Opinion
Civil Action No. 97-WY-1892-AJ
Decided June 18, 1998 Filed June 1, 1998
For USA, defendant: William G. Pharo, United States Attorney's Office, Denver, CO U.S.A.
For USA, defendant: Arthur P. Yoon, Christopher H. La Rosa, U.S. Department of Justice, Washington, DC U.S.A.
98-2 U.S. Tax Cas. (CCH) P50,543; 82 A.F.T.R.2d (RIA) 5110
ORDER GRANTING DEFENDANT'S MOTION FOR PARTIAL SUMMARY JUDGMENT
The Motion for Partial Summary Judgment filed by the United States, the plaintiffs' response thereto, and the defendant's further reply came before the Court for consideration. The Court, having considered the motion, response, and reply, the materials submitted by the parties in support of their respective positions, the pleadings of record, the applicable law, and being fully advised in the premises, FINDS and ORDERS as follows:
Background
In their amended complaint, plaintiffs challenge the determination by the Internal Revenue Service ("IRS") disallowing their 1989, 1990 and 1992 claims for additional "Schedule C" business interest expenses in the amounts of $20,149.80, $22,902.17; and $50,901.51, as well as a claim for an additional self-employer health insurance deduction in the amount of $625.00 for 1989; and a claim for a child care credit in the amount of $400.00 in 1990. It is only the claim for business interest expense that is the subject of the pending motion.
Plaintiff, Dr. Karl Stecher, Jr., owned and operated an unincorporated neurosurgical practice since July of 1982. He reported income and expenses of that practice on Schedule C to plaintiffs' joint federal income tax returns using a cash method of accounting. In April 1992, plaintiffs filed an amended tax return for the 1989 tax year, claiming interest business expense of $20,291.00 for interest paid on their individual tax deficiencies for prior tax years on Schedule C for Dr. Stecher's neurosurgery practice.
Plaintiffs filed an amended individual return on July 27, 1992 for the 1990 tax year. In this return, they claimed interest business expense of $23,663.00 for interest paid on individual tax deficiencies for prior tax years on Schedule C for Dr. Stecher's neurosurgery practice.
Plaintiffs filed an amended individual return on April 27, 1995 for the 1990 tax year. In this return, they claimed interest business expense of $51,268.00 for interest paid on individual tax deficiencies for prior tax years on Schedule C for Dr. Stecher's neurosurgery practice.
Dr. Stecher stated that interest paid in 1989, 1990 and 1992 on the individual tax deficiencies for prior tax years is allocable to his neurosurgery practice because (1) the neurosurgery practice was the source of the income generating the tax liability and (2) he had underestimated the taxpayers' income tax liability during a period when his practice was growing and accelerating in net income.
After plaintiffs' amended tax returns for 1989, 1990 and 1992 were audited by the IRS, the IRS determined that the interest at issue that had been paid in those years was not deductible as a business interest expense on Schedule C. The IRS treated the interest paid on the underpayments of individual income taxes, regardless of the source of income, as nondeductible personal interest. This lawsuit was then filed by plaintiffs. Plaintiffs seek a redetermination of the IRS's decision to disallow the claimed business interest expenses.
Plaintiffs have relied primarily on two cases to support their argument that the interest they claim is deductible as business interest expense. These cases include Kikalos v. Commissioner, T.C. Memo 1998-92, 1998 WL 90729 (T.C 1998), in which the tax court held that the interest was deductible as interest on an indebtedness properly allocable to a trade or business within the meaning of Section 163(h)(2)(A) of the Internal Revenue Code. They also rely on Allen v. United States, 987 F. Supp. 460 (E.D.N.C. 1997).
Standard of Review Fed.R.Civ.P. 56
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); Allen v. Muskogee, Oklahoma, 119 F.3d 837, 839-840 (10th Cir. 1997). A disputed fact is material if it might affect the outcome of the suit under governing law, and the dispute is genuine if the evidence is such that a reasonable jury could return a verdict for the nonmoving party. The factual record and reasonable inferences therefrom are construed in the light most favorable to the nonmovant. Id., quoting Anderson v. Liberty Lobby, Ind., 477 U.S. 242, 248, 91 L.Ed.2d 202, 106 S.Ct. 2505 (1986) and Gullickson v. Southwest Airlines Pilot's Assoc., 87 F.3d 1176, 1183 (10th Cir. 1996). The moving party need not affirmatively negate the nonmovant's claim in order to obtain summary judgment, but instead bears the initial burden of showing — that is, point out to the district court — that there is an absence of evidence to support the nonmoving party's case. Id., quoting from Celotex Corp. v. Catrett, 477 U.S. 317, 325, 91 L.Ed.2d 265, 106 S.Ct. 2548.
