## Facts

- James and Cheryl Redlark operated an unincorporated telephone-equipment installation business, Carrier Communications, from 1979 to 1985.
- The business kept records on an accrual method, but the Redlarks reported income and expenses on their joint returns using the cash method.
- An IRS examination produced adjustments and, after resolving other items, additional assessments for tax, penalties, and interest for certain years.
- The interest on the assessed deficiencies was substantial and was paid in installments from 1987 to 1990.
- The Redlarks claimed deductions for portions of this deficiency interest as business expenses, asserting the deficiencies stemmed from business-related accounting errors and were therefore allocable to their trade or business.
- The IRS disallowed the deductions under Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A), which treats interest on underpayments of individual income tax as personal interest, even if the taxed income has a business source.
- The Tax Court invalidated the temporary regulation as inconsistent with I.R.C. § 163(h)(2)(A), and the Commissioner appealed.

## Issues

1. Whether Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A), classifying interest on underpayments of individual income tax as nondeductible personal interest, is a permissible interpretation of I.R.C. § 163(h), including the exception for interest “properly allocable to a trade or business” in § 163(h)(2)(A).

## Decision

- The Ninth Circuit reversed the Tax Court.
- The court held that the phrase “properly allocable” in I.R.C. § 163(h)(2)(A) is ambiguous as applied to interest on individual income tax underpayments.
- Applying Chevron deference, the court upheld Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) as a reasonable (permissible) construction of I.R.C. § 163(h).
- The court concluded that interest on an individual’s income tax deficiency is personal interest and is not transformed into business interest merely because the underlying income arose from a trade or business.

## Legal Principles

- Under I.R.C. § 163(h)(1), individuals generally may not deduct “personal interest,” subject to specific statutory exceptions.
- The exception in I.R.C. § 163(h)(2)(A) for interest “properly allocable to a trade or business” does not unambiguously require that deficiency interest on an individual’s income tax be treated as business interest.
- When the statute is ambiguous, Treasury regulations interpreting I.R.C. § 163(h) receive Chevron deference and are upheld if reasonable.
- Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) reasonably classifies interest on underpayments of individual federal income tax as nondeductible personal interest, regardless of whether the deficiency is connected to business-source income.

## Conclusion

The Ninth Circuit sustained Treasury’s regulatory classification of interest on individual income tax underpayments as nondeductible personal interest, holding that the trade-or-business exception in I.R.C. § 163(h)(2)(A) does not compel deductibility and that the temporary regulation is a permissible interpretation of the statute.


Redlark v. Commissioner, 141 F.3d 936 (9th Cir. 1998)