Is interest on taxes always personal?A hotly hot·ly
In an intense or fiery way: a hotly contested will.
Adv. 1. hotly - in a heated manner; "`To say I am behind the strike is so much nonsense,' declared Mr Harvey heatedly"; "the contested issue of late is an individual's deduction of interest on tax deficiencies related to S corporation and schedule C adjustments. The crux Crux (krks) [Lat.,=cross], small but brilliant southern constellation whose four most prominent members form a Latin cross, the famous Southern Cross. of the inquiry is whether the statutory definition of business interest is ambiguous, thus requiring the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. to issue interpretive in·ter·pre·tive also in·ter·pre·ta·tive
Relating to or marked by interpretation; explanatory.
in·terpre·tive·ly adv. regulations to clarify Congress's legislative intent, and whether the regulations are a valid interpretation of such intent.
The general rule of Sec. 163 states that "there shall be allowed as a deduction all interest paid or accrued ac·crue
v. ac·crued, ac·cru·ing, ac·crues
1. To come to one as a gain, addition, or increment: interest accruing in my savings account.
2. within the taxable year Taxable year
The 12-month period an individual uses to report income for income tax purposes. For most individuals, their tax year is the calendar year. on indebtedness." However, Sec. 163(h) disallows a deduction for personal interest, defined as interest that is not (1) interest properly allocable al·lo·ca·ble
Capable of being allocated.
Adj. 1. allocable - capable of being distributed
distributive - serving to distribute or allot or disperse to a trade or business, (2) investment interest, (3) interest from a passive activity, (4) qualified residence interest or (5) interest payable on any unpaid portion of estate tax for the period in which an extension of time for payment is in existence. It would appear that interest related to tax deficiencies from flowthrough trade or business adjustments are ordinary and necessary business expenses, and, therefore, deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). . Additionally, it would appear that this interest would be properly allocable to a trade or business based on the allocation rule provided in Temp. Regs. Sec. 1.163-8T, which provides that interest expense allocated to a trade or business expenditure is taken into account under Sec. 163(h)(2)(A), and, therefore, by definition, is not personal interest.
The basis for the debate over whether interest on business-related tax deficiencies is personal or not stems from Temp. Regs. Sec. 1.163-9T(b)(2), which states that personal interest includes interest paid on underpayments of Federal, state or local income taxes, and on indebtedness used to pay such taxes (regardless of the source of the income generating the tax liability).
Example: A, an individual, owns stock of an S corporation. On its return for 1987, the corporation underreports its taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. . Consequently, A underreports A's share of that income on his personal tax return. In 1989, A pays the resulting deficiency plus interest to the IRS. The interest paid by A in 1989 on the tax deficiency is personal interest, despite the fact that the additional tax liability may have arisen out of income from a trade or business.
The result would be the same if A's business had been operated as a sole proprietorship A form of business in which one person owns all the assets of the business, in contrast to a partnership or a corporation.
A person who does business for himself is engaged in the operation of a sole proprietorship. .
Prior to the adoption of Temp. Kegs. Sec. 1.163-9T in 1987, the courts had long established that this type of interest was an ordinary and necessary business expense and, therefore, deductible. For example, in Standing, 259 F2d 450 (4th Cir. 1958), the Fourth Circuit concluded that legal expenses and deficiency interest on an adjustment to a sole proprietor's tax liability could be deducted de·duct
v. de·duct·ed, de·duct·ing, de·ducts
1. To take away (a quantity) from another; subtract.
2. To derive by deduction; deduce.
v.intr. as an ordinary and necessary business expense. The Fourth Circuit noted that in Kornhauser, 276 US 145 (1928), the Supreme Court held that when "a suit or action against a taxpayer is directly connected with his business the expense incurred is a business expense within the meaning of the Code." Thus, the Standing court concluded that the interest claimed as a deduction was an ordinary and necessary business expense; this general holding was reaffirmed in Polk, 276 F2d 601 (10th Cir. 1960) and Reise, 299 F2d 380 (7th Cir. 1962).
Subsequent to the issuance of Temp. Regs. Sec. 1.163-9T there have been a number 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 F SUPP Federal Supplement (decisions of US district courts) 460 (DC N.C. 1997) and Miller, 841 F Supp 305 (DC N.D. 1993).
