Redlark v. Comm'r of Internal Revenue

Decision Date11 January 1996
Docket NumberNo. 4445–94.,4445–94.
Citation106 T.C. No. 2,106 T.C. 31
PartiesJames E. REDLARK and Cheryl L. Redlark, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

Clare Golnick, S Lake Tahoe, CA, for petitioners.

Paul L. Dixon, Las Vegas, NV, for respondent.

Ps deducted the amount of interest on the portion of a deficiency in Federal income tax arising out of adjustments caused by accounting errors of their unincorporated business. They claimed that the interest was properly allocable to business indebtedness and therefore not personal interest under sec. 163(h)(2)(A), I.R.C. R disallowed such deduction on the ground that it was personal interest under sec. 1.163–9T(b)(2)(I)(A), Temporary Income Tax Regs., 52 Fed.Reg. 48409 (Dec. 22, 1987), and limited Ps' total interest deduction to the amounts allowed by sec. 163(h)(5), I.R.C. Held,sec. 1.163–9T(b)(2)(I)(A), Temporary Income Tax Regs., is invalid insofar as it applies under the circumstances involved herein. Held, further, the amount of the interest so allocated by Ps is deductible as interest on an “indebtedness properly allocable to a trade or business” within the meaning of sec. 163(h)(2)(A), I.R.C.

OPINION

TANNENWALD, Judge:

Respondent determined deficiencies in petitioners' 1989 and 1990 Federal income taxes in the amounts of $46,409 and $6,927, respectively. The issue in dispute is whether petitioners may deduct certain interest on Federal income tax deficiencies, paid by petitioners in 1989 and 1990, where the deficiencies arose in part due to a correction for errors made in computing petitioners' income from their business.

All the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference.

Background

At the time the petition was filed, petitioner James E. Redlark was a resident of Palm Springs, California, and petitioner Cheryl L. Redlark was a resident of South Lake Tahoe, California.

Respondent examined petitioners' Federal income tax returns for 1979, 1980, 1981, 1982, 1983, 1984, and 1985, following which respondent and petitioners agreed to adjustments to petitioners' income for each of the years.

The adjustments were due in part to a correction for errors made in converting petitioners' revenue from Carrier Communications, petitioners' unincorporated business, from an accrual basis to cash basis for tax purposes. The adjustments involved the timing of the reporting of business income.

In 1989 and 1990, petitioners paid interest on the Federal income tax deficiencies for the 1982, 1984, and 1985 years.

On Schedule C of their 1989 and 1990 Federal income tax returns, petitioners claimed an allocable portion of such interest as a business expense.

Respondent disallowed a business deduction for the interest but did allow 20 percent of the interest paid in 1989 and 10 percent of the interest paid in 1990 as a deduction under the phase-in provisions of section 163(h)(5). 1

Petitioners assert that the amount of the interest expense which they have calculated as being attributable to Carrier Communications is an ordinary and necessary expense of a trade or business under section 162, deductible in computing adjusted gross income under section 62(a), and is therefore not personal interest under section 163(h).

Respondent argues that petitioners are not entitled to a deduction because, under section 1.163–9T(b)(2)(i)(A), Temporary Income Tax Regs., 52 Fed.Reg. 48409 (Dec. 22, 1987), interest on a Federal individual income tax deficiency is nondeductible personal interest under section 163(h).

Petitioners reply that section 1.163–9T(b)(2)(i)(A), Temporary Income Tax Regs., is invalid insofar as it disallows a deduction for interest on a deficiency that is an ordinary and necessary expense of a trade or business.

Section 62(a) provides in part:

(a) General Rule.—For purposes of this subtitle, the term “adjusted gross income” means, in the case of an individual, gross income minus the following deductions:

(1) Trade and business deductions.—The deductions allowed by this chapter (other than by part VII of this subchapter) which are attributable to a trade or business carried on by the taxpayer, if such trade or business does not consist of the performance of services by the taxpayer as an employee.

Section 162(a) provides in part:

There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *

Section 163(h) provides in 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),

Before proceeding to a determination of the effect of pertinent regulations, we must first consider whether the interest expense involved herein is sufficiently connected to the business of Carrier Communications so as to satisfy the “properly allocable to a trade or business” exception of section 163(h)(2)(A), without regard to the regulations.

