The Interest Deducation: Several New Installments in a Continuing Saga


Leon Gabinet


Obwervers of the federal tax scene have often noted a recurring phenomenon which enlivens the day-to-day work of the entire tax fraternity. I refer, of course, to those general upheavals caused by court decisions, treasury rulings, or new bits of legislation which purport to settle touchy issues. The result of these periodic upheavals is a sharp increase in the output of critics and commentators, all of which raises the commentative cauldron to the boiling point. By the time the boil has quieted to a simmer, a new issue and a new pronouncement (or perhaps a new pronouncement about an old is- sue) will appear upon the scene and the process will begin again.

The deduction for interest is no exception to the boil-simmer-boil cycle. Although Code section 1632 contains brief and seemingly straightforward provisions, the variety of transactions which lend themselves to the use of the interest deduction has provided the impetus for a loving exploration of its possibilities. By definition, such taxpayer exploration focuses on the outer limits of the statutory provisions. The administrative and judicial reaction to this probing has again produced a shock wave, this time emanating from two distinct centers. The first such center is Revenue Ruling 68-643,' dealing with the issue of prepayment of interest by cash basis taxpayers. The second, and perhaps more important, center encompasses three sections of the Tax Reform Act of 1969:' (1) Section 221, which limits the deductibility of "excess investment interest" over "net investment income" (as those terms are defined in that section); (2) section 421, which authorizes the Commissioner to issue regulations regarding the classification of corporate interests as either stock or indebtedness; and (3) section 411, which limits the deductibility of interest on certain corporate indebtedness issued to acquire the stock or assets of another corporation.

These developments constitute new pronouncements relating to old problems. Inevitably, they will give rise to analysis, speculation and rethinking of taxpayer activity, for they embody some radically new approaches. It is the purpose of this paper to examine and evaluate these new substantive ground rules and to consider the manner in which they redefine the deductibility of interest.



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Case Western Reserve Law Review

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21 Case Western Reserve Law Review 466 (1970)

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