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petitioner attempts to correlate the exclusion from gross income
pursuant to section 108 with an item of income that is "tax-
exempt" pursuant to section 1366(a)(1)(A), e.g., sections 101(a)
(insurance proceeds in excess of premiums paid not subject to
taxation), 103(a) (State and local bond interest not subject to
taxation), 111(a) (no tax imposed on income arising from the
recovery of any amount deducted in prior years to the extent that
such income did not produce a tax benefit). In effect,
petitioner argues that the COD income otherwise excluded from
gross income is mandated by statute (sections 1366(a)(1)(A) and
1367(a)(1)(A)) to pass through to the S corporation shareholders.
On the other hand, respondent argues that the COD income
exclusion is tax-deferred, rather than permanently tax-exempt.
There is no definition of "tax-exempt" for purposes of
sections 1366 and 1367. The word "exclusion", however, has been
generally defined to mean the act of excluding or the state of
being excluded. Webster's II New Riverside University Dictionary
450 (1984). In turn, "exclude" is defined as to keep out, or to
omit from consideration, and disregard. Id. An exclusion that
is subject to an offset (the tax attribute reductions) and may be
subject to taxation in the future (that is, excluded from gross
income for the taxable year) does not signify or indicate an item
of income that is necessarily tax exempt on a permanent basis.
In contrast, the language in section 103(a) expressly delineates
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