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T.C. 655, 661-667 (1986)(advances for interest that were added to
the nonrecourse mortgage principal, pursuant to the terms of the
mortgage, constituted a true debt obligation), affd. 856 F.2d
1169 (8th Cir. 1988).
When petitioners’ policies terminated, their policy loans,
including capitalized interest, were charged against the
available proceeds at that time. This satisfaction of the loans
had the effect of a pro tanto payment of the policy proceeds to
petitioners and constituted income to them at that time. See
Minnis v. Commissioner, supra at 1056 (dictum); Caton v.
Commissioner, T.C. Memo. 1995-80; Dean v. Commissioner, T.C.
Memo. 1993-226. A contrary result would permit policy proceeds,
including previously untaxed investment returns, to escape tax
altogether and finds no basis in the law.
Petitioners argue that if the distributions on the
terminated insurance policies are taxable, then they should be
allowed an offsetting deduction for interest paid on the policy
loans. Deductions are a matter of legislative grace, and
petitioners bear the burden of showing that they are entitled to
the claimed deductions. Rule 142(a); INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992). Section 163(a) generally
allows as an interest deduction all interest paid or accrued
within the taxable year on indebtedness. As an exception to this
general rule, however, in the case of a taxpayer other than a
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