PUBLISHED

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

RICHARD R. ALLEN, SR., a resident
of Fayetteville, NC,
Plaintiff-Appellee,

v.
                                                                   No. 98-1401
UNITED STATES OF AMERICA, acting
by and through the Internal
Revenue,
Defendant-Appellant.

Appeal from the United States District Court
for the Eastern District of North Carolina, at Raleigh.
James C. Fox, District Judge.
(CA-96-909-5-F2)

Argued: October 27, 1998

Decided: April 20, 1999

Before WILKINSON, Chief Judge, and ERVIN and
WILKINS, Circuit Judges.

_________________________________________________________________

Reversed by published opinion. Judge Ervin wrote the opinion, in
which Chief Judge Wilkinson and Judge Wilkins joined.

_________________________________________________________________

COUNSEL

ARGUED: Charles Bricken, Tax Division, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant.
David D. Dahl, MANNING, FULTON & SKINNER, P.A., Raleigh,
North Carolina, for Appellee. ON BRIEF: Loretta C. Argrett, Assis-
tant Attorney General, Janice McKenzie Cole, United States Attor-
ney, Jonathan S. Cohen, Tax Division, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant.

_________________________________________________________________

OPINION

ERVIN, Circuit Judge:

The Internal Revenue Service (IRS) and taxpayer Allen dispute
whether § 163(h) of the Internal Revenue Code (I.R.C.) of 1986 is
facially ambiguous, and further, whether Temp. Treas. Reg. § 1.163-
9T(b)(2)(i)(A), which prohibits the deduction of individual income
tax deficiency interest, is a valid regulation. See I.R.C. § 163(h)
(1986); Temp. Treas. Reg. § 1.163-9T (1987). The district court
found for Allen, ruling that the language of § 163(h) is clear, unam-
biguous, and in conflict with Temp. Treas. Reg.§ 1.163-
9T(b)(2)(i)(A).

As the expert agency charged with administering the Internal Reve-
nue Code, the Treasury may promulgate reasonable regulations for
the purpose of implementing ambiguous Code provisions. We find
without doubt that I.R.C. § 163(h) is facially ambiguous; we also find
Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) to be a reasonable con-
struction of I.R.C. § 163(h). Accordingly, we reverse the district court
and hold that an individual taxpayer may not deduct income tax defi-
ciency interest, regardless of the source of the income.

I.

With the Tax Reform Act of 1986, Congress largely eliminated the
deduction for personal interest under the U.S. Tax Code. Pursuant to
a provision of this Act, I.R.C. § 163(h), individual taxpayers may no
longer deduct interest on indebtedness, with the exception of "interest
paid or accrued on indebtedness properly allocable to a trade or busi-
ness." I.R.C. § 163(h)(2)(A).

The Treasury has issued regulations implementing I.R.C. § 163(h);
one such regulation includes within the scope of non-deductible per-

                    2
sonal interest any interest paid "on underpayments of individual Fed-
eral, State, or local income taxes ... regardless of the source of the
income generating the tax liability." Temp. Treas. Reg. § 1.163-
9T(b)(2)(i)(A).

In 1995 the IRS denied Taxpayer Allen a deduction for his pay-
ment of income tax deficiency interest. Allen subsequently filed a tax
refund suit in district court. The district court ruled that the language
of I.R.C. § 163(h) is so unambiguous on its face that Temp. Treas.
Reg. § 1.163-9T(b)(2)(i)(A) is per se invalid. The Government
appeals from this judgment.

II.

The facts of this case are essentially uncontested. Allen is a real
estate developer; he is also the director and majority shareholder of
D.R. Allen & Son, Inc.( the "Company"), a North Carolina corpora-
tion in the business of general contracting. In August of 1983 the
Company found itself in need of additional working capital, which it
sought to borrow from First Union Bank. In his personal capacity as
the owner of valuable real estate, Allen agreed to transfer certain of
his properties to the Company, to provide an injection of equity and
to serve as collateral for the First Union loan.

