T.C. Memo. 2004-244
UNITED STATES TAX COURT
ROGER L. WATKINS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19587-02. Filed October 26, 2004.
Eric J. Zinn and Gregory W. Berger, for petitioner.
Mary T. Klaasen, for respondent.
MEMORANDUM OPINION
HAINES, Judge: Respondent determined a $518,463 deficiency
in petitioner’s Federal income tax for 1998 (year in issue). The
sole issue for decision is whether petitioner’s receipt of
$2,614,744 in exchange for an assignment of a right to receive
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future lottery installment payments constitutes ordinary income
or capital gain during the year in issue.1
Unless otherwise noted, all section 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
The parties submitted this case fully stipulated pursuant to
Rule 122. The stipulation of facts and the attached exhibits are
incorporated herein by this reference. At the time the petition
was filed, petitioner resided in Hotchkiss, Colorado.
Petitioner purchased a $1 lottery ticket sometime before May
1, 1993. On May 1, 1993, petitioner won $12,358,688 from the
Colorado State lottery with this ticket. At the time he won the
lottery, petitioner was married to Tammy Watkins (Mrs. Watkins).
The lottery prize amount was payable in 25 annual installments
beginning on May 3, 1993, and payable on the third of May for the
next 24 years.
1
The parties stipulated that if the assignment does not
constitute the sale of a capital asset, then a $200,000 fee paid
to Will Hoover Group is deductible only as a miscellaneous
itemized deduction on petitioner’s Schedule A, Itemized
Deductions, for 1998, as respondent determined in the notice of
deficiency.
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Petitioner reported the receipt of the first five lottery
installment payments as ordinary income on his Federal income tax
returns.
On February 7, 1997, petitioner and Mrs. Watkins were
divorced by order of the District Court, Park County, of the
State of Colorado. As part of the divorce settlement, the
district court awarded petitioner and Mrs. Watkins each one-half
interest in the future lottery installment payments as of May 3,
1998.
On or about April 10, 1998, petitioner entered into a
contract with Stone Street Capital, Inc. (Stone Street) to sell
and assign his one-half interest in the remaining lottery
installment payments beginning with the annual payment due on May
3, 1999. The remaining lottery installment payments were as
follows:
Year Amount
1999 $384,220
2000 398,436
2001 413,178
2002 428,465
2003 444,318
2004 460,756
2005 477,805
2006 495,483
2007 513,815
2008 532,826
2009 552,540
2010 572,983
2011 594,183
2012 616,167
2013 638,965
2014 662,606
2015 687,122
2016 712,545
2017 738,909
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The contract sale price of petitioner’s interest in the
remaining lottery installment payments was $2,614,744. On June
16, 1998, an order from the District Court for the City and
County of Denver, Colorado, directing the Colorado State lottery
to make assigned payments to Stone Street was issued. Petitioner
received consideration of $2,614,744 for the remaining lottery
installment payments from Stone Street on June 29, 1998.
On petitioner’s 1998 tax return, he reported the one-half
share of the annual installment payment awarded in the divorce
settlement, i.e., $185,256, due on May 3, 1998, as ordinary
income. Also on the 1998 tax return, petitioner reported the
consideration received for the assignment of his one-half
interest in the remaining lottery installment payments to Stone
Street as the sale of a capital asset of $2,414,744, with a basis
of zero. The sale amount represented the price paid by Stone
Street, i.e., $2,614,744, minus $200,000 paid to Will Hoover
Group as consulting fees for services provided in the assignment
to Stone Street.
In the notice of deficiency, respondent determined that
petitioner’s assignment of his right to future lottery
installment payments to Stone Street was not a sale of a capital
asset, and the consideration received was includable as ordinary
income in the full amount of $2,614,744. Further, respondent
determined the deduction of $200,000 for consulting fees was
allowable as a miscellaneous itemized deduction. Petitioner
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timely filed a petition with the Court to dispute respondent’s
determinations.
Discussion
The parties dispute whether petitioner’s receipt of
$2,614,744 in exchange for the assignment of his right to receive
future lottery installment payments constitutes ordinary income
or capital gain during the year in issue. 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 was a sale of a
capital asset relies on reasoning found in United States v.
Maginnis, 356 F.3d 1179 (9th Cir. 2004). We note from the outset
that we are not bound by the opinion of the Court of Appeals for
the Ninth Circuit because appeal of this decision would lie in
the Court of Appeals for the Tenth Circuit, which has not ruled
on this issue. Sec. 7482(b)(1)(A).
Additionally, in Maginnis, the Court of Appeals affirmed the
District Court holding that under the substitute for ordinary
income doctrine the sale of a right to future lottery payments
should be taxed as ordinary income.2 Id. at 1187. Petitioner
2
Under the “substitute for ordinary income doctrine”, a
court narrowly construes the term “capital asset” when taxpayers
make attempts to transform ordinary income into capital gain.
See Commissioner v. P.G. Lake, Inc., 356 U.S. 260, 265 (1958).
