CA-6 Values Lottery Payments Using IRS Annuity Tables
In Negron 1 the Sixth Circuit held that for estate tax purposes, a decedent's remaining lottery payments must be valued using the IRS annuity tables.
In 1991, three individuals won a lottery. Each winner was entitled to receive 26 annual payments. Two of the winners died in 2001, with 15 more annual lottery payments remaining to be paid to them. The lottery payments were not assignable and could not be used as collateral. The executor of both estates elected to receive a lump-sum cash settlement of the remaining lottery payments rather than continuing to receive the annual lottery payments. In calculating the amount of the lump-sum distribution, the state lottery commission determined the present value of the remaining lottery payments by using a discount rate of 9%, which was the discount rate used by the lottery commission on the date that the decedents won the lottery. Each estate included on the estate's tax return the amount of the lump-sum payment received from the lottery commission.
On audit, the IRS determined that the proper method for valuing the remaining lottery payments was to use the IRS annuity tables and apply the discount rate that was in effect on the date of the decedent's death. For one of the decedents, the IRS discount rate was 5%, and for the other decedent the IRS discount rate was 5.6%. The value ascribed to the lottery payments by the IRS was higher than the amount the estate received from the lottery commission. In valuing annuities, the lower the interest rate, the higher the value of the annuity. This explains why the IRS annuity tables produced a substantially higher value than the lump-sum payment received by each estate from the lottery commission.
Both estates paid the additional tax assessed by the IRS and filed a refund claim. The IRS denied both refund claims, and both the estates filed a refund suit in the U.S. District Court.2In the district court, the IRS argued that the IRS annuity tables must be used to value the remaining lottery payments. The estate contended that an exception was warranted because the IRS annuity tables created an unreasonable and unrealistic result. The district court held that a departure from the IRS annuity tables was warranted if the taxpayer could show that: (1) the value ascribed by the IRS annuity tables was unrealistic and unreasonable, and (2) there is a more reasonable and realistic means by which to determine the market value. The court found that the nontransferability of an annuity affected its fair market value and that therefore the value ascribed by the IRS annuity tables was unrealistic and unreasonable. The IRS appealed the decision of the district court to the Sixth Circuit.
The Sixth Circuit stated that the issue in this case boiled down to whether the IRS used an appropriate discount rate when calculating the present value of the remaining lottery payments. The estate argued that it was unreasonable for the estate to be taxed on amounts in excess of the amount actually received by the estate from the lottery commission. The court recognized, however, that the difference in the amount received from the lottery commission and the value of the remaining lottery payments for federal estate tax purposes occurred solely because of the difference between the discount rates used by the lottery commission and those used by the IRS.
The appellate court stated that the two discount rates yielded different results because they served different purposes: the discount rate used by the lottery commission approximated the value of the unpaid annuity as if it had been paid in a lump sum initially. The discount rate used by the IRS valued the annuities as an ongoing annuity or continuing stream of periodic payments.
The court concluded that the lump-sum calculation used by the lottery commission was simply an alternative method of valuing lottery winnings and did not make the IRS method unreasonable. The Sixth Circuit stated that it was the estate's choice to take a lump-sum payment rather than to continue the annuity payment. Thus, if the estate had chosen instead to continue to receive the lottery payments, the discount rate of the lottery commission would not have been applied. Accordingly, the court believed that it was solely the estate's choice that resulted in the estate being subject to estate taxes on more than the estate actually received from the lottery commission.
The Sixth Circuit stated that the IRS annuity tables must be applied unless the party seeking to depart from their use meets the substantial burden of showing that: (1) the result of using the IRS annuity tables is so unrealistic and unreasonable that some modification or a complete departure from the IRS annuity tables should be taken, and (2) a more reasonable and realistic means of determining value is available. The court believed that this standard gives proper deference to the IRS annuity tables but ensures that the IRS annuity tables will not be applied when the results would be arbitrary, capricious, or manifestly contrary to the statute.
