Tedori v. USA, 98-56049

• Citation: 211 F.3d 488
• Decision Date: 18 May 2000
• Docket Number: No. 98-56049,98-56049
• Parties: (9th Cir. 2000) FREDERICK J. TEDORI, ROBIN J.TEDORI, Plaintiffs-Appellants, v. ORDER AND UNITED STATES OF AMERICA, Defendant-Appellee
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

Page 488

211 F.3d 488 (9th Cir. 2000)

FREDERICK J. TEDORI, ROBIN J.TEDORI, Plaintiffs-Appellants, v. ORDER AND UNITED STATES OF AMERICA, Defendant-Appellee.

No. 98-56049

UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT

Argued and Submitted February 8, 2000

Filed May 1, 2000

As Amended May 18, 2000

COUNSEL: Denton N. Thomas and Susan Gorman, Andrews & Kurth, Houston, Texas, and William H. Lancaster, Andrews & Kurth, Los Angeles, California, for the plaintiffs-appellants.

Jonathan S. Cohen, Tamara W. Ashford, Tax Division, United States Department of

Justice, Washington, D.C., for the defendant-appellee.

Appeal from the United States District Court for the Central District of California; Ronald S.W. Lew, District Judge,¹ Presiding. D.C. No.CV-97-05439-RSWL

Before: Harry Pregerson and Kim McLane Wardlaw, Circuit Judges, and Milton I. Shadur, District Judge.

SHADUR, District Judge:

Taxpayers Frederick and Robin Tedori (collectively "Tedoris"), sole shareholders of an Interest Charge Domestic International Sales Corporation ("DISC"), have claimed as a deduction on their 1989 and 1990 joint federal income tax returns the interest they had paid to the United States on the deferred amounts of their DISC-related tax liability. This litigation stems from the Government's denial of those deductions on the premise that the interest paid was non-deductible personal interest under 26 U.S.C. S163(h).² Acting on crossmotions for summary judgment, the district court ruled for the Government and against Tedoris, dismissing their suit for refund. We have jurisdiction pursuant to 28 U.S.C.S1291. For the reasons given below, we affirm.

Background

No facts in this action are in dispute. Tedoris are the sole shareholders and managers of Enterplast, Inc. ("Enterplast"), a Texas corporation exporting and selling plastic raw materials. Beginning with calendar (and tax) year 1986, Enterplast elected to be taxed as a DISC because it met these conditions (paraphrased, except where quotation marks are employed, from the corresponding subsections of Section 992(a)(1)):

(A) at least 95% of its gross receipts were "quali fied export receipts,"

(B) in terms of their adjusted bases, at least 95% of its assets were "qualified export assets,"

(C) it did "not have more than one class of stock and the par or stated value of its outstanding stock [was] at least $2,500 on each day of the taxable year,"

(D) it had elected "to be treated as a DISC," and

(E) it was "not a member of any controlled group of which a [Foreign Sales Corporation] is a mem ber."

"Qualified export receipts" and "qualified export assets" are respectively defined in Sections 993(a) and (b).

Though obligated to file informational income tax returns, a DISC is not a taxable entity, but is instead taxed at the shareholder level under Section 995.³ Each DISC shareholder is ratably taxed currently on a portion of the DISC's income as a constructive dividend ("deemed distribution"), regardless of whether that income is actually distributed. ⁴ But the shareholders are not taxed on the remaining part of the income until (1) it is actually distributed or is deemed distributed, (2) the shareholders dispose of their stock in the DISC or (3) the DISC loses its special status (see Section 995(c)). As footnote 3 indicates, each DISC shareholder must pay an interest charge on the deferred amount.

As required by Section 995(f), Tedoris reported Enterplast's deferred DISC-related tax liability for the 1989 and 1990 tax years as $616,149 and $1,263,399, respectively. Having paid an interest charge on that liability in the amounts of $46,656 for 1989 and $115,514 for 1990, Tedoris then sought to deduct those interest amounts in their joint income tax returns for those years.⁵

On audit the Internal Revenue Service ("IRS") rejected both of those deductions because the interest payments were deemed nondeductible personal interest. That disallowance created tax deficiencies for Tedoris of $22,720 for 1989 and $32,344 for 1990. Both deficiencies were paid, and Tedoris then filed timely claims for refund, contending that the interest payments were not personal interest because they were properly deductible either as "properly allocable to a trade or business" under Section 163(h)(2)(A) or as "investment interest" under Section 163(h)(2)(B).