The two transfers at issue occurred in 1984. The first involved a
partnership, Clarendon House, that held among its assets a tract of
land upon which apartments were subsequently built. On January 1,
1984, Allen transferred his interest in the Clarendon House partner-
ship to the Company. The Company sold the Clarendon House tract
in May of 1984.

The second transfer involved a 52-acre parcel of land (the "Belk
tract") upon which stood the Belk Service Center and the D.R. Allen
& Son office building. In July of 1984 Allen entered a contract to sell
the parcel for nearly $3.7 million. The closing date, originally sched-
uled for September of 1984, was later extended. Allen then trans-
ferred his interests in the land, the improvements, and the contract of
sale to the Company. In October of 1984 the Company sold the tract
pursuant to the modified contract of sale.

                     3
The Company reported the gain on the sale of the Clarendon House
tract and the Belk tract on its corporate income tax return for 1984.
The IRS eventually audited Allen and determined that he should have
reported the gain on the sale of both properties on his own 1984 indi-
vidual return. In September of 1992 the IRS assessed Allen an addi-
tional $833,664 of income tax due for the year 1984, with the
deficiency arising primarily from the unreported gain on the sale of
the Belk and Clarendon House tracts.

Allen petitioned the Tax Court for a redetermination of the defi-
ciency. While the Tax Court proceeding was pending, Allen paid the
government $1,000,000 toward his potential 1984 income tax liabil-
ity, directing that $500,000 of this sum should be applied to interest
on his as-yet undetermined deficiency. In 1993 the parties settled the
Tax Court case, with Allen agreeing to an increase in his 1984 income
tax liability of $541,882. The following year Allen filed an amended
1992 return and claimed a refund of $159,650 in 1992 income tax,
based on a deduction from his 1992 income of the $500,000 paid to
the IRS as interest on his 1984 deficiency.

In January of 1995 the IRS disallowed Allen's refund claim, noting
in a letter of explanation that income tax deficiency interest is consid-
ered nondeductible personal interest pursuant to Temp. Treas. Reg.
§ 1.163-9T(b)(2)(i)(A). Allen challenged the IRS determination by
filing the instant case in district court.

Following a bench trial the district court ruled in Allen's favor. The
court concluded that Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) con-
tradicts the plain and unambiguous meaning of I.R.C.§ 163(h). See
Allen v. United States, 

, 468 (E.D.N.C. 1997). Given
its view of the plain meaning of § 163(h), the district court declined
to undertake any analysis of the statute's legislative history. See 

; see also Chevron U.S.A. v. Natural Res. Def.
Council, Inc., 

, 842-843 (1984) ("[i]f the intent of Con-
gress is clear, that is the end of the matter; for the court, as well as
the agency, must give effect to the unambiguously expressed intent
of Congress").

Having invalidated Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A), the
district court proceeded to find that Allen's $500,000 interest payment

                     4
was deductible as an ordinary and necessary expense of his real estate
business. See 

.

III.

The validity of Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) appears
to be an issue of first impression in the Fourth Circuit, although tax-
payers have litigated the issue elsewhere. We note that a sharply
divided United States Tax Court refused to uphold the regulation in
1996, see Redlark v. Commissioner, 

, 46 (1996); however,
the Ninth Circuit later reversed this decision. See Redlark v.
Commissioner, 

, 941 (9th Cir. 1998). The Eighth Circuit
has also judged Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) to be a per-
missible construction of I.R.C. § 163(h). See Miller v. United States,

(8th Cir. 1995).

We begin our own inquiry by asking whether the statute is facially
ambiguous. Ordinarily we give great deference to the Commissioner's
interpretation of ambiguous Code provisions; thus when a statute is
ambiguous we must uphold any Treasury regulation that implements
the statutory purpose in some reasonable manner. See Rowan Cos. v.
United States, 

, 252 (1981). Yet, on those occasions
when Congress speaks unambiguously, we must overturn a regulation
that clearly conflicts with the plain text of the statute. See
NationsBank of N.C., N.A. v. Variable Annuity Life Ins. Co., 

, 257 (1995) (citing 

).

