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agreement. The loans had no fixed maturity date for repayment,
and RSI could have demanded the outstanding principal balances at
any time. During 1987 and 1988, petitioners and RSI did not
record, set, or otherwise contemplate a rate of interest on these
loans.
Also during 1987 and 1988, petitioners made repayments to
RSI in the total amounts of $839,702 and $381,734, respectively.
(RSI's ending balances in 1987 and 1988 for all of its advances
to petitioners were $2,282,482 and $2,093,993, respectively.) No
interest expense relating to these payments was shown on
petitioners' joint Forms 1040, U.S. Individual Income Tax Return,
nor was interest income reflected on RSI's Forms 1120, U.S.
Corporation Income Tax Return. Whenever petitioner and RSI
exchanged money during this period, RSI's financial ledger simply
reported a debit or credit to "note payable--shareholder", as
appropriate. Likewise, petitioner's financial ledger reported a
credit or debit to "accounts payable/account receivable--RSI", as
appropriate. Neither petitioners' nor RSI's ledger explicitly
characterized the repayments as either principal or interest.
However, the ledgers indicate that all payments by petitioners to
RSI reduced the outstanding principal of the loans dollar-for-
dollar by the amount of the payments.
In 1990, petitioners retained the accounting firm KPMG Peat
Marwick (KPMG) to analyze the ledgers of both petitioners and
RSI. KPMG calculated what RSI's interest income on the loans
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