Shirley B. Prebola n.k.a. Shirley D. Begy v. Commissioner

2005 T.C. Memo. 261

• Court: United States Tax Court
• Decided: November 8, 2005
• Docket: 4117-04
• Status: Unpublished

Opinion

T.C. Memo. 2005-261

UNITED STATES TAX COURT

SHIRLEY B. PREBOLA n.k.a. SHIRLEY D. BEGY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 4117-04. Filed November 8, 2005.

Gerald W. Dibble, for petitioner.

Kevin M. Murphy, for respondent.

MEMORANDUM OPINION

COHEN, Judge: Respondent determined a deficiency of

$1,310,766 in petitioner’s Federal income tax for 2000. The

deficiency was attributable to respondent’s recharacterizing the

lump-sum proceeds received by petitioner for the sale of rights

acquired from the New York State lottery as ordinary income

instead of capital gain. Unless otherwise indicated, all section - 2 -

references are to the Internal Revenue Code in effect for the

year in issue, and all Rule references are to the Tax Court Rules

of Practice and Procedure.

Background

This case was submitted fully stipulated under Rule 122.

The stipulated facts are incorporated as our findings by this

reference. Petitioner resided in Rochester, New York, at the

time that she filed her petition.

On May 31, 1997, petitioner won $17.5 million in the New

York State Lottery. Petitioner was entitled to receive 26 annual

payments totaling $17.5 million that began in June 1997 and will

end in May 2022. Petitioner received annual lottery payments for

1997 through 1999. She reported those payments as ordinary

income on her income tax returns for each of those years.

On January 14, 2000, petitioner sold all of her then

remaining lottery rights to Settlement Funding LLC (Settlement

Funding) of Norcross, Georgia, for a lump-sum payment of

$7.1 million. This sale was pursuant to an agreement between the

parties dated November 4, 1999, and a New York Supreme Court

Order dated November 29, 1999. Settlement Funding issued to

petitioner a Form 1099-B, Proceeds From Broker and Barter

Exchange Transactions, for 2000. The Form 1099-B listed proceeds

from the sale of “Stocks, bonds, etc.” of $7.1 million. - 3 -

Petitioner filed Form 1040, U.S. Individual Income Tax

Return, for 2000. On Schedule D, Capital Gains and Losses,

attached to that return, petitioner reported the sale of her

lottery rights as a long-term capital gain of $7.1 million. The

Internal Revenue Service determined that petitioner’s income from

the sale of the lottery rights was includable as ordinary income,

not as a capital gain.

Discussion

The parties dispute whether petitioner’s receipt of

$7.1 million in exchange for the assignment of her right to

receive future lottery installment payments to Settlement Funding

constitutes ordinary income or capital gain. Resolution of this

issue depends on whether petitioner’s right to receive the

remaining lottery installment payments was a capital asset within

the meaning of section 1221.

Petitioner’s argument that the assignment of the right to

receive the remaining payments was the sale of a capital asset

purports to apply the “parameters” but disputes the reasoning in

United States v. Maginnis, 356 F.3d 1179 (9th Cir. 2004). In

Maginnis, the Court of Appeals held that, under the substitute

for ordinary income doctrine, the sale of a right to future

lottery payments should be taxed as ordinary income. Id. at

1187. (Under the substitute for ordinary income doctrine, a

court will narrowly construe the term “capital asset” when a - 4 -

taxpayer makes an attempt to transform ordinary income into

capital gain. See Commissioner v. P.G. Lake, Inc., 356 U.S. 260,

265 (1958).) The Court of Appeals found that there was no sale

of a capital asset because there was no underlying investment of

capital in return for the receipt of the lottery ticket and

because the sale did not reflect an increase in value over cost

to any underlying asset held by the taxpayer. Id. at 1183.

Petitioner argues that her right to receive future lottery

payments in this case was a capital asset because her purchase of

the lottery ticket was an underlying investment in capital.

Further, petitioner argues that there was an increase in value

above the cost of any underlying asset she held because “the

assigned payments appreciated in value due to impersonal market

forces”. Finally, petitioner argues that respondent’s reliance

on the substitute for ordinary income doctrine is misplaced.

In Maginnis, the taxpayer assigned his right to receive the

remaining installments of a lottery prize to a third party in

exchange for a lump-sum payment. The Court of Appeals held that

the taxpayer could not argue that a purchase of a lottery ticket

was a capital investment. Id. Further, because the Court of

Appeals held that the lottery ticket was not a capital

investment, it also held that there was no “cost” to the taxpayer

for the right to receive the future lottery payments. Therefore,

the money received for the sale of the right could not be seen as - 5 -

reflecting an increase of value above the cost of any underlying

asset. Id. at 1184; see also Watkins v. Commissioner, T.C. Memo.

2004-244 (taxpayer’s right to receive future annual lottery

payments did not constitute a capital asset); Clopton v.

Commissioner, T.C. Memo. 2004-95; Boehme v. Commissioner, T.C.

Memo. 2003-81. Petitioner’s arguments fail to distinguish her

situation from that of the taxpayer in Maginnis.

Additionally, the governing facts in the instant case are

indistinguishable from the facts in Davis v. Commissioner, 119

T.C. 1 (2002), and other cases, in which a taxpayer assigned a

right to future lottery installment payments in return for a

lump-sum payout at a discounted value from a third party. We

held in each of these cases that a right to future lottery

installment payments did not constitute a capital asset within

the meaning of section 1221. See Wolman v. Commissioner, T.C.

Memo. 2004-262; Watkins v. Commissioner, supra; Lattera v.

Commissioner, T.C. Memo. 2004-216; Clopton v. Commissioner,

supra; Simpson v. Commissioner, T.C. Memo. 2003-155; Johns v.

Commissioner, T.C. Memo. 2003-140; Boehme v. Commissioner, supra.

It is unnecessary to repeat the thorough analysis set forth in

Davis v. Commissioner, supra. Petitioner has not attempted to

distinguish Davis and the other cases, instead arguing analogies

to cases in different contexts. We see no reason to depart from

the consistent treatment of identical issues. We hold that the - 6 -

$7.1 million received by petitioner from Settlement Funding in

exchange for petitioner’s right to receive the remaining lottery

installment payments is ordinary income and not capital gain.

To reflect the foregoing,

Decision will be entered

for respondent.