United States Court of Appeals
Fifth Circuit
F I L E D
IN THE UNITED STATES COURT OF APPEALS November 6, 2003
FOR THE FIFTH CIRCUIT
Charles R. Fulbruge III
Clerk
No. 03-60261
Summary Calendar
DANIEL V. ALFARO; IRMA L. ALFARO,
Petitioners-Appellants,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
--------------------
Appeal from a Decision of the
United States Tax Court
--------------------
Before JOLLY, SMITH, and WIENER, Circuit Judges.
WIENER, Circuit Judge:
Petitioners-Appellants Daniel V. Alfaro and Irma L. Alfaro,
husband and wife (“Taxpayers”) appeal the ruling of the United
States Tax Court (“Tax Court”) in its Memorandum Opinion,1
upholding the notice of deficiency issued by the Internal Revenue
Service (“IRS”) on behalf of Respondent-Appellee, Commissioner of
Internal Revenue (“CIR”). That notice of deficiency disallowed the
Taxpayers’ claim of a 1996 interest expense deduction of
$1,527,695, the amount that they paid in accrued statutory interest
that year on an income tax deficiency for a prior year. None
1
Alfaro v. Comm’r, T.C.M. (CCH) (2002).
dispute that the interest had been paid in 1996 in connection with
a compromise between the parties under which the Taxpayers remitted
additional taxes on income earned by Daniel Alfaro in his law
practice during prior years. Neither is it disputed that this law
practice was Mr. Alfaro’s principal trade or business. In this
issue of first impression in this circuit,2 we affirm the Tax
Court’s validation of the Treasury regulation relied on by the
Commissioner for the proposition that statutory interest paid by an
individual taxpayer on prior income tax deficiencies is not the
kind of interest that is deductible. We do so even though the tax
deficiency that produced the liability for statutory interest was
the result of underpayment of tax on income generated by the
principal trade or business of one of the individual taxpayers.
I.
FACTS AND PROCEEDINGS
Based entirely on stipulations, the Tax Court found that, from
at least 1982 through 1996, Attorney Alfaro was the sole proprietor
of his law practice. The IRS audited the Taxpayers' joint income
tax returns for the years 1982-88 and assessed deficiencies related
entirely to Taxpayers' income from that law practice. In 1995 the
Taxpayers and the IRS settled all matters related to the years in
question, and in 1996, the Taxpayers paid $1,527,695 in accrued
2
Five other circuits have addressed this issue previously,
however, and all have held as we do today. See infra n.7.
2
statutory interest on their agreed income tax deficiencies for the
subject years. The income that was the subject of the tax
deficiency and in turn gave rise to the statutory interest at issue
here was produced by Mr. Alfaro’s law practice and thus arose from
his principal trade or business for purposes of reporting on
Schedule C. For 1996, the year in which the Taxpayers paid the
statutory interest, they claimed an interest expense deduction on
Schedule C of their joint return.
As reflected in a notice of deficiency issued to the Taxpayers
in 2000 as a result of an audit of their 1996 return, the IRS
disallowed that interest expense deduction. The Taxpayers
challenged the deficiency determination in the Tax Court, arguing
that the interest was deductible because the underlying income on
which the taxes had been owed was from Mr. Alfaro‘s trade or
business in the practice of law and thus not “personal interest”
for purposes of § 163(h) of the Internal Revenue Code ("I.R.C.").
The gravamen of the Taxpayers’ argument in the Tax Court was that
the Commissioner’s reliance on Temporary Treasury Regulation §
1.163-9T(b)(2)(i)(A) (the “Regulation”) was misplaced. They insist
that the Regulation is invalid because, according to Taxpayers, it
conflicts with I.R.C. § 163(h). In rejecting the Taxpayers’
argument, the Tax Court relied in large part on its recent opinion
in Robinson v. Commissioner3 which held this kind of interest to be
3
119 T.C. 44 (2002).
3
non-deductible personal interest, relying on the Regulation as
authority. Taxpayers timely filed a notice of appeal.
II
ANALYSIS
A. Standard of Review
If the Regulation is valid, the Tax Court must be affirmed.