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argues on the basis of reasoning stated as follows by the Court
of Appeals:
Two factors are crucial to our conclusion, although we do
not hold that they will be dispositive in all cases.
Maginnis (1) did not make any underlying investment of
capital in return for the receipt of his lottery right, and
(2) the sale of his right did not reflect an accretion in
value over cost to any underlying asset Maginnis held. * * *
[Id. at 1183; fn. ref. omitted]
Petitioner argues that his purchase of the lottery ticket was an
underlying investment of capital. Further, petitioner argues
that the assignment of lottery installment payments did reflect
an accretion in value over cost to an underlying asset petitioner
held because the assigned future lottery installment payments
appreciated in value due to “impersonal market forces outside of
the control of the asset’s owner”. We disagree. We find that
the facts in Maginnis are indistinguishable from the instant
case.
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. Id. at 1181. The Court of
Appeals held that the taxpayer could not argue that a purchase of
a lottery ticket was a capital investment. Id. at 1183. The
Court of Appeals stated that “the purchase of a lottery ticket is
no more an underlying investment of capital than is a dollar bet
on the spin of a roulette wheel.” Id. at 1184. 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
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taxpayer for the right to receive the future lottery payments,
and, therefore, the money received for the sale of the right
could not be seen as reflecting an increase of value above the
cost of any underlying asset.3 Id.; see also Boehme v.
Commissioner, T.C. Memo. 2003-81 (holding taxpayer’s right to
receive future annual lottery payments did not constitute a
capital asset). We reiterated this reasoning in Clopton v.
Commissioner, T.C. Memo. 2004-95, in which we held that the lump-
sum amount received in exchange for an interest in a trust
holding the right to receive future lottery payments was ordinary
income. As a result, petitioner’s arguments fail under Maginnis.
Additionally, we find the facts in the instant case
indistinguishable in substance from the facts in our opinion of
Davis v. Commissioner, 119 T.C. 1 (2002), and cases relying on
this opinion, 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. Id. at 3; 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.
We held in each of these cases that a right to future lottery
3
We note that petitioner’s tax return reported a zero cost
basis with regard to amount received for the assignment of the
future lottery installment payments to Stone Street.
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installment payments did not constitute a capital asset within
the meaning of section 1221.4 Davis v. Commissioner, supra at 7;
4
SEC. 1221. CAPITAL ASSET DEFINED.
For purposes of this subtitle, the term “capital asset”
means property held by the taxpayer (whether or not
connected with his trade or business), but does not
include--
(1) stock in trade of the taxpayer or other
property of a kind which would properly be included in
the inventory of the taxpayer if on hand at the close
of the taxable year, or property held by the taxpayer
primarily for sale to customers in the ordinary course
of his trade or business;
(2) property, used in his trade or business, of a
character which is subject to the allowance for
depreciation provided in section 167, or real property
used in his trade or business;
(3) a copyright, a literary, musical, or artistic
composition, a letter or memorandum, or similar
property, held by--
(A) a taxpayer whose personal efforts created
such property,
(B) in the case of a letter, memorandum, or
similar property, a taxpayer for whom such
property was prepared or produced, or
(C) a taxpayer in whose hands the basis of
such property is determined, for purposes of
determining gain from a sale or exchange, in whole
or part by reference to the basis of such property
in the hands of a taxpayer described in
subparagraph (A) or (B);
(4) accounts or notes receivable acquired in the
ordinary course of trade or business for services
rendered or from the sale of property described in
paragraph (1);
(5) a publication of the United States Government
(including the Congressional Record) which is received
(continued...)
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Lattera v. Commissioner, supra; Clopton v. Commissioner, supra;
Simpson v. Commissioner, supra; Johns v. Commissioner, supra;
Boehme v. Commissioner, supra. Given the similarity of facts, it
would serve no purpose in repeating the analysis provided in
Davis v. Commissioner, supra. See also Sec. State Bank v.
Commissioner, 111 T.C. 210, 213-214 (1998)(“The doctrine of stare
decisis generally requires that we follow the holding of a
previously decided case, absent special justification.”), affd.
214 F.3d 1254 (10th Cir. 2000).
Pursuant to Davis v. Commissioner, supra, and its progeny,
we hold that the $2,614,744 received by petitioner from Stone
Street in exchange for petitioner’s right to receive one-half of
the remaining lottery installment payments is ordinary income and
not capital gain.
4
(...continued)
from the United States Government or any agency
thereof, other than by purchase at the price at which
it is offered for sale to the public, and which is held
by--
(A) a taxpayer who so received such
publication, or
(B) a taxpayer in whose hands the basis of
such publication is determined, for purposes of
determining gain from a sale or exchange, in whole
or in part by reference to the basis of such
publication in the hands of a taxpayer described
in subparagraph (A).
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In reaching our holding herein, we have considered all
arguments made, and, to the extent not mentioned above, we
conclude that they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be
entered for respondent.