Redlark v. Commissioner

The Redlarks (plaintiffs) ran a business, Carrier Communications, that installed telephone equipment. The Redlarks kept their books according to the accrual method of accounting but reported their income on their income-tax returns using the cash method of accounting. The Redlarks were audited, and the Internal Revenue Service (IRS) determined that the Redlarks should have filed their tax returns using the accrual method. As a result, the Redlarks owed additional taxes, interest, and penalties spanning several years. The Redlarks made payments on almost $450,000 of interest in installments and claimed tax deductions on portions of the interest payments, labeling the payments as business expenses because they stemmed from accounting errors made while running Carrier Communications. The Commissioner of Internal Revenue (the Commissioner) (defendant) held that none of the interest payments were deductible because Temporary Treasury Regulation § 1.163-9T(b)(2)(i)(A) (the Temporary Regulation), issued by the Commissioner, stated that interest on income-tax deficiencies, regardless of whether the income came from a business or trade, was personal interest within the meaning of § 163(h) of the Internal Revenue Code. Section 163(h) disallows tax deductions for personal-interest payments unless the interest is from a debt that is properly allocable to a trade or business. The Redlarks petitioned the United States Tax Court, which struck down the Temporary Regulation as conflicting with § 163(h). The Commissioner appealed.