We review de novo the Tax Court’s legal determination of the
validity of a Treasury regulation.4
B. Contentions of Taxpayers
In their appellate brief, counsel for Taxpayers present a
strong and cogent argument for reversing the Tax Court. As
summarized in that brief, Taxpayers begin by noting that Congress
is presumed to have known the case law that was in existence when
it enacted the Tax Reform Act of 1986, adding I.R.C. § 163(h) to
the Code to abolish the deductibility of specified types of
interest. The Taxpayers advance that the prior jurisprudence made
clear that interest paid on an individual taxpayer’s income tax
deficiency is deductible when the underlying deficiency was on
income from the trade or business of such taxpayer. And, urge the
Taxpayers, given the absence of an unmistakable showing of
congressional intent to reverse or depart from such pre-existing
case law, it must be presumed to continue in effect. Furthermore,
argue the Taxpayers, the language of the 1986 Tax Reform Act
4
Herbel v. Comm’r, 129 F.3d 788, 790 (5th Cir. 1997).
4
reflects a congressional intent for this species of interest to
remain deductible.
The Taxpayers continue by insisting that, by characterizing
all interest payments on an income tax deficiency of an individual
as non-deductible, without excepting interest on a deficiency
properly allocable to income from a trade or business, the
Regulation is inconsistent with the plain wording of I.R.C. §
163(h). And a regulation that contradicts the plain meaning of the
statute that it addresses, assert the Taxpayers, is invalid.
Taxpayers further contend that the Treasury’s issuance of the
Regulation without following routine notice and comment procedures
eschews the usual deference to which regulations promulgated by a
federal agency are entitled under Chevron U.S.A., Inc. v. Natural
Resources Defense Council, Inc.5 Finally, Taxpayers urge that it
would be bad policy to allow a corporation to deduct interest paid
on tax deficiencies related to income from a trade or business
without affording non-corporate taxpayers the same privilege.
C. Contentions of the Commissioner
The Commissioner supports the Tax Court’s ruling in reliance
on its own opinion in Robinson,6 in which that court upheld the
validity of the Regulation. The Commissioner first notes that all
five courts of appeals that have addressed the Regulation have
5
467 U.S. 837 (1984).
6
119 T.C. 44 (2002).
5
upheld it.7 Next, the Commissioner takes issue with the Taxpayers’
position on deference. The Commissioner reiterates the well-known
Chevron maxim that agency regulations are valid and must be upheld
if they implement the related statute in some reasonable way or if
they are “based on a permissible construction of the statute.”8
The Commissioner’s deference argument continues to the effect that
the Taxpayers' reliance on United States v. Mead Corp.9 for the
proposition that the Regulation is not entitled to Chevron
deference because of its promulgation without formal notice or
comment, is misplaced.10 The Commissioner urges us to apply the
factors listed by the Supreme Court in Barnhart v. Walton11 in
considering the deference issue presented here.
The Commissioner notes that I.R.C. § 163(h) eliminates
deductions of “personal interest” by non-corporate taxpayers,
emphasizing that non-deductible “personal interest” includes
“interest paid or accrued on indebtedness properly allocable to a
7
Allen v. United States, 173 F.3d 533 (4th Cir. 1999);
McDonnell v. United States, 180 F.3d 721 (6th Cir. 1999); Kikalos
v. Comm’r, 190 F.3d 791 (7th Cir. 1999); Miller v. United States,
65 F.3d 687 (8th Cir. 1995); Redlark v. Comm’r, 141 F.3d 936 (9th
Cir. 1998).
8
Chevron USA, Inc., 467 U.S. at 843.
9
533 U.S. 318 (2001).
10
The Taxpayers assert that according to Mead, the Regulation
should be evaluated under the less deferential standard established
by the Supreme Court in Skidmore v. Swift & Co., 323 U.S. 134
(1994).
11
535 U.S. 212 (2002).
6
trade or business.”12 The Commissioner observes that I.R.C. §
163(h) fails to specify a method of "properly" allocating interest
and does not purport to answer the question whether interest paid
on an underpayment of individual income tax is deemed to be
“properly allocable to a trade or business” when the interest is
paid on tax liability arising from adjustments to reported income
from an individual’s non-corporate trade or business. Thus,
concludes the Commissioner, I.R.C. § 163(h) is ambiguous because
the undefined term “properly allocable to a trade or business” is
susceptible of more than one reasonable interpretation.