Discussion
The material facts are not in dispute. However, the Court believes that plaintiffs' continued reliance on the precedent cited in the foregoing sections of this Order is misplaced and that the government's motion for partial summary judgment must be granted. Kikalos v. Commissioner, T.C. Memo 1998-92, 1998 WL 90729 (T.C. March 3, 1998) and Allen v. United States, 987 F. Supp. 460 (E.D.N.C. December 2, 1997) both relied on the reasoning of the tax court in Redlark v. Commissioner, 106 T.C. 31 (Jan. 11, 1996).
In the tax court's Redlark decision, the majority determined that Temporary Treasury Regulation § 1.163-9(b)(2)(i)(A), which treats interest on income tax deficiencies as nondeductible personal interest, was not valid and was an impermissible reading of Section 163(h)(2)(A) of the Internal Revenue Code. The tax court further held that the interest involved was interest "on indebtedness properly allocable to a trade or business" and thus excluded it from the personal interest under Section 163(h)(2). The tax court also declined to follow the decision of the Eighth Circuit Court of Appeals in Miller v. United States, 65 F.3d 687 (8th Cir. Sept. 7, 1995). In Miller, the Eighth Circuit upheld the IRS determination treating interest on income tax deficiencies as nondeductible personal interest and upheld the validity of the Temporary Treasury Regulation.
The tax court's Redlark decision was reversed by the Ninth Circuit Court of Appeals in Redlark v. Commissioner, 141 F.3d 936, 1998 WL 164767 (9th Cir. April 10, 1998), which is a decision that post-dates Kikalos. In its Redlark opinion, the Ninth Circuit noted that the dispute centered on the meaning of the words "properly allocable" as used in § 163(h)(2) disallowing deductions for all "personal interest" unless the interest in question is "paid or accrued on indebtedness properly allocable to a trade or business (other than the trade or business of performing services as an employee)." It stated:
We agree with the Commissioner. It is not our function to determine what would be the best or most advisable method for the Commission to employ in implementing the tax code. "Congress has delegated to the Commissioner, not to the courts, the task of prescribing all needful rules and regulations for the enforcement of the Internal Revenue Code." . . . So long as the Commissioner issues regulations that "implement the congressional mandate in some reasonable manner," . . . we must defer to the Commissioner's interpretation. Only if the code has a meaning that is clear, unambiguous, and in conflict with a regulation does a court have the authority to reject the Commissioner's reasoned interpretation and invalidate the regulation . . . "If Congress has explicitly left a gap for the agency to fill, there is an express delegation of authority to the agency to elucidate a specific provision of the statute by regulation . . . Where this is so, prior decisions of reviewing courts that seem to have favored a different interpretation of the statute will not override the agency's reasonable construction . . . Rather, "legislative regulations are given controlling weight unless they are arbitrary, capricious, or manifestly contrary to the statute." . . .
As an initial matter, we find untenable the Redlarks' assertion that the words, "properly allocable," unambiguously specify that interest on business-related personal income tax deficiencies should be deductible. The Eighth Circuit has stated the matter succinctly.
I.R.C. § 163(h)(2)(A) generally disallows any deduction for personal interest paid or accrued by a noncorporate taxpayer. Personal interest is defined as any interest with specified exceptions including interest on debt allocable to a trade or business. The provision, however, does not define what constitutes business interest. Therefore, there is an implicit legislative delegation of authority to the Commissioner to clarify whether income tax deficiency interest is "properly allocable to a trade or business."
Miller, 65 F.3d at 690. When Congresses uses such broad, generalized language in defining an important term in a statute a claimant must make a compelling argument, based on the language and history of the statute itself, that Congress can only have intended one meaning to attach to that language before we will find that the administering agency has no authority to employ a different construction. The Redlarks have offered no such compelling arguments. [footnote omitted].
