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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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