In contrast, notes the Commissioner, the regulations
implementing I.R.C. § 163(h) do address the precise issue now
before us. The Regulation provides that interest “[p]aid on
underpayments of individual Federal, State, or local income taxes
... regardless of the source of the income generating the tax
liability” is included in the category of non-deductible personal
interest.13 The Commissioner asserts that the Regulation does not
conflict with the language of the Code section; on the contrary,
the Regulation constitutes a reasonable position, because the duty
to pay one’s individual income tax is not a business obligation but
a personal one. As such, reasons the Commissioner, the payment of
interest resulting from a failure to pay such taxes in full when
12
I.R.C. § 163(h)(2)(A) (emphasis added).
13
Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A).
7
due is likewise personal, regardless of the origin of the
underlying income.
As for pre-1986 jurisprudence, the Commissioner points out
that the cases cited by the Taxpayers did not address whether an
item of interest was deductible per se. In addition, urges the
Commissioner, the pre-§163(h) case law did not contain any
reasoned, persuasive analysis that would support the Taxpayers’
position that interest on underpayments of personal income tax is
a business expense when the individual taxpayer’s income tax
liability arose from income derived from his principal trade or
business. And, not surprisingly, the Commissioner finds comfort in
Robinson and all prior federal appellate cases on point.
The Commissioner’s argument that we perceive to be most
compelling is grounded in the General Explanation of the Tax Reform
Act of 1986, the so-called "Blue Book," which was prepared by the
staff of Congress’s Joint Committee on Taxation. This publication
states unequivocally that interest on underpayments of federal and
state income taxes constitute personal interest (and are therefore
not deductible), even when the income on which the tax is imposed
was generated by a trade or business. The Tax Court in Robinson14
and the five courts of appeals that have validated the Regulation15
relied heavily on this statement in the Blue Book.
14
T.C. 44 (2002).
15
See supra note 6.
8
D. Validity of the Regulation
Despite the forceful case advanced by counsel for the
Taxpayers, we begin with trepidation in the face of the solid array
of five federal courts of appeals that have validated the
Regulation and none that has held to the contrary: We are always
chary to create a circuit split. Adding to this daunting prospect
is the Tax Court’s Robinson decision to the same effect.16 It is
in the context of that high hurdle that we read the Joint Tax
Committee’s explanation:
Under the Act, personal interest is not deductible.
Personal interest is any interest, other than interest
incurred or continued in connection with the conduct of
a trade or business (other than the trade or business of
performing services as an employee), investment interest,
or interest taken into account in computing the
taxpayer’s income or loss from passive activities for the
year. Thus, personal interest includes, for example,
interest on a loan to purchase an automobile, interest on
a loan to purchase a life insurance policy, and credit
card interest, where such interest is not incurred or
continued in connection with the conduct of a trade or
business. 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.17
We agree with the Commissioner’s position that the Blue Book
directly supports the Regulation: Interest paid on an underpayment
of an individual’s income tax is personal interest, notwithstanding
16
119 T.C. 44 (2002).
17
Staff of the Joint Comm. on Taxation, 100th Cong., 1st
Sess., General Explanation of the Tax Reform Act of 1986 266 (Comm.
Print 1987) (emphasis added) (footnote omitted).
9
that the tax liability that generated the interest is owed on
income from the Taxpayer’s trade or business.
The Taxpayers are correct that, inasmuch as the Blue Book was
prepared following the adoption of the statute that it explains,
this publication is not binding authority. As the Eleventh Circuit
said in Estate of Wallace v. Commissioner, however, the Blue Book
provides “a valuable aid to understanding the statute.”18 The
Commissioner properly reminds us that, in the absence of definitive
legislative history —— as is the situation here —— substantial
weight should be given to the Blue Book.19 Importantly, the
Regulation tracks the Blue Book, and must be sustained if it is
“based on a permissible construction of the statute.”20
Furthermore, congressional actions post-dating the
promulgation of the Regulation have not revealed any disagreement
or conflict with the Regulation’s treatment of I.R.C. § 163(h).
18
965 F.2d 1038, 1050 n.15 (11th Cir. 1992). See also
McDonald v. Comm’r, 764 F.2d 322, 336 n.25 (5th Cir. 1985) (stating
that the Blue Book is “entitled to great respect”).
