Goldstein v. Comm'r of Internal Revenue, Docket No. 94448.

• Decision Date: 28 May 1965
• Docket Number: Docket No. 94448.
• Citation: 44 T.C. 284
• Parties: KAPEL GOLDSTEIN AND TILLIE GOLDSTEIN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

44 T.C. 284

KAPEL GOLDSTEIN AND TILLIE GOLDSTEIN, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 94448.

Tax Court of the United States.

Filed May 28, 1965.

I.Meyer Pincus, for the petitioners.

John E. McDermott, Jr., and Donald H. Cuozzo, for the respondent.

Held, that sums which petitioner Tillie Goldstein paid, purportedly as ‘prepaid interest’ on two newly created items of ‘indebtedness,‘ within the intendment of section 163(a), I.R.C. 1954; and accordingly said sums are not deductible.

PIERCE, Judge:

On October 20, 1964, this Court filed in this case Memorandum Findings of Fact and Opinion, and also entered a decision in accordance therewith.

Thereafter on November 19, 1964, the petitioners filed herein motions for reconsideration of said Memorandum Findings of Fact and Opinion, and also for revision of said decision. The Court, upon consideration thereof, entered an order herein on November 23, 1964, wherein it was ordered: (1) That the said decision entered in this case on October 20, 1964, be, and the same was, withdrawn and vacated; (2) that petitioners' motion for reconsideration of the Memorandum Findings of Fact and Opinion issued under date of October 20, 1964, be, and the same was granted; and (3) that said Memorandum Findings of Fact and Opinion be, and the same was, withdrawn for reconsideration of the case.

The following are now the Findings of Fact and Opinion of the Court in this case.

The Commissioner determined a deficiency in the income tax of the petitioners for their taxable calendar year 1958, in the amount of $55,193.34.

The sole issue for decision is whether the sums of $52,596.61 and $28,800 (totaling $82,396.61), which petitioner Tillie Goldstein paid to certain lending institutions on December 31, 1958, and which she claims to be deductible for income tax purposes entirely in that year, as ‘prepaid interest’ on two newly created items of ‘indebtedness' in the respective amounts of $465,000 and $480,000 (totaling $945,000), actually did, in substance and reality, constitute payments of ‘interest * * * on indebtedness' within the intendment of section 163(a) of the Internal Revenue Code of 1954.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts and all exhibits identified therein are incorporated herein by reference; subject however to an understanding that descriptive words used therein, such as ‘promissory note,’ ‘interest,’ ‘sales,‘ and ‘loans,‘ are not conclusive as to the true character of the transactions to which they relate, or as to the actual existence of an ‘indebtedness' within the meaning of the applicable statute.

General Background Facts

The petitioners, Kapel Goldstein and Tillie Goldstein, are husband and wife who, during the taxable year here involved, resided in Brooklyn, N.Y. For said taxable year, they filed a joint Federal income tax return, on the cash receipts and disbursements basis, with the district director of internal revenue at Brooklyn. The issue presented concerns only the wife, Tillie Goldstein, whom we will hereafter refer to as Tillie.

During the taxable year 1958, Tillie was a housewife; she was approximately 70 years of age. Her husband, Kapel, with whom she lived, was a retired garmentworker who received a pension of $780 per year. The couple's only income for the taxable year, exclusive of the proceeds from a winning Irish Sweepstakes ticket hereinafter mentioned, consisted of said $780 pension of the husband plus interest income of $124.45 from savings bank accounts. Also as of December 1, 1958 (which was prior to the receipt of said sweepstakes winning), the total assets of said couple consisted of the following:

+-----------------------------------------------------------------------+
                ¦Two accounts at Dry Dock Savings Bank                           ¦$2,050¦
                +----------------------------------------------------------------+------¦
                ¦Account at First National City Bank                             ¦360   ¦
                +----------------------------------------------------------------+------¦
                ¦Note receivable from Lou Katz                                   ¦6,000 ¦
                +----------------------------------------------------------------+------¦
                ¦Loan receivable from Sidney Handsman                            ¦3,000 ¦
                +----------------------------------------------------------------+------¦
                ¦Funds on deposit, New York Life Insurance Co. (matured endowment¦      ¦
                +----------------------------------------------------------------+------¦
                ¦policy)                                                         ¦1,000 ¦
                +----------------------------------------------------------------+------¦
                ¦U.S. Government Series E bonds                                  ¦1,000 ¦
                +----------------------------------------------------------------+------¦
                ¦Cash surrender value of life insurance policies (estimated)     ¦2,500 ¦
                +----------------------------------------------------------------+------¦
                ¦Total assets                                                    ¦15,910¦
                +-----------------------------------------------------------------------+
                

The record does not disclose the amount of their liabilities, if any; nor does it disclose what portion, if any, of the above assets belonged to Tillie.

During the latter part of said year 1958, fortune smiled broadly on Tillie, for she learned that a ticket which she held on the Irish Sweepstakes was a winner; and that she would soon receive therefrom the sum of $140,218.75. Thereafter in December of said year, she did receive this amount. She deposited the same in a New York bank; and thereafter she included the same in gross income, in the above mentioned income tax return which she and her husband filed for the year 1958.

Tillie and her husband were the parents of a son, Bernard Goldstein, who in 1958 was a certified public accountant practicing in New York City. Beginning in November 1958, Bernard began a series of consultations with the attorney representing petitioners in the instant case— at least one phase of which consultations was the tax consequences to Tillie of her sweepstakes winnings. The question of using the provisions of the Internal Revenue Code allowing deductions for interest paid on indebtedness, came up. Bernard wanted to use that section (section 163, I.R.C. 1954), to save his mother taxes.

As a result of the foregoing discussions with the attorney, Bernard formulated and carried out a plan involving the use of the interest expense deduction provisions of the 1954 Code, which he calculated would result in total Federal income taxes of $23,014.04 on his mother's sweepstakes winnings, as opposed to the tax of about $69,600 on such winnings which was determined in the deficiency notice herein after disallowance of the claimed deduction for interest. Bernard's plan envisioned, in substance, the ‘purchase’ by his mother Tillie of $1 million face amount of U.S. Treasury 1 1/2-percent notes, with ‘borrowed’ funds on which she would prepay 4-percent ‘interest’ for 1 1/2 to 2 1/2 years in the approximate amount of $80,000; and then the deduction by Tillie of such interest in its entirety, on the same 1958 income tax return on which her sweepstakes winnings of approximately $140,000 would be reported as income. The plan which was thereafter carried out, actually involved two separate transactions for the purported purchase of U.S. Treasury notes: One involving Treasury 1 1/2-percent notes, maturing on October 1, 1962; and the other involving Treasury 1 1/2-percent notes, maturing on October 1, 1961. The

facts regarding these two transactions are as follows. Facts re Transactions Involving Treasury 1 1/2-Percent Notes Maturing October 1, 1962

In late December 1958, Bernard acting on behalf on his mother Tillie, had consultations with the New York investment firm of Garvin, Bantel, & Co. (hereinafter called Garvin-Bantel) regarding the tax-saving plan which he and said attorney had formulated. Garvin-Bantel was a member of both the New York and American Stock Exchanges, and it also engaged in the business of acting as a money broker. In this latter capacity its function was to arrange loans on behalf of third parties with various banks with which it had working arrangements, in consideration for commissions paid to it by such banks.

Thereafter on December 29, 1958, one of Garvin-Bantel's officers or employees, acting pursuant to said consultations with Bernard, contacted the First National Bank of Jersey City (hereinafter called the Jersey City bank), and arranged for said bank to make a ‘loan’ to Tillie in the amount of $465,000; which loan would be evidenced by a personal promissory note of Tillie, maturing on October 15, 1961; on which loan Tillie would prepay ‘interest’ at 4 percent per annum; and which loan would be ‘secured’ by $500,000 face amount of Treasury 1 1/2s due October 1, 1961, which were to be ordered for the Jersey City bank by Garvin-Bantel. The Jersey City bank agreed to this arrangement for the ‘loan,‘ without any of its officers or employees seeing or talking either to Tillie or to Bernard, and also without them making any investigation of the credit or financial standing of Tillie or of her husband, Kapel. Indeed, the bank's records erroneously listed the occupation of Kapel as a ‘Retired Gormet,‘ when in fact he was a retired garmetworker.

On the next day, December 30, 1958, one of Garvin-Bantel's officers or employees called Malon S. Andrus, Inc. (hereinafter called Andrus), a dealer in Government securities, and arranged for Andrus to sell to the Jersey City bank $500,000 face amount of Treasury 1 1/2s, due October 1, 1962, at 92.30, ¹ (or $464,687.50) plus accrued interest of$1,875. Andrus paid a commission to Garvin-Bantel of 1/32 on said notes (or $156.60) in respect to this transaction— all of which commission was retained by Garvin-Bantel and not credited to Tillie. Andrus' records indicated that the transaction was a sale by it to...