Initially, we note that respondent does not question petitioners' calculation of the amounts of the total interest payments that are allocable to those portions of the income tax deficiencies based on adjustments to the income from Carrier Communications. Moreover, respondent has stipulated that those adjustments reflected the correction of errors made in converting the revenue of Carrier Communications giving rise to such income from the accrual to the cash basis, i.e., the timing of reporting such income. In this context, petitioners have satisfied some of the conditions that have thus far enabled us to avoid a decision as to the impact of section 163(h)(2)(A) and the temporary regulation thereunder. Tippin v. Commissioner, 104 T.C. 518, 529 (1995) (taxpayer failed to show any relationship between the interest expense and any business); Crouch v. Commissioner, T.C.Memo. 1995–289 (record failed to support taxpayer's allocation); Rose v. Commissioner, T.C.Memo. 1995–75 (investment interest).2 The question remains, however, whether the elements giving rise to the deficiencies to which the interest herein relates are of such a nature as to permit such interest to constitute a business expense within the meaning of section 162(a), and therefore of section 62(a), and, as a result, to be characterized as interest “on indebtedness properly allocable to a trade or business” within the meaning of section 163(h)(2)(A) 3 in the event that the temporary regulation is not applicable. We think a review of the cases decided prior to the enactment of section 163(h)(2)(A), in respect of the deductibility of interest on income tax deficiencies as a business expense, will throw light on this question and is therefore a significant element in our analysis of the impact of that section on petitioners' claimed interest deduction. It is to that review that we first turn our attention.

In Standing v. Commissioner, 28 T.C. 789 (1957), affd. 259 F.2d 450 (4th Cir.1958), we faced the question of whether interest on a deficiency in Federal income tax resulting in part from improper reporting of income from a sole proprietorship on the cash basis instead of the accrual basis, along with related attorney's and accountant's fees, was deductible as a business expense. The taxpayers took a deduction under section 22(n)(1) of the Internal Revenue Code of 1939, the predecessor of section 62(a), in order to arrive at adjusted gross income. While our analysis was focused on the deductibility of attorney's fees, we held that the deficiency was based on adjustments “attributable to the business of the sole proprietorship” and allowed the deduction for deficiency interest as an ordinary and necessary business expense. Our reasoning was adopted by the Court of Appeals.

In Polk v. Commissioner, 31 T.C. 412 (1958), affd. 276 F.2d 601 (10th Cir.1960), we had to decide whether interest on a deficiency, arising out of inventory valuation corrections, was a deductible business expense for purposes of calculating a net operating loss carryover. Finding that the deficiency arose in connection with the taxpayer's business, the Court determined that the case was controlled by Standing v. Commissioner, supra, and held that the interest was deductible as an ordinary and necessary business expense and was to be taken into account in determining the net operating loss carryover. Again, our reasoning was adopted by the Court of Appeals.

In Reise v. Commissioner, 35 T.C. 571 (1961), affd. 299 F.2d 380 (7th Cir.1962), we again had to decide whether certain expenses, including interest on a Federal income tax deficiency, stemming from the reporting of sales on a cash basis instead of an accrual basis, were deductible as business expenses in computing a net operating loss carryback. Recognizing that prior to Standing v. Commissioner, supra, and Polk v. Commissioner, supra, we had denied taxpayers a deduction for deficiency interest in Aaron v. Commissioner, 22 T.C. 1370 (1954), we concluded that, in Standing and Polk, we had departed from the restrictive view of the phrase “attributable to trade or business carried on by the taxpayer” utilized in Aaron 4 and that Aaron should no longer be followed where net operating losses were concerned. Reise v. Commissioner, supra at 579. We reaffirmed the reasoning of Standing and Polk and, finding the factual situation indistinguishable from those cases, held the deficiency interest deductible as a business expense in determining the amount of a net operating loss...

