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People enter and sometimes win lotteries, receiving a long-term stream of cash. The winnings from a lottery are included in one's estate. Unfortunately, the lottery winners in Carol J. Negron, Executrix v. U.S., 103 AFTR2d 2009-634 (6th Cir. 2009), failed to appreciate the impact of the IRS method of calculating the remaining annuity payments. In Negron, the Sixth Circuit reversed and remanded to the district court, sternly stating that the IRS annuity tables (§7520 and Regs. §20.2031-7(d) and §20.7520-1) generally control, and the taxpayer has a heavy burden to successfully argue that the IRS tables produce an unreasonable and unrealistic result.
The Sixth Circuit panel determined that the district judge had been swayed away from the law by the facts of the case. In 1991, three people jointly won the Ohio Super Lotto Jackpot of $20 million. Two of these winners died in late 2001. Both were entitled to 15 more lottery payments. Payments were, as is typical, not assignable and not able to be used as collateral. Negron, the plaintiff, was appointed executrix of both estates and cashed in the annuities for lump sum payments. She paid estate taxes based on the lump sum payment received, and not the present value of the remaining annuity payments, determined by the IRS tables. Unfortunately, the Ohio tables for such valuation differed from the IRS tables. Ohio used a 9% discount rate, rather than the 5.0% and 5.6% discount rates applicable to the estates under the IRS tables. The discount rate used by the Ohio lottery was a present value calculated from the date of the lottery and the IRS present value was from tables in effect at the time of death. The Ohio calculation resulted in a lower lump sum payment than the IRS annuity tables provide. Thus, the IRS requested and received an additional $330,302 from the estate of one decedent and $141,175 from the estate of the other. The executrix appealed for both estates. In reviewing the district court's ruling that the IRS tables be ignored, the Sixth Circuit noted that the taxpayer chose to take the lump sum payment, and this payment caused the reduction in value:
It is tempting to accept the argument that a person's estate should not be taxed on a lottery annuity amount it did not receive. The additional tax burden does not seem fair. However, the difference in the amount received and the value for federal tax purposes occurred because of the interaction between the state and federal discount rates: Ohio with a discount rate in effect on the date the prize was won and the IRS with a discount rate in effect on the date of death. … The estates chose to take lump sum payments rather than to continue the annuities…. It was the estates' choice that made the results of the IRS assessment particularly unpleasant ….
There remains a split among circuits and some district courts in circuits which have not formally considered the issue. Prior to Negron, the split was:
Second and Ninth Circuits holding that the IRS tables need not be followed because the tables do not accurately reflect the fair market value of future lottery payments with marketability restrictions, and the Fifth Circuit and district courts in Massachusetts and New Hampshire (First Circuit) requiring that the tables be used. Gribauskas Est. v. Comr., 342 F.3d 85 (2d Cir. 2003); Shackleford v. U.S., 262 F.3d 1028 (9th Cir. 2001); Cook v. Comr., 349 F.3d 850, 854-55 (5th Cir. 2003); Anthony v. U.S., 520 F.3d 374 (5th Cir. 2008); Davis v. U.S., 491 F. Supp.2d 192 (D.N.H. 2007); Donovan Est. v. U.S., 95 AFTR2d 2005-2131 (D. Mass. 2005). The Fifth Circuit opinions have all held that the valuations inherent in the tables already take into consideration marketability restrictions, and so no additional “lack of marketability” discount will be allowed.
Practice Point: Even if you are in the Second or Ninth Circuit, do not rely on earlier decisions to the effect that the IRS annuity valuation tables need not be followed. If you work with a lottery winner in the pre-death planning stage, help plan for a way of paying the estate taxes other than having to cash in the annuity for a lump sum. If you are not consulted until after death and the only way to pay the estate taxes is to cash in the annuity or borrow to pay the estate taxes, be creative and see if there are, perhaps, private purchasers in the market who are willing to take the risk of non-assignability and pay more in a lump sum than the lottery commission.
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