Contrary to the Redlarks' assertions, the fact that courts consistently allowed the type of deduction they are now seeking before the enactment of the Tax Reform Act of 1986 and its implementing regulations does not lend support to the argument that such a deduction must continue to be allowable under the new statute. Congress regularly affords administrative agencies leeway in which to change or modify their regulations in response to changing economic conditions and policy concerns. That is the entire point of a delegation of limited policy-making authority under an ambiguously worded statute. "An initial agency interpretation is not instantly carved in stone. On the contrary, the agency, to engage in informed rulemaking, must consider varying interpretations and the wisdom of its policy on a continuing basis." . . . Thus, an agency may "from time to time change its interpretation" of a statutory term without calling into question its authority to interpret that term. . . . If an agency's own previous gloss on an ambiguous statute does not render the statute any the less a proper object of interpretation, neither does the previous gloss of a reviewing court do so . . .
Having determined that the term, "properly allocable," is subject to interpretation by the Commissioner, we now must decide whether Temporary Treasury Regulation § 1.163-9T(b)(2)(i)(A) represents a reasonable interpretation of the term. We have little trouble in doing so. As the Eighth Circuit noted, the legislative history that attended the enactment of I.R.C. § 163(h) is entirely consonant with the Commissioner's conclusion that personal income tax obligations are always essentially personal in nature . . . In explaining the import of I.R.C. § 163(h), the report of the Conference Committee says that "personal interest also generally includes interest on tax deficiencies." H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II-154. There is no suggestion in the report that Congress intended to preserve an exception for interest on income tax deficiencies that arise in the ordinary course of a business. [footnote omitted].
The General Explanation of the Tax Reform Act of 1986 likewise supports the Commissioner's interpretation of the Code. See Staff of the Joint Committee on Taxation, 100th Cong., 1st Sess., General Explanation of the Tax Reform Act of 1986 266 (Comm. Print. 1987). While such post-enactment explanations cannot properly be described as "legislative history," they are at least instructive as to the reasonableness of an agency's interpretation of a facially ambiguous statute. . . . In this case, the general explanation clearly supports the Commissioner's interpretation, providing that "personal interest also includes interest on underpayments of individual Federal, State, or local income taxes notwithstanding that all or a portion of the income may have arisen in a trade or business, because such taxes are not considered derived from the conduct of a trade or business." General Explanation, supra, at 266; see also id. at 266 n. 60 ("Personal interest does not include interest on taxes, other than income taxes, that are incurred in connection with a trade or business." . . .
All that the Redlarks have done to support their argument that the Commissioner's interpretation of the Code is an unreasonable one is to point once against to the consistent practice, prior to 1986, of allowing deductions on income tax deficiency interest of the kind that they seek here. But, as we have explained, the fact that the reasonable construction that an agency adopts in interpreting an ambiguous statute is inconsistent with past interpretations or the past practice of the agency does not, without more, call into question the propriety or the reasonableness of the new construction. . . .
Temporary Treasury Regulation § 1.163-9T-(b)(2)(i)(A) represents a reasonable interpretation of a facially ambiguous statute. It is neither arbitrary, capricious, nor in conflict with any other statutory provision or the purposes of the code as a whole. That being, our inquiry is at an end.
Redlark v. Commissioner, 141 F.3d 936 at 942, 1998 WL 164767, at *3-*5 (most citations and footnotes omitted).
The Ninth Circuit's Redlark decision is in accord with the decision of the Eighth Circuit in Miller v. United States, 65 F.3d 687. The Eighth Circuit's analysis provides in part as follows:
Turning to the language of the Code itself, I.R.C. § 163(h)(2)(A) generally disallows any deduction for personal interest paid or accrued by a noncorporate taxpayer. Personal interest is defined as any interest with specified exceptions including interest on debt allocable to a trade or business. The provision, however, does not define what constitutes business interest. Therefore, there is an implicit legislative delegation of authority to the Commissioner to clarify whether income tax deficiency interest is "properly allocable to a trade or business." . . . On review, we consider whether the agency's determination is based on a permissible construction of the statute, . . . and whether that construction "harmonizes with the statute's `origin and purpose.'" . . .
