Lottery Winners and the IRS

April 30, 2012 by Bart Chepenik

As Florida lottery ticket sales increase so do the dreams of winning. Scratch-off ticket sales for the week ending March 4, 2012 in Florida, exceeded $60 million, the highest level of sales achieved since the Florida Lottery launched its first ticket in 1988. Some winners plan ahead by attempting to minimize the taxes they will have to pay if they make gifts to family members from lottery proceeds.

Lottery winners may form an entity owned by multiple family members, allowing those family members to share directly in the lottery winnings. Lottery proceeds can be paid directly to the entity. This is all fine if there was in fact a real and binding arrangement to share the proceeds. However, if there was not, the IRS considers this a gift and will impose a tax in the value of the proceeds that the family member receives as a result of the winnings.

Family members are obligated to pay gift taxes depending if the family agreements were in fact pre-existing arrangements or are only a product of post-lottery planning. Some have criticized these arrangements saying there is a "lottery winnings" exception to federal gift taxes that gives a free pass to the sharing of the winnings among family members.
A recent Tax Court case warns that there is no such lottery exception and that the IRS will scrutinize such lottery sharing arrangements and asserts gift taxes when appropriate.

In this recent Georgia case, the winner created a corporation after the win, and corporation claimed the lottery proceeds. The winner and her spouse owned 49% of the stock, and the remaining 51% were owned by her other family members. The IRS asserted a gift as to 51% of the proceeds. The winner claimed there was a binding contract to share the proceeds and thus no gift.

The “terms” of the so-called family agreement consisted solely of offhand statements made throughout the years about sharing and taking care of one another in the event someone came into a substantial amount of money. The Court found that this is not enough. There was no requirement that each family member buy lottery tickets. There was no pattern of purchasing tickets. There was no pooling of money. There were no predetermined sharing percentages. And while both the lottery winner and her father testified that the agreement covered only “substantial” winnings, neither gave any indication as to what “substantial” was defined as.

Who was party to the agreement was also vague. The father stated that the agreement included himself and his wife, his three children, and their spouses. Yet when asked what would have happened if his son-in-law had bought a winning ticket by himself, specifically whether this ticket would have been included in the deal, he stated: “Knowing this gentleman, I would assume, yes, it would be in the agreement.” The court found then that this family had only a very sharing nature but it simply does not rise to the level of an enforceable contract. What the family had at best was an unenforceable contract to agree on something if in fact one of them was the recipient of a substantial lottery prize.

The Court’s findings allowed the IRS to asses a $771,570 gift tax deficiency to be paid by the family members of the lottery winner. The take away from this and other cases involving lottery winnings is that there can be valid arrangements that allow for sharing of proceeds that will not give rise to a gift. However, they need to have elements of regular and consistent purchases, a clear agreement to share winnings, common knowledge of all participants of purchases, and joint decision making as to winnings. Absent such elements, a gift will result if sharing occurs – there is no lottery winnings exception to gift taxes.

If you live in the Miami-Dade, Broward or West Palm Beach area and need help navigating through these and other IRS issues. Please feel free to contact the attorneys at Chepenik Trushin at (305) 981-8889 for an initial consultation.

Resources:

The Lottery Winnings Exception to Federal Gift Taxes, Rubin on Tax (2012)

Dickerson v. Commissioner of Internal Revenue, T.C. Memo. 2012-60, United States Tax Court.