To continue reading

Request your trial
21 cases
  • In re Vale
    • United States
    • United States Bankruptcy Courts. Seventh Circuit. U.S. Bankruptcy Court — Northern District of Indiana
    • 24 Septiembre 1996
    ...interest on a debt allocable to a trade or business and is based upon the recent Tax Court case of Redlark v. Commissioner of Internal Revenue, 106 Tax Court No. 2, 1996 WL 10243, and that additional support is found in the case of Polk v. Commissioner of Internal Revenue, 31 T.C. 412 1958 ......
  • Swallows Holding, Ltd. v. Comm'r of Internal Revenue
    • United States
    • United States Tax Court
    • 26 Enero 2006
    ...reasoned interpretation and invalidate the regulation .” Redlark v. Commissioner, 141 F.3d 936, 939 (9th Cir.1998), revg. 106 T.C. 31, 1996 WL 10243 (1996). For the Secretary to issue a regulation giving a clear 18–month grace period doesn't contradict anything in the Code, at least anythin......
  • Bankers Life and Cas. Co. v. U.S.
    • United States
    • United States Courts of Appeals. United States Court of Appeals (7th Circuit)
    • 17 Abril 1998
    ...tax regulations. See, e.g., Western Nat'l Mut. Ins. Co. v. Commissioner, 65 F.3d 90, 93 (8th Cir.1995); Redlark v. Commissioner, 106 T.C. 31, 38-39, 1996 WL 10243 (1996). This all leads us to the $64,000 question: If the deference test walks like Chevron and talks like Chevron, why shouldn'......
  • Robinson v. Comm'r of Internal Revenue, 9574–99.
    • United States
    • United States Tax Court
    • 5 Septiembre 2002
    ...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......
  • Request a trial to view additional results
1 firm's commentaries
  • Supreme Court Downplays The Blue Book’s Interpretative Value
    • United States
    • Mondaq United States
    • 12 Diciembre 2013
    ...Light, Gas & Water Div. and refused to be bound by the conclusions drawn in the Blue Book. See Redlark, et. ux. v. Commissioner, 106 T.C. 31, 57 (1996) ("we should not be bound by statements in the 1986 Bluebook"). Lawson v. Commissioner, T.C. Memo. 1994-286, attempts to reconcile the T......
5 books & journal articles
  • Is the deduction of interest on tax deficiencies finally over?
    • United States
    • The Tax Adviser Vol. 31 No. 8, August - August 2000
    • 1 Agosto 2000
    ...taxes and on indebtedness used to pay such taxes ... regardless of the source of the income generating the tax liability...." In Redlark, 106 TC 31 (1996), a divided Tax Court evaluated Temp. Regs. Sec. 1.163-9T(b)(2)(i)(A). The court stated that a temporary regulation is accorded the same ......
  • Is interest on taxes always personal?
    • United States
    • The Tax Adviser Vol. 29 No. 8, August - August 1998
    • 1 Agosto 1998
    ...of cases focusing on the validity of this regulation. The Tax Court held the regulation invalid in Kikalos, TC Memo 1998-92, and Redlark, 106 TC 31 (1996). Additionally, the district courts have held the regulation invalid in Allen, 487 F Supp 460 (DC N.C. 1997) and Miller, 841 F Supp 305 (......
  • Individual income tax underpayment interest is nondeductible.
    • United States
    • The Tax Adviser Vol. 33 No. 12, December 2002
    • 1 Diciembre 2002
    ...This decision applies to over 20 million noncorporate businesses. It overrules Redlark, 141 F3d 936 (9th Cir. 1998), rev'g and rem'g 106 TC 31 (1996), and follows the rulings of the Fourth, Sixth, Seventh, Eighth and Ninth Circuits. Robinson is appealable to the Fifth Sec. 162(a) allows a d......
  • Individual taxpayers disallowed deficiency interest deduction.
    • United States
    • The Tax Adviser Vol. 30 No. 8, August 1999
    • 1 Agosto 1999
    ...of deficiency interest arising from an unincorporated trade or business. Two Tax Court cases have allowed the deduction. In Redlark, 106 TC 31 (1996), a sharply divided Tax Court allowed the deduction; the Ninth Circuit, however, reversed this decision. The other Tax Court case allowing the......
  • Request a trial to view additional results

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT