Goldstein v. Commissioner
364 F.2d 734 (1966)

  • Goldstein won the Irish Sweepstakes (a big horserace). When he realized that this would move him up to a higher tax bracket, he developed a plan to avoid paying a lot of taxes on his winnings.
  • Goldstein took out a big loan and bought government bonds with the money. Then he used the horserace winnings to prepay the interest on the loan, and used the bonds as collateral on the loan.
    • Effectively, this meant that instead of having one big payday from the horse race, Goldstein would get smaller payments from the bonds over the course of many years. That would keep him in a low tax bracket because the taxable gain from the winnings would be cancelled out by the deductible interest payments.
  • Goldstein filed his taxes and claimed a deduction for all the interest he prepaid, based on 26 U.S.C. 163(a). The IRS denied the deduction. Goldstein appealed.
    • The IRS argued that based on Knetsch v. United States (364 U.S. 361 (1960)), interest payments made solely for tax avoidance purposes were not deductible. (aka the Sham Transaction Doctrine).
      • The two basic elements of a sham transaction are that the only purposes of the transaction was to create a deduction and that there were no assets outside of the deal that could be called upon to satisfy any liability (aka a non-recourse loan).
    • Goldstein distinguished his situation from Knetsch since the loan he made was not a non-recourse loan, and Goldstein's assets were potentially at risk if the loan went bad.
      • In Knetsch, if Knetsch defaulted on the loan, the bank couldn't go after his assets, so he had nothing at risk.
      • Goldstein was on the hook for the loan. If for some reason the government defaulted on the bonds, then the bank could take Goldstein's other assets (like his house).
        • But in reality, the chance that the government would default on the bonds was pretty much 0%.
  • The Tax Court found for the IRS. Goldstein appealed.
  • The Appellate Court affirmed and denied the deduction.
    • The Appellate Court found that an interest payment may not be deductible under 163(a) even though the underlying debt is a full recourse debt.
      • The Appellate Court found that the only reason for the transaction was for tax avoidance purposes.
      • Goldstein's assets were never at risk unless the government defaulted on their bonds, and the chance of that was so small that it effectively meant that none of Goldstein's other assets were at risk.
      • Therefore, Goldstein's situation was no different than Knetsch, and the Sham Transaction Doctrine still applies.