Question

In 20X7, Troy, a resident of Connecticut, wins the Connecticut LOTTO grand prize of $15 million.

The LOTTO contest is governed by the following rules.

The prize is to be paid in 20 equal installments ( in this case, $750,000 per year) with no interest provided for.

The rights to the prize award are not assignable. If a winner dies during the payout period, however, the remaining installment payments are to be made to the winner’s duly appointed executor.

The prize award is not specifically funded or guaranteed by any state agency. It constitutes a general obligation of the state of Connecticut.

Troy dies in 20X9 after having received two payments of $750,000 each. Troy’s estate includes the present value of the remaining $13.5 million prize award in the estate at $4.86 million. This is determined by using the IRS table amount of $6.75 million and discounting it for absence of security ( ie., no separate funding or guarantee of payment by a state agency) and lack of marketability (ie., the award cannot be assigned). The table is be used in valuing, among other income interests, private (ie., noncommercial) annuity contracts.

Upon audit of the estate tax return, the IRS disputes the deviation from the table amount. The IRS argues that the absence-of-security discount is inappropriate because the state of Connecticut has never defaulted on any of its LOTTO obligations. Furthermore, the lack-of-marketability discount is inappropriate applied to annuity-type situations. Unlike stocks and bonds and other ownership interests, private annuities are not subject to marketplace valuation procedures.

Who should prevail? The taxpayer or the IRS.

Do the following:

(1)      Give your opinion. In it, show authorities, citing law, regulations, interpretations and decisions applicable.

(2)      Enumerate and explain every step you take in reaching your result. These are extremely important - just as important as the conclusion itself.

Answer 1

1) The relevant legal precedents are :-

Carol J. Negron, Executrix v. U.S., 103 AFTR2d 2009-634 (6th Cir. 2009)

THis circuit reversed the district court's decision of ignoring the IRS table and ruled in favour of the IRS stating that the IRS table should be used.

A recent case, Estate of Shackleford, 82 AFTR 2d 98-5538, 1998 WL 723161 , suggests that, for lottery winners dying between 4/30/89 and 12/13/95, departure from the Section 7520 annuity tables may be warranted.In Shackleford, the taxpayer died in 1990 after receiving the first three annuity payments of his lottery prize. His estate reported the value of the remaining annuity at $2.4 million, rather than the $4 million called for by the Section 7520 tables. The court noted that Reg. 20.7520-3(b) permits a departure from the annuity tables for decedents dying after 12/13/95.

In another similar case ,The IRS concluded that the taxpayer's estate was required to use the standard Section 7520 annuity factors to value the annuity payments and that discounts for lack of marketability and income taxes could not be applied to the valuation of the annuity payments.

Therefore, going by the above cases, the IRS method would prevail.

2)Reason for arriving at the above conclusion lies in the following facts of a case explained below

In a case ( 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. In this case the estate valued the annuity at $2.6 m instead of IRS valuation of $ 3.5 m. 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.

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 the value of an annuity is distinct in nature from interests to which a marketability discount is typically applied (unlike an item like 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.Therefore lack of marketability discount is not relevant.