Lance R. and Elaine C. LeFleur - Page 24

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           of deficiency with respect to the inclusion of an additional                               
           $800,000 of the lump sum as gross income.                                                  
           III.  Deductibility of Legal Fees and Costs                                                
                 As we have often stated, deductions are a matter of                                  
           legislative grace, and petitioners bear the burden of proving                              
           that they are entitled to any deductions claimed.  Rule 142(a);                            
           INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).                                     
                 Both parties agree that petitioner's legal fees and costs                            
           are deductible, if at all, under section 162 as expenses paid or                           
           incurred in the course of petitioner's trade or business.                                  
           However, the deductibility of petitioner's legal expenses must                             
           also be tested against section 265.                                                        
                 Section 265 provides in pertinent part as follows:                                   
                 (a) GENERAL RULE.--No deduction shall be allowed for--                               
                       (1) EXPENSES.--Any amount otherwise allowable as a                             
                 deduction which is allocable to one or more classes of                               
                 income * * * wholly exempt from * * * taxes imposed by                               
                 this subtitle * * *                                                                  
           Since we held above that none of the settlement proceeds are                               
           excludable from income under section 104(a)(2), section 265 does                           
           not apply to disallow any portion of the otherwise deductible                              
           expenses.  Our inquiry, however, does not end here.  We must next                          
           consider whether petitioners' deduction must be itemized rather                            
           than taken on Schedule C.                                                                  
                 Section 62, which defines AGI, lists the deductions from                             
           gross income which are allowed for the purpose of computing AGI                            

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