Regulation denying deduction for interest on tax deficiency is void.

In 1987 and 1990, the Redlarks paid interest on income tax deficiencies for prior years. On their schedules C for those years they deducted part of that interest, claiming it was allocable to business debt--that is, to tax adjustments relating to their unincorporated business.

The Internal Revenue Service disallowed the interest deduction, claiming that under temporary regulations section 1.163-9T(b)(2)(A), interest on individual income tax deficiencies is personal and nondeductible.

Under Internal Revenue Code section 163(h), personal interest is not deductible. Section 163(h)(2)(A) says interest on debt that is "properly allocable to a trade or business" is not included in the personal interest category. However, temporary regulations section 1.163-9T(b)(2)(A) says interest on a federal individual income tax deficiency is nondeductible personal interest.

The Redlarks argued the regulation was invalid because it disallowed a deduction for interest that they believed constituted an ordinary and necessary business expense.

Result: For the taxpayers. The regulation is invalid as it applies to this case. The interest deducted by the Redlarks is on debt "properly allocable to a trade or business" under section 163(h)(2) (A). Therefore, they are entitled to deduct the allocated portion of interest paid to the IlkS.

Note: This is the first time the Tax Court has considered the validity of this regulation. The Eighth Circuit Court of Appeals, affirming the decision of a district court, decided in Miller (1995) that the same regulation was valid.

* Redlark, 106 TC No. 2.

Edited by Anne Wagenbrenner, JD, LLM, editor, AICPA client newsletters.

FYI 

* The Internal Revenue Service has announced that the optional mileage allowance for business travel after 1995 was raised to $0.31 per mile. The optional rate increased to $0.10 per mile for medical care travel or for a move that qualifies for the moving expense deduction. And the rate for rural mail carriers increased to $0.465 per mile.

* Final regulations clarify when an employer who ceases operations must furnish wage statements to employees and the Social Security Administration. According to Internal Revenue Code section 31.6071(a)-1 (a)(3)(ii), an employer who is required to file a final form 941 must file form W-2 and transmittal form W-3 with the SSA on or before the last day of the second calendar month after the period covered by the employer's final form 941.

* The IRS has issued final and temporary regulations (TD 8644) that limit the application of the generation-skipping transfer tax on nonresident alien property to transfers that are subject to estate or gift taxes. The tax is applied only when an estate or gift tax is imposed based on where the property is situated at the time of the transfer.