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expenses paid or incurred during the taxable year in carrying on
any trade or business." I.R.C. section 162(a). An individual
taxpayer reduces adjusted gross income by enumerated items,
including a limited amount of qualified interest, as part of the
computation of alternative minimum taxable income. I.R.C.
section 55(b)(1), (e)(1)(D), (e)(3). The denouement of these
statutory machinations is a taxpayer calculating alternative
minimum tax liability can fully deduct interest that constitutes
a business expense. However, he or she cannot fully deduct any
other interest to the extent it exceeds the cap on qualified
interest.
The deficiency interest paid by plaintiffs exceeded the
amount they were entitled to deduct as qualified interest; thus,
plaintiffs may only fully deduct the deficiency interest if it
constitutes a business expense. We conclude the penalty interest
represents a personal expense because the obligation to pay taxes
is personal to plaintiffs.
With a few exceptions inapplicable to this controversy,
partnerships and S corporations calculate and report their
taxable income in the same manner as individual taxpayers, but
these entities do not incur tax liability.5 I.R.C. sections 701,
703, 1363(a), 1363(b), 6031(a), 6037(a). Instead, the partners
and shareholders pay taxes on their shares of the partnerships'
and S corporations' various items of income, gain, loss,
deduction and credit. I.R.C. sections 701, 702(a), 1366(a).6 A
5 Certain circumstances not relevant here will result in tax
liability for an S corporation. See I.R.C. section 1363(a).
6 The Supreme Court has noted a partnership is a separate
entity from its partners for the purpose of calculating and
reporting its income but has no bearing on the partners'
individual tax liability for the partnership's income. United
States v. Basye, 410 U.S. 441, 448 (1973).
In advocating their opposing arguments, plaintiffs and the
government have suggested Commissioner v. Polk, 276 F.2d 601
(10th Cir. 1960), disposes of this controversy. In Polk, we
considered whether interest paid on a tax deficiency arising from
an individual's livestock business qualified as a deduction
"attributable to the operation of a trade or business" to compute
a net operating loss under 122(d)(5) of the 1939 tax code. To
determine the interest's deductibility, the court examined
whether the interest fell within the category of ordinary and
necessary business expenses deductible from gross income as
provided in 23(a)(1)(A) of the 1939 code, the precursor to
section 162(a). Polk, 276 F.2d at 602. The court noted the
facts of each case determine whether penalty interest qualifies
(continued...)
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