KNETSCH v. UNITED STATES

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Case Basics
Docket No. 
23
Petitioner 
Knetsch
Respondent 
United States
Tags
Term:
Facts of the Case 

Knetsch purchased annuity savings bonds from Sam Houston Life Insurance Company. In return, the company gave Knetsch loans and an annuity contract that would produce monthly annuity payments upon maturity. However, Knetsch kept borrowing from the insurance company in amounts that kept the net cash value of the annuity so low that it could produce no financial benefit other than tax deductions. Knetsch claimed payments to the insurance company as interest paid on indebtedness. The Commissioner of Internal Revenue disallowed the deductions and determined a deficiency amount for each of the two years in question. After paying the deficiency, Knetsch brought suit to obtain a refund in the United States District Court for the Southern District of California. The court ruled in favor of United States, holding that the transaction was a sham because it did not create “indebtedness” and, therefore, there was “no commercial economic substance” beyond the tax deductions. The U.S. Appeals Court for the Ninth Circuit affirmed.

Question 

Did the transaction between Knetsch and the insurance company create an indebtedness within the meaning of the Internal Revenue Code?

Conclusion 
Decision: 6 votes for United States, 3 vote(s) against
Legal provision: Internal Revenue Code

No. In a 6-3 decision, Justice William J. Brennan wrote for the majority affirming the lower court’s decision that the transaction was a sham. The loans the insurance company gave Knetsch were essentially rebates for a substantial portion of the interest payments and the small amount kept by the company was its fee for providing a “façade of loans” to be used to provide tax deductions. Justice William O. Douglas dissented, saying that as long as a transaction is allowed within the limits of insurance policies it should be recognized by the Internal Revenue Service, and any remedy should be left to the legislature.

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KNETSCH v. UNITED STATES. The Oyez Project at IIT Chicago-Kent College of Law. 10 September 2014. <http://www.oyez.org/cases/1960-1969/1960/1960_23>.
KNETSCH v. UNITED STATES, The Oyez Project at IIT Chicago-Kent College of Law, http://www.oyez.org/cases/1960-1969/1960/1960_23 (last visited September 10, 2014).
"KNETSCH v. UNITED STATES," The Oyez Project at IIT Chicago-Kent College of Law, accessed September 10, 2014, http://www.oyez.org/cases/1960-1969/1960/1960_23.