Francis Lawrence and Kathryn Tenopir Remkiewicz - Page 6




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          was to protect his ability to earn income.  Accordingly, we must            
          consider whether the legal fees are attributable to petitioner’s            
          employment status and not to the tax-exempt income.                         
               Section 1.265-1(b), Income Tax Regs., deals with the                   
          definition of the terms “exempt” and “nonexempt” income for                 
          purposes of section 265.  Section 1.265-1(b)(1), Income Tax                 
          Regs., in pertinent part, states that a “‘class of exempt income’           
          means any class of income (whether or not any amount of income of           
          such class is received or accrued) wholly exempt from the taxes             
          imposed by subtitle A of the Code.”  Section 1.265-1(b)(2),                 
          Income Tax Regs., defines “nonexempt income” as “any income which           
          is required to be included in gross income.”  There is no                   
          question that petitioner’s lawsuit recovery was exempt income.              
          Likewise, petitioner’s current and possibly his future                      
          compensation from employment would meet the definition for                  
          nonexempt income set forth in the regulation.  In that regard, in           
          addition to the $140,000 recovery, petitioner’s attorney’s                  
          efforts permitted him to continue earning employee compensation,            
          both during the year under consideration and for future years.4             
               Section 1.265-1(c), Income Tax Regs., provides for                     
          allocation of expenses between exempt and nonexempt sources of              
          income, as follows:                                                         

               4 For the taxable year under consideration (1996),                     
          petitioner reported almost $69,000 in wages from employment in              
          the Oakdale School District.                                                





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