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between a corporation and a shareholder, the deemed transfer of
forgone interest from the corporation to the shareholder is
treated as a distribution, which generally is taxed as a dividend
to the shareholder. KTA-Tator, Inc. v. Commissioner, supra at
106; McGinnis v. Commissioner, T.C. Memo. 1993-45; see H. Conf.
Rept. 98-861, at 1012, 1984-3 C.B. (Vol. 2) at 266.
Petitioners contend that section 7872 does not apply to the
instant case, arguing that interest on the loans had accrued at
the AFR in 1987 and 1988 and was in fact paid in those years,
although petitioners admit that interest was not expressly
allocated as such until 1990. Petitioners maintain that proposed
regulations under section 7872 provide support for a post-tax-
yearend partial allocation of a repayment to interest at the AFR.
Petitioners further assert that the adjustments made by
respondent to the returns of RSI and petitioners for the years at
issue shows the propriety of such post-tax-yearend partial
allocations to interest.
Respondent, on the other hand, argues that there was forgone
interest on the loans and therefore section 7872 applies in this
case, since neither petitioners nor RSI had agreed to any
interest liability during 1987 and 1988. Moreover, respondent
avers, no evidence exists that any of petitioners' payments to
RSI in 1987 and 1988 were in fact applied to interest owed on the
loans. Under the circumstances, respondent maintains that a
repayment cannot be partially allocated to interest at the AFR
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