Mark Hancock, a self-employed attorney owns his own law practice as an unincorporated sole proprietorship. Hancock is having to pay $18,000 in interested on tax that he owes because in 2012 the IRS disallowed several business deductions that he used in 2010 and 2011. He is now having to pay the deficiency, assessed penalties, and $18,000 in interest on the tax he owed. Mark Hancock is wondering if he can deduct the interest he owes in the current year. Sec 162 states “Section 162(a) allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Section 262, however, provides that no deduction is allowed for personal, living, or family expenses.” Sec. 163 states “There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness”. The case Kikalos v Comm., in 1997 Nick and Helen Kikalos underreported their income and they owed more than tax then they had paid. They petitioned with the court to deduct their interest payments from the previous years that was filed incorrectly. They owed more than $300,000 from penalties. The court denied their request because it is a personal expense not a business expense because underpayment does not constitute as a business expense. Even though Mark Hancock’s interest of $18,000 is in relation to his business, it is considered non-deductible personal interest because it was an underpayment that was owed due to filing his taxes incorrectly. He cannot deduct the interest in the current year.
When it comes to interest, it is hard to have specific laws because the situations are always different. In the Kikalos case, I understand why their interest payment is considered a personal interest because they chose to not include income on their taxes. That is a personal decision and they need to pay the price of