                        T.C. Memo. 1996-466



                      UNITED STATES TAX COURT



             FRED AND YVONNE MICHAEL, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15057-94.                Filed October 16, 1996.


     Ted H. Merriam and David A. Sprecace, for petitioners.

     Richard D. D'Estrada, for respondent.



                        MEMORANDUM OPINION



     FAY, Judge:   By notice of deficiency dated May 23, 1994,

respondent determined a deficiency in petitioners' 1991 Federal

income tax return in the amount of $21,113 and an addition to tax

and a penalty under sections1 6651(a)(1)2 and 6662(a) in the

     1
      All section references are to the Internal Revenue Code in
effect for the year at issue, and all Rule references are to the
                                                   (continued...)
                                   - 2 -

amounts of $3,790 and $2,903, respectively.       After concessions,

the sole issue for decision is whether petitioners are entitled

to an interest deduction for interest they paid to the Internal

Revenue Service (the Service) during 1991 on tax deficiencies for

earlier years.3

Background

       This case was submitted fully stipulated pursuant to Rule

122.       The stipulation of facts and the attached exhibits are

incorporated herein by this reference, and the facts contained

therein are found accordingly.       At the time the petition was

filed, petitioners resided in Thornton, Colorado.

       During the year in issue, Fred Michael (petitioner) was

unemployed.       Petitioner Yvonne Michael's principal business was

running Four Sisters, an Indian art retail store.




       1
      (...continued)
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
       2
      Petitioners concede that they are liable for an addition to
tax under sec. 6651(a)(1) equal to 25 percent of any deficiency
determined herein.
       3
      On their 1991 joint Federal income tax return, petitioners
deducted $21,286.76 on Schedule A as legal fees. Respondent
concedes that $7,211 is an allowable deduction for legal fees
under sec. 212 but is subject to the 2 percent of adjusted gross
income limitation on Schedule A. Petitioners concede that the
remaining $14,075.76 claimed as legal fees is not an allowable
deduction. Respondent concedes that petitioners are not liable
for an accuracy-related penalty under the provisions of sec.
6662(a).
                               - 3 -

     Prior to the year in issue, during the 1981 and 1982 taxable

years, petitioner worked as a furniture lumper.   A lumper is a

laborer employed to handle freight or cargo.   On their 1981 and

1982 Federal income tax returns, petitioners claimed withholdings

were made on petitioner's behalf in the amounts of $11,060.84 and

$12,601.25, respectively.   Following an audit, the Commissioner

determined that these amounts, which were claimed as withholding

for the taxable years 1981 and 1982, were never withheld or paid

to the Service during the taxable years 1981 and 1982.   The

Commissioner further determined that petitioner was an indepen-

dent contractor during the 1981 and 1982 taxable years in which

he worked as a furniture lumper.   The Commissioner determined

that, as an independent contractor, petitioner was liable for

self-employment tax in the amounts of $2,245 and $2,356 for the

tax years 1981 and 1982, respectively.   Petitioners paid $42,700

in interest in 1991 to the Service on account of their tax

liabilities arising from the overstatement of credits for with-

holding and the failure to pay self-employment tax during the

1981 and 1982 tax years.

     On Schedule C of their 1991 Federal income tax return,

petitioners claimed this interest expense as a business expense.

Respondent disallowed the entire $42,700 deduction as a Schedule

C interest expense.
                              - 4 -

Discussion

     Petitioners assert that the interest expense is attributable

to petitioner's trade as a furniture lumper and therefore deduct-

ible as an ordinary and necessary expense of a trade or business

under section 162.4

     Respondent argues that petitioners are not entitled to an

interest deduction under section 1.163-9T(b)(2)(i)(A), Temporary

Income Tax Regs., 52 Fed. Reg. 48409 (Dec. 22, 1987), which

treats interest incurred on a Federal individual income tax

deficiency as nondeductible personal interest under section

163(h).

     Section 163(h) provides in part:

          SEC. 163(h). Disallowance of Deduction for
     Personal Interest.

               (1) In general. In the case of a
          taxpayer other than a corporation, no
          deduction shall be allowed under this chapter
          for personal interest paid or accrued during
          the taxable year.

