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petitioner to have claimed a deduction on her 1988 amended return
and not reported the 1992 refund she received. We agree with
respondent.
The trust originally paid the interest on the tax deficiency
and deducted that amount, $2,724,752, as an interest expense on its
1988 fiduciary return. When this return was amended to reflect the
agreement among the IRS, the trust representatives, and petitioner
to recharacterize the trust as a grantor trust, the interest
expense deduction the trust had claimed was allocated to petitioner
and was reflected on her amended 1988 income tax return. The
deduction resulted in a tax benefit in proportion to the full
amount of the deduction. And the amount was ultimately returned to
petitioner (via the refund check) in 1992.13
In sum, the refund of the interest on the tax deficiency,
previously deducted, gives rise to taxable income under the tax-
12(...continued)
return attributed “to Edith Hunter Hornberger all trust income
and deductions, including the deduction for the $2,357,495.08 of
interest paid on the estate tax.”
13 In Hillsboro Natl. Bank v. Commissioner, 460 U.S. 370
(1983), the Hillsboro Bank paid State taxes and deducted them
when paid, pursuant to sec. 164(e). Later, the State refunded
the taxes directly to the bank’s shareholders. The Government
sought to include the shareholders’ refund of the State taxes in
the income of the bank. See id. at 372-374. The Supreme Court
concluded that “unless a nonrecognition provision of the Internal
Revenue Code prevents it, the tax benefit rule ordinarily applies
to require the inclusion of income when events occur that are
fundamentally inconsistent with an earlier deduction.” Id. at
372.
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