In a case this year ( Gribauskas, 116 TC no. 12), the Tax Court ruled that future payments of lottery winnings must be valued for estate tax purposes using the IRC section 7520 valuation tables. This ruling specifically rejected a California district court’s 1999 decision in Shackleford Est. v. United States, which held using the section 7520 tables was unreasonable because the lottery winnings’ lack of liquidity was not taken into account ( “Court Rules on Lottery Payoffs,” JofA, May00, page 85 ).
In 1992 Gribauskas and his wife won approximately $16 million in the Connecticut lottery, payable in 20 annual installments of about $790,000 each. After they received the first payment, they divorced; the settlement provided each spouse with one-half of the remaining installment payments. In June 1994, Gribauskas died, still entitled to 18 annual payments of approximately $395,000 each.
Gribauskas’ estate tax return included the lottery payments as an unsecured debt obligation due from Connecticut and listed them with a present value of approximately $2.6 million. Instead of considering the payments to be an annuity, the estate, using the estate tax principle of fair market value, had decided the payments were not marketable because they were nonassignable and could not be accelerated and had, therefore, discounted them.
The IRS determined the present value of the payments should have been $3.5 million, based on the tables. It concluded the installments, regardless of whether they constituted an annuity under the estate tax inclusion rules of IRC section 2039, fell under section 7520. Furthermore, no regulatory exceptions or features—such as lack of marketability—exempted applying the valuation tables to the winnings.
The Tax Court agreed with the IRS, concluding the payments were an annuity under section 7520. The court rejected the estate’s arguments that the annuity table value was unrealistic and unreasonable because it did not take into account the unsecured nature of the payment obligation, the lack of a corpus to draw on or the estate’s inability to assign, sell or transfer the interest.
Furthermore, the Tax Court specifically disagreed with the district court’s decision in Shackleford , stating that it offered no support for considering marketability in valuing annuities and that Congress’ enactment of section 7520 showed it was strongly in favor of standardized actuarial valuation. The court also said that, as a practical matter, the value of an annuity is distinct in nature from interests to which a marketability discount is typically applied, such as closely held stock. The annuity’s value exists solely in the anticipated payments. The inability to liquidate those installments does not diminish the value of an enforceable right to a specific payment for a given number of years.
Observation. In light of this decision by the Tax Court, practitioners should reconsider any planning that relied on Shackleford .
—James Ozello, Esq.,
Ozello Tax and Legal Consulting,
Ringwood, New Jersey.