Interest Deductions When Interest Added to Principal Balance

A cash basis taxpayer owes interest and principal to a lender on a home mortgage loan. The taxpayer goes to another lender, borrows additional money against the residence, and uses the loan proceeds to pay off the accrued interest on the first loan. Such an interest payment should be deductible (assuming the interest is otherwise deductible under the Code).

Now look at a similar factual situation. Here, the taxpayer does not borrow money from a new lender, but modifies his existing loan with the existing lender to add the accrued interest to the principal balance. When such accrued interest is eliminated via an increased principal loan balance, can the taxpayer likewise treat that as a deductible interest payment?

Notwithstanding that the taxpayer is in a similar economic situation in both circumstances, the Tax Court has ruled that no interest deduction is allowed in the second circumstance. This is based on the settled principle that a cash basis taxpayer can deduct interest only when paid, and the delivery of a promissory note to satisfy an interest obligation is not treated as payment. In the second circumstance, “the borrower is able to postpone paying the interest until some time in the future, over the life of the loan or as part of a balloon payment at maturity...No money changed hands; petitioners simply promised to pay the past-due interest, along with the rest of the principal, at a later date.”

So while the economics of these two situations is similar, sometimes form over substance matters!

Copeland, TC Memo 2014-226

Some 2015 Inflation Adjustments

Section 877A(g)(1)(A) 5 year average income threshold for being a covered expatriate	$160,000
Section 877A(a)(1) covered expatriate gross income exclusion	$690,000
Section 911 earned income exclusion	$100,800
Section 2010 unified credit basic exclusion amount	$5,430,000
Section 2503 annual exclusion amount	$14,000 (unchanged)
Sections 2503 and 2523 annual exclusion amount for gifts to noncitizen spouses	$147,000
Section 4161 tax on arrow shafts	$0.49 (bet you didn’t know there was such a thing)
Section 6039F large gift from foreign persons reporting threshold	$15,601
Section 6601(j) 2% interest portion under Section 6601	$1,470,000

Rev.Proc 2014-61

IRS to Ease Up on Civil Forfeitures for Structured Deposits

Depositors to banks who intentionally limit cash deposits to under $10,000 to avoid triggering information reporting requirements by the bank (currency transaction reports) can be committing a crime, even though they are unaware that such “structuring” is illegal. Such activities can lead to forfeitures of the funds involved.

A lot of publicity has been given to the unfairness of these forfeitures when the deposited proceeds are from legal sources and/or the depositors were not knowledgeable of the illegality of structuring. See this story, for example. This is part of larger concerns about general abuse of civil forfeiture laws by government entities in general, where such seizures occur without regard to whether the persons involved are charged or convicted of a crime.

The Chief of IRS Criminal Investigation, presumably in response to this adverse publicity, has now indicated that it will scale back such forfeitures for structuring. The following is the statement given by Richard Weber to the New York Times:

After a thorough review of our structuring cases over the last year and in order to provide consistency throughout the country (between our field offices and the U.S. attorney offices) regarding our policies, I.R.S.-C.I. will no longer pursue the seizure and forfeiture of funds associated solely with “legal source” structuring cases unless there are exceptional circumstances justifying the seizure and forfeiture and the case has been approved at the director of field operations (D.F.O.) level. While the act of structuring — whether the funds are from a legal or illegal source — is against the law, I.R.S.-C.I. special agents will use this act as an indicator that further illegal activity may be occurring. This policy update will ensure that C.I. continues to focus our limited investigative resources on identifying and investigating violations within our jurisdiction that closely align with C.I.'s mission and key priorities. The policy involving seizure and forfeiture in “illegal source” structuring cases will remain the same.