The Sixth Circuit did not agree with the conclusion of the district court that on account of the restrictions on transfer contained in the lottery annuity, the IRS annuity tables produced an unrealistic and unreasonable result. The court believed that the nonmarketability of the annuities is an assumption underlying the IRS annuity tables. The court believed that the property right to be valued in this case is the legally enforceable, virtually risk-free right to receive annual payments that cannot be assigned to a third party. The court stated that a marketability factor is not necessary to determine the value of a guaranteed income stream and that the value of the decedent's interest at the time of death is readily ascertainable and fairly reflected by the present value of the remaining payments using the IRS annuity tables in effect on the date of death. The Sixth Circuit therefore reversed the decision of the district court.
The decision of the Sixth Circuit in Negron is not the first judicial decision regarding the valuation of lottery payments for estate tax purposes. It is surprising the number of times a court has been called upon to address this issue.
The Ninth Circuit 3 and the Second Circuit 4 have held that the IRS annuity tables are not to be used in valuing lottery payments for estate tax purposes where the lottery payments are nontransferable. However, the Fifth Circuit 5, the Tax Court 6, and the U.S. District Court of Massachusetts 7 have held that the IRS annuity tables are to be used in valuing lottery payments for estate tax purposes regardless of whether the lottery payments are nontransferable. This split in the courts is likely to remain unless and until the U.S. Supreme Court settles the issue. In providing guidance to practitioners regarding these cases, one commentator has stated: "The Tax Court is consistent in its opinions, but the courts of appeal are not, which bolsters the Tax Court's opinions. Both sides of the argument have valid points supporting their position. For taxpayers in circuits that have not yet addressed this issue, it is difficult to determine how those courts will side. The safer and less expensive tact, litigation wise, is certainly to use the valuation tables. If a taxpayer uses an expert's appraisal, expect a court fight and decide in advance whether the expected time and expense will be worth the anticipated tax benefit."8 Wise advice for all of us.
1 103 AFTR 2d 2009-634, 553 F3d 1013, 2009-1 USTC 60571 (CA-6, 2009).
2 See Negron, 99 AFTR 2d 2007-3127, 2007-1 USTC 60541, 502 F Supp 2d 682 (DC Ohio, 2007).
3 Shackleford, 88 AFTR 2d 2001-5658, 262 F3d 1028, 2001-2 USTC 60417 (CA-9, 2001), aff'g Estate of Shackleford, 84 AFTR 2d 99-5902, 99-2 USTC 60356 (DC Cal., 1999).
4 Estate of Gribauskas, 92 AFTR 2d 2003-5914, 342 F3d 85, 2003-2 USTC 60466 (CA-2, 2003), rev'g 116 TC 142 (2001).
5 Cook, 92 AFTR 2d 2003-7027, 349 F3d 850, 2003-2 USTC 60471 (CA-5, 2003); Anthony, 101 AFTR 2d 2008-983, 520 F3d 374, 2008-1 USTC 60558 (CA-5, 2008).
6 Estate of Gribauskas, 116 TC 142 (2001); Estate of Cook, TC Memo 2001-170, RIA TC Memo 2001-170, 82 CCH TCM 154.
7 Estate of Donovan, 95 AFTR 2d 2005-2131, 2005-1 USTC 50322, 2005-1 USTC 60500 (DC Mass., 2005).
8 Madden, Tax Planning for Highly Compensated Individuals, 10.02 (Thomson Reuters/WG&L).
Frank S. Baldino is an attorney at Lerch, Early & Brewer in Bethesda, Maryland who practices in the areas of estate planning and probate administration and who co-chairs the firm's Estate Planning and Probate Group. He has extensive experience in the areas of estate planning, charitable giving, estate planning for non-U.S. citizens, tax planning with respect to retirement plans and stock options, asset protection planning, business succession planning and estate and trust administration. Frank may be contacted at 301-657-0715 or firstname.lastname@example.org.