               (2) Personal interest. For purposes of
          this subsection, the term "personal interest"
          means any interest allowable as a deduction
          under this chapter other than--

                    (A) interest paid or accrued
               on indebtedness properly allocable
               to a trade or business (other than
               the trade or business of performing
               services as an employee) * * *

     4
      Sec. 162(a) provides in part: "There shall be allowed as a
deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business".
                               - 5 -

     Petitioners, however, contend that section 1.163-

9T(b)(2)(i)(A), Temporary Income Tax Regs., supra, is invalid

because it is not a reasonable interpretation of the legislative

definition of personal interest contained in section

163(h)(2)(A).   In support of this contention, petitioners rely on

our recent decision in Redlark v. Commissioner, 106 T.C. 31

(1996), in which we held that under the facts presented in that

case, section 1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs.,

supra, was invalid, and that the interest on the deficiency in

that case constituted an ordinary and necessary expense of a

trade or business and, accordingly, was deductible.    Petitioners'

reliance on Redlark v. Commissioner, supra, is misplaced.

     We noted in Redlark v. Commissioner, supra at 47, that there

are situations where deficiency interest will not constitute an

ordinary and necessary business expense allocable within the

meaning of section 163(h)(2)(A).   Therefore, we begin our analy-

sis with whether the interest expense involved herein is an

ordinary and necessary expense sufficiently connected to the

business of petitioner so as to satisfy the "properly allocable

to a trade or business" exception of section 163(h)(2)(A).

     The case herein is appealable to the Court of Appeals for

the Tenth Circuit, which, in Commissioner v. Polk, 276 F.2d 601

(10th Cir. 1960), affg. 31 T.C. 412 (1958), affirmed our decision

that interest on an income tax deficiency, arising out of inven-

tory valuation corrections, was a deductible business expense for
                               - 6 -

purposes of calculating a net operating loss carryover.    Accord-

ing to the Court of Appeals:   "An item of expense is not deduct-

ible as a business expense merely because it arose in connection

with the taxpayer's business and was proximately related thereto.

To be deductible, it must be an ordinary and necessary expense

incurred in the operation of the business".   Id. at 602-603.    The

Court of Appeals' view of the type of situations in which

interest on a deficiency may be deducted as an ordinary and

necessary expense arising out of the operation of a business is

reflected in the following statement:

     Unless it can be said that the failure to properly
     evaluate inventories, which form a part of a taxpayer's
     return, arises because of the nature of the business,
     and is ordinarily and necessarily to be expected,
     interest on a deficiency assessment does not arise out
     of the ordinary operation of the business and may not
     be deducted. [Fn. ref. omitted.]

Id. at 603.   This Court in Redlark v. Commissioner, supra at 37,

noted that the above-quoted language might have been intended to

"[narrow] the types of situations where the ordinary and

necessary business expense requirement of section 162 has been

satisfied."   In Redlark, however, we indicated that the Court of

Appeals for the Tenth Circuit's test was met under the specific

facts presented.   We must now decide whether the facts of the

present case also meet the Court of Appeals' test.

Failure To Pay Self-Employment Tax

     Petitioner believed that, for the tax years 1981 and 1982,

he was an employee and therefore not liable for self-employment
                                - 7 -

tax.    The Commissioner determined that petitioner was not an

employee during 1981 and 1982 but was instead an independent

contractor.    Following this determination by the Commissioner,

petitioner paid, in 1991, deficiencies in self-employment tax for

1981 and 1982 and interest on those liabilities.

       As indicated above, the Court of Appeals for the Tenth

Circuit, to which an appeal in this case would lie, held in

Commissioner v. Polk, supra, that interest paid by an individual

taxpayer on an income tax deficiency was deductible as an

ordinary and necessary expense where the deficiency resulted from

the taxpayer's understatement of his business income.    However,

the facts of Polk are distinguishable from the facts herein.       The

taxpayer in Polk raised and produced livestock and used an inven-

tory accounting method that required him to value his livestock

yearly.    The Court of Appeals stated that, because properly

valuing livestock is not an exact science, the taxpayer's under-

reporting of income arose because of the nature of his business

and is "ordinarily and necessarily to be expected."     Commissioner

v. Polk, supra at 603.    Thus, the interest on the deficiency was

held to be an ordinary and necessary business expense.     Id.

