[Ed note: We're lucky to have WS+B Partner Hal Terr to keep us apprised of the happenings in the estate, trust, and gift world. Today, Hal tackles the case of Tonda Lynn Dickerson, which reminds us that winning the lottery is sometimes more trouble than it's worth.
Now, on to Hal:]
Everyone has at one time or another dreamed of winning the lottery, leaving the grind of a 9-5 job and living the life of luxury. As CPAs, this is a fantasy we indulge in hourly from January until April.
Instant wealth has its pitfalls, however. We were recently reminded of this when Louise White, an 81-year old Rhode Island resident, won last month’s Powerball lottery of $336.4 million. Before claiming the lottery winning she consulted with an attorney, and the lottery winnings were claimed by the “Rainbow Sherbert Trust”. Hopefully she obtained better legal advice then Tonda Lynn Dickerson, who won the Florida lottery in 1999, but upon sharing her newfound riches with her family, was held by the Tax Court to have made a taxable gift.
Tonda worked at a Waffle House in Alabama where a patron, Mr. Seward, would give lottery tickets as tips. In 1999, Mr. Seward gave Tonda a Florida lottery ticket for the previous night’s lottery which happened to be the winning ticket for over $10 million.
Tonda claimed there was an implied agreement with her family that winning the lottery meant sharing the windfall with them. To facilitate this, Tonda consulted with her father and attorney and created an S Corporation which would claim the lottery winnings. Tonda and her husband would own 49% of the S Corporation and her parents and siblings would own the other 51%.
Soon after, the IRS came knocking on Tonda’s door, requesting she file a gift tax return. Tonda did so, but claimed that no gift was made. The IRS disagreed, arguing that she made a gift of $2,412,388 and owed gift tax of $771,570.
In the gift tax regulations, a transfer of property to a corporation for less than adequate consideration represents gifts to the other individual shareholders of the corporation to the extent of their proportionate interests. Tonda argued that there was no taxable gift because at the time the lottery ticket was received there had previously existed and remained in effect a binding and enforceable contract under Alabama state law to share the winnings. Alternatively, she argued that the family members and Tonda were all members of an existing partnership.
The Tax Court determined under Alabama state law that the terms were too indefinite, uncertain and incomplete, and even if the agreement was enforceable, would not be allowed under Alabama anti-gambling statute. The Tax Court contrasted the facts in this case to the Estate of Winkler, where an implied family partnership did exist.
In Winkler, the family pooled their money to purchase lottery tickets, the purchase of the tickets was a consistent activity and each member of the family was treated as a partner, including attending the meetings with the accountant and attorney having a say in formulating the agreement. To the contrary, in this case, Tonda’s father made the ultimate decision on how the lottery proceeds would be divided, and there was no requirement that each family member buy the lottery tickets, no pooling of money and no predetermined sharing percentages. As such, the Tax Court found that Tonda had made a gift of 51% of the S Corporation to her family.
Next, the Tax Court had to determine the value of the gift. Tonda had made many implied promises in sharing of lottery winnings. With the promise of sharing the lottery winning with her family, her co-workers at the Waffle House also believed they had a right to a share of the lottery winning. The co-workers sued Tonda in Alabama court for their share of the winning, but ultimately lost on the same grounds that the oral agreement between the co-workers was unenforceable on public policy because it was “founded on gambling consideration.”
This lawsuit actually worked in Tonda’s favor against the IRS. Under the gift tax regulations, the value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having a reasonable knowledge of the facts. With the potential claim of the co-workers, the value of the gift should be discounted for the cost of the potential litigation. The Tax Court agreed with the expert testimony and discounted the value of the gift to $1,248,765.
What can we learn from this case? If you ever win the lottery, go to an exotic island and live the life of luxury. There are ways to support your family through annual exclusion gifting, direct payments for medical care and education and usage of the lifetime gift exemption. If you are going to make a transfer of the lottery proceeds, make sure you have your facts straight before going to the lottery office to claim your winnings.