Tax Watch: Couple takes their lumps after winning lottery
A couple who traded a portion of their annualized lottery winnings for a lump sum from a finance company found out the hard way that the lump sum is ordinary taxable income.
In 1991, James Davis won $13.58 million in California’s online lottery.
Under the rules in effect in 1991, Mr. Davis was entitled to receive the winnings in 20 annual payments of $679,000, minus taxes.
In 1997, he and his wife Dorothy agreed to receive a lump-sum payment of $1.04 million from Singer Asset Finance Co. LLC of West Palm Beach, Fla., in exchange for a portion of 11 of the 14 remaining lottery payments.
The California Superior Court granted the couple an order approving the assignment of their lottery winnings to Singer.
After the assignment, the couple was entitled to receive from the lottery payments of $514,000 instead of $679,000.
Singer issued the couple a Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions,” showing gross proceeds of $1.04 million from the sale of “stocks, bonds, etc.”
The California lottery issued them a Form W-2G, “Certain Gambling Winnings,” showing gross winnings of $514,000 and $143,920 in tax.
The couple filed a timely 1997 Form 1040, reporting the assignment of the lottery payments as a sale of capital assets held for more than one year, and reported a long-term capital gain of just over $1.03 million.
The couple reported the $514,000 received from the lottery as ordinary income.
The IRS issued the couple a deficiency notice for 1997 and recharacterized the payments from Singer as ordinary income.
Tax Court Judge Carolyn P. Chiechi agreed with the IRS’ reading of another court case and rejected the couple’s argument that the $1.04 million they received from Singer was proceeds from the sale of a capital asset.
The court noted that the couple assigned to Singer their right to receive a portion of future annual lottery payments that were ordinary income.
In exchange, Singer paid the couple for the right to receive the ordinary income and not for an increase in the value of the income-producing property.
The judge ruled that the couple’s right to receive future annual lottery payments from the California lottery wasn’t a capital asset under the tax rules.
Thus, the $1.04 million payment from Singer was ordinary income, she determined.
Cite: James F. Davis, et ux., v. Commissioner, 119 T.C. No. 1
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