       Unlike the taxpayer in Polk, here petitioner has not made a

showing that the part of the 1981 and 1982 income tax deficien-

cies resulting from his failure to pay self-employment tax, and

on which he paid interest, arose as a normal or usual incident of

his business as a furniture lumper.     Petitioners argue that it is
                                - 8 -

very difficult for a lumper to determine his status as either an

employee or an independent contractor.     Petitioners cite several

cases which have addressed this issue, some of which conclude the

lumper was an employee, while others conclude the lumper was an

independent contractor.    Lanigan Storage & Van Co. v. United

States, 389 F.2d 337 (6th Cir. 1968); McGuire v. United States,

349 F.2d 644 (9th Cir. 1965); Service Trucking Co. v. United

States, 347 F.2d 671 (4th Cir. 1965); R & H Corp. v. United

States, 255 F. Supp. 870 (W.D. Pa. 1966).     Petitioners' argument

is not persuasive.   Petitioners were put on notice of a possible

problem with petitioner's status as an employee because peti-

tioner never received a Form W-2 from any of the persons or

entities he worked for.    Petitioners included with each of their

1981 and 1982 income tax returns a temporary handwritten Form W-2

which petitioner prepared himself.      Petitioners give no indica-

tion that they investigated why no Form W-2 was issued to

petitioner or whether the amounts they claimed as withholdings

were in fact withheld.    The record contains no evidence that

petitioner, given a good faith effort, would not have been able

to correctly file as an independent contractor.     Indeed, there is

no probative evidence regarding the principal's control over the

details of his work, or in regard to any other factor commonly

taken into account to distinguish an employee from an independent

contractor.   See, e.g., Walker v. Commissioner, 101 T.C. 537, 542

(1993).   Thus, petitioner did not show that his failure to pay
                                - 9 -

self-employment taxes was a normal or usual incident of his

business, as was the case in Commissioner v. Polk, supra.

     Past cases have required a stronger connection between the

adjustments creating the deficiency and the taxpayer's business.

See Polk v. Commissioner, 31 T.C. 412 (1958) (holding that

adjustment arising from revaluations of taxpayer's inventory was

sufficiently connected and proximately related to taxpayer's

business); Standing v. Commissioner, 28 T.C. 789 (1957) (holding

that adjustment arising from accounting errors in taxpayer's

business was proximately related to taxpayer's business), affd.

259 F.2d 450 (4th Cir. 1958).   Therefore, we find that no part of

the deficiencies arising because of petitioner's failure to pay

self-employment taxes during the 1981 and 1982 taxable years was

attributable to petitioner's trade or business.

Overstated Withholding by Petitioner

     Petitioners claimed on their 1981 and 1982 Federal income

tax returns credits for withholding in the amounts of $11,060.84

and $12,601.25, respectively.   These amounts were never in fact

withheld or paid over to the Service.    A portion of the interest

expense deducted by petitioners on their 1991 Federal income tax

return represents interest on the unpaid tax liabilities arising

from the overstatement of credits for withholding.   That interest

was paid during the taxable year 1991.

     Petitioners have failed to prove that the interest paid on

the tax liabilities resulting from their overstated withholding
                               - 10 -

qualifies as interest "accrued on indebtedness properly allocable

to a trade or business" of their own.     See Rose v. Commissioner,

T.C. Memo. 1995-75.    In Rose, the taxpayers paid interest on a

deficiency that arose from underpayment of estimated tax and late

payment of their tax.    This was not produced by any adjustment to

their income but instead resulted solely from the taxpayers' late

payment of their tax liabilities.    We concluded that that

interest was not attributable to a trade or business.

     In the case at bar, petitioners' deficiencies for 1981 and

1982 resulted in part from a failure to remit taxes reported as

withheld on petitioner's Form W-2.      As noted earlier, the Form

W-2 was prepared by petitioner himself.     He did not receive a

Form W-2 from any individual or entity he may have worked for

during 1981 or 1982.    Thus, he has not demonstrated any basis,

much less the good faith basis contemplated by Commissioner v.

Polk, 276 F.2d 601 (10th Cir. 1960), for believing that any tax

was withheld from his compensation and paid over to the Service

on his behalf.   Petitioners have failed to show that interest on

their deficiencies, insofar as attributable to their overstate-

ment of withholding credits, arose as a natural, usual, or

unavoidable consequence of petitioner's business.     Petitioners,

therefore, have failed to carry their burden of showing that the

interest imposed on their income tax deficiencies due to their

overstated credits for withholding was allocable to a trade or
                             - 11 -

business or deductible as an ordinary and necessary business

expense.   See id. at 602.

Conclusion

     Petitioners have failed to carry their burden of proving

that the interest expense deduction they took for interest paid

to the Service on their tax deficiencies was allocable to a trade

or business within the meaning of section 163(h)(2)(A).   To

reflect the foregoing and concessions by the parties,

                                        Decision will be entered

                                   under Rule 155.