19
See, e.g., Federal Power Comm’r v. Memphis Light, Gas &
Water Div., 411 U.S. 458, 472 (1973) (describing General
Explanation of Tax Reform Act of 1965 as “compelling contemporary
indication” of the effect of a provision). See also Estate of
Hutchinson v. Comm’r, 765 F.2d 665, 670 (7th Cir. 1985) (concluding
that Blue Book explanations are “highly indicative of what Congress
did, in fact, intend” particularly when consistent with other
evidence of legislative intent).
20
NationsBank of N.C., N.A. v. Variable Annuity Life Ins.
Co., 513 U.S. 251, 257 (1995) (quoting Chevron U.S.A., Inc. v.
Natural Resources Defense Council, 467 U.S. 837, 843 (1984)).
10
When Congress modified the definition of “personal interest” in
1988, nothing said or done indicated dissatisfaction with the
Regulation. Likewise, when Congress enacted OBRA in 1990,21
affecting aspects of interest in the corporate arena, the
Conference Committee report stated that “[i]ndividuals are not
permitted to deduct personal interest. For this purpose, personal
interest includes interest on underpayments of the individual’s
income taxes, even if all or a portion of the individual’s income
is attributable to a trade or business.”22
Finally, we perceive logical support for concluding that the
Regulation’s augmentation of I.R.C. § 163(h) is reasonable —— and
thus valid —— when it proscribes the deductibility of statutory
interest paid by an individual taxpayer for prior delinquent or
deficient payments of income tax. These and other statutory
interest provisions of the I.R.C. and the Treasury regulations
presumably serve the dual purpose of (1) encouraging full and
timely payment of taxes, and (2) making the Treasury whole by
replacing the value of the lost use of the funds between their due
date and their subsequent receipt. If amounts paid by individual
taxpayers as statutory interest on delinquencies were then allowed
21
Omnibus Budget Reconciliation Act of 1990, Pub. L. No. 101-
508 § 11341, 104 Stat. 1388, 1388-470 (codified as amended at 26
U.S.C. § 6621).
22
H.R. Conf. Rep. No. 101-964, at 1100 (1990), reprinted in
1990 U.S.C.C.A.N. 2374, 2805. See Davis v. United States, 71 F.
Supp. 2d 622 (W.D. Tex. 1999).
11
to be deducted against income in the year such interest is paid ——
thereby reducing taxes due to the Treasury for that year —— the
taxpayer's incentive to pay promptly and fully would be reduced by
the amount of the tax benefit provided to the taxpayer by such a
deduction. Likewise, the value of the amount recouped through
statutory interest to cover the Treasury's lost use of these tax
dollars during the period that the deficiency subsisted would be
diminished by the deduction of that interest and the concomitant
reduction in taxes collected by the Commissioner for the year of
the interest payment. When we assume (as we must) that rates of
statutory interest are reasonable, the effective rate that would
result from allowing a subsequent deduction in the amount of the
statutory interest paid would, per force, be less than reasonable.
The fact that a different treatment appertains to corporate
taxpayers is of no moment, given the innumerable differences in the
taxation of individuals and corporations.
In sum, after carefully considering these and the other
arguments advanced, on the one hand, by Taxpayers and, on the other
hand, by the Commissioner, we are satisfied that the Regulation is
valid, and that its rule —— that an individual’s income tax
liability, regardless of the nature of the income giving rise to
the liability, is a personal, non-business obligation, so that
interest owed by the individual for failing timely and fully to pay
his tax obligations is also personal —— is reasonable. This result
is not affected by the fact that the interest obligation arises
12
from the individual taxpayer’s deficiency for taxes owed on income
that happens to have been derived from his trade or business.
III.
CONCLUSION
The Taxpayers’ income from the prior years in question was
derived from Attorney Alfaro’s law practice, which is his principal
trade or business. His obligation to pay taxes on that income,
however, and thus the deficiency for failing to pay them in a full
and timely manner, were personal. Consequently, the interest that
Taxpayers paid on that personal tax deficiency was itself personal
and thus not deductible under I.R.C. § 163(h), as reasonably
interpreted by Temporary Treasury Regulation § 1.163-
9T(b)(2)(i)(A). The Tax Court’s ruling, validating the Regulation
and upholding the deficiency assessed to the Taxpayers, is
therefore
AFFIRMED.
13
Alfaro v. Commissioner
Court: Court of Appeals for the Fifth Circuit
Date filed: 2003-11-06
Citations: 349 F.3d 225
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