Generally, in reviewing tax regulations, a court owes the same deference to temporary regulations as to final regulations. However, interpretive regulations, which merely interpret a tax statute, are afforded less weight than legislative regulations, which are promulgated prom·ul·gate
tr.v. prom·ul·gat·ed, prom·ul·gat·ing, prom·ul·gates
1. To make known (a decree, for example) by public declaration; announce officially. See Synonyms at announce.
2. by the IRS pursuant to congressional grant of authority to define a statutory term. The Supreme Court, in Chevron U.S.A., 467 US 837 (1984), prescribed pre·scribe
v. pre·scribed, pre·scrib·ing, pre·scribes
1. To set down as a rule or guide; enjoin. See Synonyms at dictate.
2. To order the use of (a medicine or other treatment). a two-part test for lower courts to use in determining whether an administrative agency's interpretation of a statute is reasonable. Chevron requires a court reviewing an interpretation of a statute to determine first whether Congress has directly spoken to the question at issue. If the intent of Congress is clear, that is the end of the matter. If the court determines that Congress has not directly addressed the question at issue and the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency's answer is based on a permissible per·mis·si·ble
Permitted; allowable: permissible tax deductions; permissible behavior in school.
per·mis construction of the statute. Thus, if an agency's interpretation of a statute "fills a gap or defines a term in a way that is reasonable in light of-the legislature's revealed design," the interpretation is given controlling weight.
The Allen court found that the statute was clear and unambiguous. It concluded that business interest was not personal interest under Sec. 163(h); thus, Temp. Regs. Sec. 1.163-9T(b)(2) contradicted the statute and was invalid. The Miller court determined that the intent of Congress was unclear, since the term "business interest" was not defined in the Code. It then proceeded to the second prong of the Chevron test to determine whether the Service's interpretation of congressional intent was based on a permissible construction of the statute. In Miller, the court stated that Congress did not intend to change a consistent history of case law and that Temp. Regs. Sec. 1.163-9T(b)(2) did not harmonize with the Code. Additionally, the Miller court cited the Conference Report from the Tax Reform Act of 1986, which provided that "personal interest also generally includes interest on tax deficiencies," and concluded that the word "generally" would not be necessary if Congress intended that all interest on tax deficiencies was to be classified as personal interest. In Kikalos, the court noted that it followed the rationale of Redlark. In all of those cases, the courts concluded that the statute was ambiguous and the regulation contradicted the allocation rules provided in Temp. Regs. Sec. 1.163-8T. Therefore, the provision that classifies interest related to tax deficiencies from trade or business follow-through items as personal interest was invalid.
The favorable fa·vor·a·ble
1. Advantageous; helpful: favorable winds.
2. Encouraging; propitious: a favorable diagnosis.
3. decisions in Miller and Redlark have been overturned by the Eighth and Ninth Circuits. The appellate courts A court having jurisdiction to review decisions of a trial-level or other lower court.
An unsuccessful party in a lawsuit must file an appeal with an appellate court in order to have the decision reviewed. also used the Chevron tests to determine that the term "properly allocable" to a trade or business in Sec. 163(h)(2)(A) is ambiguous and permits regulatory interpretation. These courts support the Service's position that the words "properly allocable" are deliberately ambiguous and constitute a delegation of authority The action by which a commander assigns part of his or her authority commensurate with the assigned task to a subordinate commander. While ultimate responsibility cannot be relinquished, delegation of authority carries with it the imposition of a measure of responsibility. to the IRS to determine when an expense may be properly allocated to a trade or business. Both appellate courts held that Temp. Regs. Sec. 1.163-9T was a reasonable interpretation of legislative intent and the fact that interest on deficiencies arising from business were historically deductible is irrelevant. The Eighth Circuit in Miller, 65 F3d 687 (1995), cited as support for its position the General Explanation of the Tax Reform Act of 1986, which states that personal interest also includes interest on underpayments of individual Federal, state or local taxes, notwithstanding that notwithstanding; although.
See also: Notwithstanding all or a portion of the income may have arisen from the conduct of a trade or business. The court admits that this document does not rise to the level of legislative history, because it was prepared by congressional staff after the enactment of the statute, but it is highly indicative of what Congress did in fact intend. In Miller, the court also cited the fact that no subsequent legislative actions have indicated any disagreement with the interpretation. As a result of the foregoing, Miller concluded that the regulation represented a permissible construction of the statute. In Redlark, 9th Cir., 4/10/98, the appellate court stated that it agreed with the conclusions reached in Miller.