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Friday, March 9, 2012

Taxpayer Must Pay Gift Taxes on Transfer of Winning Lottery Ticket to Family Corporation

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 The March 6, 2012 Tax Court decision in Dickerson v. Comr., T.C. Memo 2012-60, examined whether a waitress who received a lottery ticket and transferred it to a new family corporation made a taxable gift to the other shareholders and, if so, whether the value of the gift should be discounted because of her former co-workers’ claims for a share of the winnings. The court answered yes to both questions.

On March 7, 1999, T, a waitress in an Alabama restaurant, received a “gift” of a Florida lottery ticket from one of her regular customers, C, who often gave away lottery tickets. T had not waited on C that day so the ticket was not deemed to be a tip. C did not realize that the ticket had already won an approximately $10 million prize (or an immediate lump-sum prize of just over $5 million) in the previous evening’s lottery drawing. After learning that the ticket had won, T contacted her father, F, for advice. T knew that she wanted to share the winnings with her parents and siblings, as it was the family’s custom to share all good fortune. F contacted an attorney with the Florida lottery commission who cautioned that T should not sign the ticket and noted that a single entity would be needed to claim the prize on the family’s behalf. With the help of an attorney, F set up a family S corporation (FC) in Alabama and he alone decided that T and her (now former) husband should have a 49% interest in FC and that the other family members should divide the remaining 51% interest.

On March 12, T, along with her husband and parents (but not the siblings or their spouses), met with Florida lottery officials. T signed the claim form as FC’s president and elected to receive 30 annual payments of $354,000 each instead of the lump-sum payment. At that time, the lottery officials told the family that T’s co-workers had filed a competing claim to the ticket and that the commission would make no payments until the dispute was settled. The co-workers claimed that they were entitled to 80% of the proceeds because T was part of an agreement that any lottery winnings would be split among them. An Alabama circuit court agreed with the co-workers but the Alabama Supreme Court reversed the decision in 2000. Related legal proceedings continued at least through September 2002.

T did not file a gift tax return for 1999. The IRS eventually contacted T and asked for a return. T filed in 2007, reporting no taxable gifts related to the lottery ticket. The IRS issued a deficiency notice, arguing that T made an indirect gift of over $2.4 million to the other FC shareholders when she transferred the ticket to FC. This amount was 51% of approximately $4.7 million, which the parties agreed was the value of the ticket before taking into account the ownership dispute. (Note: The IRS, apparently, never asserted any income or gift tax deficiencies against C.)

During the trial challenging the deficiency notice, T claimed that she had not made a gift to the other shareholders, essentially because the family had either a pre-existing binding contract under state law to share any lottery proceeds or an existing partnership under federal law that was the ticket’s true owner. The court noted that, under the gift tax regulations and the case law, “a transfer of property to a corporation for less than adequate consideration represents gifts to the other individual shareholders of the corporation to the extent of their proportionate interests.”

In rejecting the binding contract theory, the Tax Court looked to Alabama law and noted, among other things, that: (1) the terms of the agreement were too indefinite to be enforceable and were “solely offhand statements made throughout the years about sharing and taking care of one another” if a family member came into a substantial amount of money; (2) the family had never defined “substantial”; (3) there was no requirement that the family members buy lottery tickets; (4) there was no pattern of buying tickets; (5) there was no pooling of money to buy tickets; (6) there were no predetermined sharing percentages; and (7) F and T decided what to do without collaboration with the other family members (T’s siblings and their spouses). Also, the court found it particularly curious that F did not divide the lottery proceeds equally. According to the court, F’s statement that he gave T a larger interest because she was “the one that received the ticket” directly contradicted T’s argument that the ticket was jointly owned by the family as soon as she received it. Moreover, even if there was an enforceable contract, the court indicated that such a contract would be void under Alabama’s anti-gambling statute.

In concluding that the family did not have an existing partnership under federal law, the court noted, again, that the family did not have a regular and consistent pattern of buying lottery tickets and that F alone made all the decisions. The court reasoned that offhand statements about sharing and “a familial sense of duty to take care of each other” were not enough to find that a partnership existed and that it owned the lottery ticket.

The court’s holding on valuation was more favorable to T. Citing the gift tax regulations, the court observed that property is valued at “the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having a reasonable knowledge of the relevant facts.” The court agreed with T that the value of her gift to the other shareholders should be discounted to take into account the potential claims to the ticket. The court stated that “a hypothetical willing buyer would have known of the potential cloud on title” and “would have determined that a lawsuit was likely and would not have paid full value for the disputed portion of the ticket.” Ultimately, the court discounted the value by 67% — 65% for the claims and 2% for litigation costs.
As unlikely as the facts of T’s case may seem, similar situations have, apparently, occurred. The 1994 romantic comedy, It Could Happen to You, starring Bridget Fonda and Nicholas Cage, is purportedly patterned on the real-life story of a Yonkers, New York, waitress who received an interest in a lottery ticket as a tip and the lottery ticket won!

If you or one of your clients occasionally (or regularly) buys lottery tickets and plans to claim joint ownership of the ticket with someone other than a spouse, perhaps it would be a good idea to start documenting those plans — before a big win. Or, if you or a client participate in a lottery ticket buying pool and some members of the pool also buy separate tickets, it would not hurt for the members to discuss how any separate tickets will be handled in the event one of those tickets wins a jackpot someday.
 
Kathy Hanson, J.D., LL.M
Federal Tax Law Editor
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