Personal interest nondeductible.

In a case of first impression for the Fifth Circuit, it joined the Tax Court and the Fourth, Sixth, Seventh, Eighth and Ninth Circuits, in upholding the validity of Temp. Regs. Sec. 1.163-9T(b)(2)(i)(A) and denying an interest deduction for an unincorporated law practice's tax deficiency. (For background, see Barton, Tax Clinic, "Individual Income Tax Underpayment Interest is Nondeductible," TTA, December 2002, p. 765; Price and Weld, "Is the Deduction of Interest on Tax Deficiencies Finally Over?" TTA, August 2000, p. 552.)

Facts: In Daniel Alfaro, 5th Cir., 11/6/03, the taxpayer operated a law practice as a sole proprietor. The IRS audited his 1982-1988 returns and assessed deficiencies solely relating to that practice. In 1995, the taxpayer paid over $1.5 million in accrued statutory interest on his agreed income tax deficiencies for the years at issue and deducted the underpayment interest on Schedule C of his 1996 return. The IRS denied the deduction under Temp. Regs. Sec. 1.163-9T(b)(2)(i)(A).

Tax Court: The taxpayer argued that the interest was deductible under Code Sec. 163(h)(2)(A) as being properly allocable to a trade or business and that Temp. Regs. Sec. 1.163-9T(b)(2)(i)(A) was invalid. The Tax Court agreed with IRS that the regulation was an authoritative interpretation of an ambiguous statute and denied the taxpayer's interest deduction.

Fifth Circuit: On appeal, the Fifth Circuit stated that the temporary regulation is based on a permissible construction of the statutory rules. The court gave weight to the fact that the temporary regulation tracks the Tax Reform Act of 1986 Blue Book. Although the Blue Book is not binding authority, the court said it does provide a valuable aid to understanding statutory rules.

The court also noted that Congress had revisited the definition of personal interest after the regulation was issued without revealing any dissatisfaction with its conclusion. Finally, the statutory interest provisions are designed to encourage full and timely payment of taxes and make Treasury whole for the lost use of funds between the due date and the time the funds are actually paid. Allowing taxpayers to deduct statutory interest on deficiencies arising from an unincorporated business or practice would undercut both of these goals.