After six months had passed with no action taken by the IRS, Tedoris filed suit in the district court. On cross-motions for summary judgment, the district court ruled on April 3, 1998 that the interest was nondeductible.⁶ In so ruling the district court held alternatively (1) that the Regulation prohibited the deduction⁷ and (2) that "the indebtedness at issue is not properly allocable to [Tedoris'] trade or business."⁸

Tedoris filed a timely notice of appeal, and (as stated earlier) jurisdiction exists under 28 U.S.C. S1291. We review the district court's grant of summary judgment and its interpretation of the Code de novo (Ingham v. United States, 167 F.3d 1240, 1243 (9th Cir.1999)).

Deductibility of the Interest at Issue

Section 163(a) allows deductions for "all interest paid or accrued within the taxable year on indebtedness. " Despite that statement of a "general rule," more recent amendments to Section 163 have dramatically curbed the availability of the interest deduction to individual taxpayers. That has been accomplished by the enactment of the Section 163(h) prohibition of deductions for "personal interest"--a generic prohibition with limited stated exceptions, which include "interest paid or accrued on indebtedness properly allocable to a trade or business . . ." and "investment interest. " Thus Section 163(h) reads in relevant part:

(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 inter est allowable as a deduction under this chapter other than--

(A) interest paid or accrued on indebted ness properly allocable to a trade or busi ness (other than the trade or business of performing services as an employee),

(B) any investment interest (within the meaning of subsection (d)) . . . .

Tedoris urge that the interest charge for their DISC-related deferred tax liability is not "personal interest " because it comes within each of the Section 163(h)(2)(A) and (B) exceptions (only one of those arguments needs to succeed in order for Tedoris to prevail). No caselaw has dealt with the precise question whether either of those exceptions applies to such a DISC-generated interest charge.

Does the Regulation Control?

Because Redlark, 141 F.3d at 939-40 held that the phrase "properly allocable" in Section 163(h)(2)(A) was ambiguous and that the Regulation was a reasonable interpretation of the Code, the Regulation's validity is beyond question here. Indeed, four other circuits have held that the Regulation is valid and that income tax deficiencies cannot be considered "indebtedness properly allocable to a trade or business" even when the income underlying the deficiency originates from the taxpayer's own business (in order of decision, Miller v. United States, 65 F.3d 687 (8th Cir. 1995); Allen v. United States, 173 F.3d 533 (4th Cir. 1999); McDonnell v. United States, 180 F.3d 721 (6th Cir. 1999) and Kikalos v. Commissioner, 190 F.3d 791 (7th Cir. 1999)). While Redlark involved the deduction of interest payments made on tax deficiencies by a couple running an unincorporated business, the same ambiguous phrase is implicated in this case, where the question is whether interest on deferred DISC-related tax liability is "properly allocable" to a trade or business.

At the outset the Government argues that the Regulation (quoted here with emphasis added) is not only valid but is dispositive of this case⁹

[P]ersonal interest includes interest--

(A) Paid on underpayments of individual Federal, State or local income taxes and on indebtedness used to pay such taxes (within the meaning of S1.168-8T), regardless of the source of the income generating the tax liability.

While the Government says that deferred DISC-related tax liability is an "underpayment," so that the deduction of interest on that amount is prohibited by the Regulation, Tedoris counter that a "deferment" is something distinct from an "underpayment," hence rendering the Regulation inapplicable.

Section 995(f)(6) says that the DISC interest charge is "treated, for purposes of this title, as interest payable under section 6601 . . . ." But Section 6601, entitled "Interest on Underpayment, Nonpayment, or Extensions of Time for payment of Tax," does not enlighten us beyond its heading. Nevertheless both sides seek comfort from that title (despite the firmly established proposition that a statutory title is not part of the statute itself).¹⁰ If that were the issue, we would agree with Tedoris that a deferment is more akin to, though not synonymous with, an extension of time.

But that is not the real issue as we view it. Instead the plain meaning of "underpayment," confirmed by its use throughout the Code, reveals that the term refers to a situation in which money is presently owed but not paid by a taxpayer.¹¹ Certainly the interest payments at issue in this case were not underpayments in the sense that they were literally tax deficiencies on money presently owed.¹² Instead Section 995(f), by postponing payment of Tedoris' obligation, clearly relieved them of any current duty to pay taxes on the deferred DISC income except for the interest charge. In other words, as the statute says, the government "deferred " Tedoris' obligation to pay taxes: Tedoris did not fail to pay money presently owed--that is, they did not underpay.

While the Government does attempt to call to its aid Proposed Treas. Regs. SS1.995(f)-1(a)(2)(i)(52 Fed. Reg. 3266) (Feb. 3, 1987...