This is not such an occasion. As enacted, § 163(h) permits a deduc-
tion for personal interest only if such interest is deemed "properly
allocable" to a trade or business. Congress did not see fit to define the
term "properly allocable" in the context of personal interest, so in the
absence of a statutory directive we conclude that§ 163(h) is mani-
festly ambiguous.1 As evidence that § 163 lacks a plain meaning, we
need look no further than the sharply divergent opinions of the United
_________________________________________________________________
1 The Ninth Circuit has voiced a similar opinion, describing as "untena-
ble" the assertion that the words "properly allocable" unambiguously ren-
der business-related income tax deficiency interest deductible. 

.

                    5
States Tax Court, which could not agree upon a single reading of the
statute. See Redlark, 

.

Taxpayer Allen persuaded the district court that§ 163(h) must be
harmonized with an antecedent line of cases in which courts classed
deficiency interest as a business expense for the purpose of calculat-
ing either adjusted gross income, see Standing v. Commissioner, 

(1957), aff'd, 

(4th Cir. 1958), or net operating
loss. See Polk v. Commissioner, 

(1958), aff'd, 

(10th Cir. 1960). See also Reise v. Commissioner, 

(1961), aff'd, 

(7th Cir. 1962). In the opinion of the dis-
trict court, these few cases "clearly establish[ed] that interest on a tax
deficiency could be a deductible business expense." 

.

We decline to adopt the view that the Standing line controls the
meaning of § 163(h), because those cases do not concern whether
income tax deficiency interest is deductible per se. Under pre-1986
tax law, most forms of interest, including personal interest, were
deductible. Standing, Polk, and Reise addressed how the taxpayer
should treat an otherwise-permissible deduction when making spe-
cific line item computations.2

The holding of Standing must be limited to the calculation of
adjusted gross income; the holdings of Polk and Reise to the calcula-
tion of net operating loss. We shall not attempt to distill from these
three cases more comprehensive decision rules for interest allocation.
As Judge Halpern of the Tax Court concluded in his Redlark dissent,
to do so would be to allow a small tail to wag a very large dog. See
Redlark, 

.

The 1986 Tax Reform Act fundamentally altered the tax character
of personal interest, creating the presumption that such interest is non-
_________________________________________________________________
2 These cases do not establish that deficiency interest is always deduct-
ible when computing adjusted gross income or net operating loss; rather,
the cases erect a high threshold for proof of a connection between the
underlying indebtedness and the taxpayer's business. See Melinda L.
Reynolds, Redlark v. Commissioner: A "Bird in the Hand" for NonCor-
porate Taxpayers? 47 Case. W. Res. L. Rev. 751, 759 (1997).

                     6
deductible. This sweeping change in the tax law casts doubt upon the
contemporary relevance of the Standing cases.3 Additionally, after the
Treasury promulgated Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A),
Congress re-wrote § 163(h) in less precise terms. As first enacted,
§ 163(h) had permitted a deduction for interest "incurred or continued
in connection with the conduct of a trade or business." In 1988 Con-
gress deleted the words "incurred or continued in connection with"
and substituted the more general "properly allocable" language. See
Technical and Miscellaneous Revenue Act of 1988, Pub.L. No. 100-
647, 102 Stat. 3342, 3390. This retroactive amendment, whatever its
purpose, rendered the meaning of § 163(h) even less certain.

IV.

Because we find that § 163(h) is ambiguous on its face, we next
examine whether Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) is a per-
missible construction of the statute. See 

. In
so doing, we need not conclude that the regulation in question is the
only, or even the best possible means of implementing the statute. See

n.11. Instead, we simply ask whether the administrative
interpretation embodied in Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A)
is reasonable. See 

.

Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) must be read in conjunc-
tion with Temp. Treas. Reg. § 1.163-8T, which provides tracing rules
for the allocation of interest expenditures. Under§ 1.163-8T, interest
is allocated in the same manner as the debt to which it relates; the
underlying debt is allocated based upon the taxpayer's use of the debt
proceeds. See Temp. Treas. Reg. § 1.163-8T(a)(3). In cases where the
taxpayer does not actually receive the debt proceeds (e.g., deficiency
interest), the IRS looks to the expenditure that gave rise to the debt,
and subjects interest on the debt to any limitations governing the
expenditure. See Temp. Treas. Reg. § 1.163-8T(c)(3)(iii).
_________________________________________________________________
3 As the Ninth Circuit observed in Redlark, "[c]ontrary to the Redlarks'
assertions, the fact that courts consistently allowed the type of deduction
they are now seeking before the enactment of the Tax Reform Act of
1986 and its implementing regulations does not lend support to the argu-
ment that such a deduction must continue to be allowable under the new

.

                    7
Pursuant to these allocation rules, deficiency interest is allocable to
the payment of income taxes, an expenditure that is purely personal
in nature. Income taxes are a personal expenditure because an individ-
ual's income tax obligation arises from all sources of income, not
merely business income, and because the payment of income taxes is
regarded, in an economic sense, as personal consumption, not as a
cost of earning income.4 It follows, therefore, that individual income
tax deficiency interest is not "properly allocable" to a trade or busi-
ness. In plain English, interest on an unpaid income tax debt is never
a cost of doing business, because no taxpayer may claim that he or
she is in the business of not paying taxes.

We find Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) to be an emi-
nently reasonable and easily administrable construction of § 163(h).
No mention of § 163(h) in the legislative history of the Tax Reform
Act would suggest otherwise. The authoritative history of the 1986
Tax Reform Act contains only a single reference to§ 163(h) as it con-
cerns tax deficiencies: a line in the Conference Committee report that
states, "[p]ersonal interest also generally includes interest on tax defi-
ciencies." H.R. Conf. Rep. No. 841, 99th Cong., 2nd Sess. II-154
(1986). This statement, otherwise unembellished, does not support the
conclusion that Congress intended to exclude income tax deficiency
interest allocable to a trade or business from the broader category of
non-deductible personal interest.

The General Explanation of the Tax Reform Act of 1986 more
directly contradicts the position of taxpayer Allen. This document,
created after the enactment of the statute it explains, provides in perti-
nent part: "[p]ersonal 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 busi-
ness, because such taxes are not considered derived from . . . the trade
or business." Staff of the Joint Committee on Taxation, 100th Cong.,
1st Sess., General Explanation of the Tax Reform Act of 1986 (266
Comm. Print 1987).
_________________________________________________________________
4 Personal consumption includes spending for the necessities and luxu-
ries of life. Under the I.R.C., such costs are presumptively non-
deductible. See Marvin A. Chirelstein, Federal Income Taxation 96
(1997).

                     8
We recognize that the General Explanation is not controlling
authority, but, in the absence of any clearer statement of legislative
intent, this explanation of the statute, prepared by the joint committee
staff, may nonetheless shed some light on the matter. The definition
of "personal interest" in the General Explanation explicitly includes
deficiency interest; this interpretation of the statute supports the posi-
tion that the Treasury has taken in Temp. Treas. Reg. § 1.163-
9T(b)(2)(i)(A).

Lastly, Allen reminds this Court that the Treasury's interpretation
of § 163(h) disadvantages all taxpayers who operate their businesses
as sole proprietors. If Allen is correct and the negative impact of
Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) is widespread, the failure of
Congress to address the status of income tax deficiency interest, once
the IRS had explicitly classed such interest as non-deductible, sug-
gests, albeit indirectly, that legislators do not view Temp. Treas. Reg.
§ 1.163-9T(b)(2)(i)(A) as inconsistent with the statute.

V.

Section 163(h) of the Internal Revenue Code is facially ambiguous
and in obvious need of interpretation. This unenviable task falls to the
Department of the Treasury, not to the federal courts. Because we
find that Temp. Treas. Reg. § 1.163-9T(b)(2)(i)(A) is a permissible,
indeed, a reasonable construction of the statute, we reverse the deci-
sion of the district court and hold that individual income tax defi-
ciency interest is a non-deductible personal expenditure.

REVERSED

                     9