates to income derived from property held for investment, or whether the interest arising on Plaintiffs' federal income tax deficiency is deductible as an investment interest expense. Plaintiffs claim that they are entitled to deduct as an investment expense under sections 163(d) and 163(h)(2)(B) of the Internal Revenue Code of 1986, as amended, interest paid in 1992 on an agreed federal income tax deficiency for 1986.

Controlling Statutes, Regulations and Legislative History

Internal Revenue Code section 163(d) provides that all interest paid or accrued within the taxable year on indebtedness shall be allowed as a deduction in computing taxable income. 26 U.S.C. § 163(d) (Supp.1999). Investment interest is interest paid or accrued on indebtedness properly allocable to property held for investment. 26 U.S.C. § 163(d)(3)(A) (Supp. 1999).

Internal Revenue Code section 163(h) provides that unless an exception applies, personal interest incurred by an unincorporated business is not deductible. 26 U.S.C. § 163(h) (Supp.1999). Section 163(h)(2)(A) further states that interest on debt "properly allocable to a trade or business is not personal interest." 26 U.S.C. § 163(h)(2)(A) (Supp.1999). Section 163(h) provides in relevant part:

(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 to a trade or business (other than the trade or business of performing services as an employee).

(B) any investment interest (within the meaning of [§ 163(d)]....)

26 U.S.C. § 163(h) (Supp.1999) (emphasis supplied).

Title 26, section 7805 of the United States Code directs the Secretary of the Treasury to prescribe all needful rules and regulations for the enforcement of the Internal Revenue Code.¹ Under this directive, the Secretary promulgated Temporary Treasury Regulation 1.163-9T(b)(2)(i)(A), which provides that a noncorporate taxpayer's payment of interest on an income tax deficiency is per se nondeductible as personal interest regardless of the source of the income generating the tax liability. This regulation states, in relevant part:

1.163-9T Personal interest (temporary).

(a) In general. No deduction ... shall be allowed for personal interest paid or accrued during the taxable year by a taxpayer other than a...