Stephen L. and Colleen Atwood - Page 5

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          termination of petitioners’ policies are not in dispute.  The               
          only issue is whether these amounts are includable in                       
          petitioners’ gross income as amounts received within the meaning            
          of section 72(e).                                                           
               Noting that very little cash was paid directly to them upon            
          cancellation of the policies, petitioners argue that the amounts            
          at issue represent merely “paper transactions” on the books of              
          the insurance companies.  They argue that, in borrowing against             
          the policies, they were borrowing their own money, and that                 
          capitalized interest on the loans merely increased their                    
          investments in the contracts.  We disagree.                                 
               Petitioners’ insurance contracts, by their terms, treated              
          the policy loans, including capitalized interest, as bona fide              
          indebtedness.  For Federal income tax purposes, their policy                
          loans constituted true loans, rather than cash advances, and were           
          not taxable distributions when received.  See Minnis v.                     
          Commissioner, 71 T.C. 1049, 1057 (1979).2   The capitalized                 
          interest on these loans is properly treated as part of the                  
          principal of this indebtedness.  See Allan v. Commissioner, 86              


               2 Subsequent to the decision in Minnis v. Commissioner, 71             
          T.C. 1049 (1979), which dealt specifically with loans under an              
          annuity contract, Congress enacted sec. 72(e)(4), which generally           
          treats loans under annuity contracts as taxable distributions.              
          Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248,           
          sec. 265(a), 96 Stat. 544.  Loans under life insurance contracts            
          and endowment contracts (other than modified endowment contracts)           
          are excepted from this treatment.  See sec. 72(e)(5)(A)(i).                 




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