Stephen L. and Colleen Atwood - Page 6

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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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