There is little legislative history available regarding the treatment of income tax deficiency interest under section 163(h)(2)(A), but what is available supports the conclusion that Temp. Treas. Reg. § 1.163-9T is a reasonable interpretation of legislative intent. The Conference Report on the Tax Reform Act of 1986 states that "personal interest also generally includes interest on tax deficiencies." . . . Further the General Explanation of the Tax Reform Act of 1986 (General Explanation), authored by the staff to the Joint Committee on Taxation, provides that "personal interest also includes interest on underpayments of individual Federal, State or local income taxes notwithstanding that all or a portion of the income may have arisen in a trade or business, because such taxes are not considered derived from the conduct of a trade or business." While we recognize that this latter document does not rise to the level of legislative history because it was prepared by congressional staff after enactment of the statute, we nevertheless find that it is "highly indicative of what Congress did, in fact, intend," . . . and consider it a "valuable aid to understanding the statute." . .
We also note that the subsequent legislative actions have not indicated any disagreement with the interpretation of I.R.C. § 163(h)(2)(A) embodied in the regulations. In 1988, Congress amended the definition of "personal interest" in I.R.C. § 163(h)(2)(A), but expressed no dissatisfaction with the rule adopted in the regulations that interest on income tax deficiencies constitutes personal interest per se . . . Congress' failure to change a challenged regulation when amending the relevant statutory provision "is an indication that Congress did not perceive the regulation to be unreasonable or inconsistent with Congressional intent." . . .
The taxpayers argue that interest on income tax deficiencies arising from business activity has been historically deductible as a business expense under I.R.C. §§ 62(a)(1) and 162 and, because those provisions of the statute were unaltered with the Tax Reform Act of 1986, Congress did not intend to alter case law that had previously allowed the deducibility of such interest.
Even if we agreed that the taxpayer's argument had some logical force, our decision would remain unaltered. Our role here is not to determine whether other reasonable interpretations of the statute exist, but instead to consider whether the regulation at issue, that noncorporate income tax deficiency interest derived from whatever source is personal interest, is a permissible construction of the statute. Because Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) is neither inconsistent with the language of the statute nor at odds with the legislative history and directly tracks the statement of the staff committee in the General Explanation, we conclude the regulation represents a permissible construction of the statute. The regulation adopts the reasonable rule that an individual's income tax liability, regardless of the nature of the income giving rise to the liability, is a personal obligation and that, consequently, interest owed by such individual because of a failure to pay his tax obligation on time necessarily is also a personal obligation. Thus, contrary to the conclusion of the district court, the provision in Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) that the interest paid on underpayments of income taxes is per se nondeductible personal interest is valid and, as such, dispositive of the taxpayers' claimed interest deduction in this case.
Miller v. United States, 65 F.3d at 690-691 (citations omitted).
The taxpayers in this case have also relied upon Allen v. United States, 987 F. Supp. 460 (E.D.N.C. 1997). Allen is a district court decision in which the district court followed the tax court's reasoning in Redlark. The tax court's Redlark reasoning has since been rejected by the Ninth and Eighth Circuits, as set forth above. The Court does not find that the Allen decision provides persuasive authority in support of the taxpayers' position in this case and that it should not be followed. Rather, this Court finds that the appellate courts' decisions in Redlark v. Commissioner, 141 F.3d 936, 1998 WL 164767 (9th Cir. 1998) and Miller v. United States, 65 F.3d 687 (8th Cir. 1995) do provide persuasive authority to be followed in the absence of a dispositive discussion of these issues by the Tenth Circuit and will follow those decisions. The interest paid on the taxpayers' tax deficiencies constitutes nondeductible personal interest, in accordance with the authority set out at length in the foregoing portions of this Order.
The Court finds there are no genuine issues of material fact and that the defendant is entitled to judgment as to all matters raised in the Motion for Partial Summary Judgment filed by the United States. Accordingly, and for the foregoing reasons, it is therefore
ORDERED that the United States' Motion for Partial Summary Judgment shall be, and is, GRANTED. It is further
ORDERED that the plaintiffs' claims for business interest expense deductions shall be denied, and that interest paid on underpayments of income taxes is properly treated as nondeductible personal interest.