by Linda Suzzanne
Griffin
As lottery winners
are becoming more common in Florida, their advisors
should understand the particular income, gift, and
estate tax issues relevant to lottery winners.
A practical difference
between planning for a lottery winner and other planning
is that generally lottery winners have not planned
for actually winning the lottery. Therefore, when
an individual or group of individuals wins millions
of dollars, emotional feelings often override financial
considerations. This author’s experience is that
most lottery winners want to drive to Tallahassee
the next day ( and who can blame them?) to establish
their winnings, while they actually have 180 days
to claim their winnings. For a more complete discussion
of lottery state law, see Linda S. Griffin and Richard
V. Harrison, Florida State Lottery Tax and Estate
Planning Issues, 70 FLA.B.J. 74 (Jan 1996).
This article focuses
on advising those clients who retain you prior to
their trip to Tallahassee of necessary planning to
save as much as possible in income, gift, estate,
and generation-skipping taxes.
For purposes of this
article assume that Mr. And Mrs. Gotrich excitedly
call you and state that they just won $30 million.
Your heart starts racing as you have visions in your
head of enormous fees. Remember, however, The Florida
Bar ethics provisions on reasonable fees.
Your clients must
understand that the ticket should not be signed until
the determination is made to who or what entity owns
the ticket. A ticket signature should not be whited
out or defaced, but language can be added to the signature
line. If, however, the ticket is lost before it is
signed, the $30 million could be a windfall to the
one who finds the ticket. Practically, the lottery
ticket should be placed in a safe deposit box until
travel to Tallahassee. Some winners have actually
hired security to move the ticket.
The ownership of the ticket and the facts relating
to the purchase of the ticket should be determined
at the time of the initial conference. Be wary if
two unrelated parties, i.e., girlfriend and boyfriend,
claim the ticket. Florida law requires that only one
entity or person can be a winner regardless of whether
the ticket is jointly owned. If more than one name
appears on the back of the ticket, payment is made
to the first person.
Mr. and Mrs. Gotrich
explain to you that the lottery ticket has not yet
been signed and their whole family ( Mr. and Mrs.
Gotrich and their five children) participated in the
purchase. If all parties actually participate in the
purchase of the ticket, planning will be more advantageous
because the benefits and corresponding tax liabilities
can be distributed among more parties.
Under prior cases
the parties intent and evidence of that intent as
to ownership of the ticket must be determined. A recent
tax court case, Estate of Winkler v. Commissioner
of Internal Revenue, TC Memo 1997-4, illustrates the
facts that successfully established a partnership
between the parents and their children.
The issue facing the
court in Winkler was whether Mrs. Winkler purchased
the winning ticket on her own behalf or on behalf
of a partnership of family members. If Mrs. Winkler
had purchased the ticket in her own name, any benefits
to Mrs. Winkler’s children would be considered
an assignment of income and/or gifts.
Mr. and Mrs. Winkler
had been married for over 50 years and had five children.
The facts indicate that the Winklers were a close
family and the children lived within a short distance
of their parents’ home. The children visited
their parents every Sunday. Because Mr. Winkler was
in poor health, he frequently went to medical clinics
in Champagne, Illinois, and Rochester, Minnesota.
The clinics were approximately two and eight hours
away, respectively.
While the family was
traveling to one of the clinics, Mr. and Mrs. Winkler
and one or more of their children suggested they purchase
lottery tickets for the weekly Lotto. Thereafter,
a family routine was established during the trips
to and from the clinics that Lotto tickets would be
purchased by whoever actually had a dollar bill.
After the tickets
were purchased, Mrs. Winkler would place them in a
glass bowl in her home where other family documents
were kept. The family members referred to the Lotto
tickets as family tickets and always regarded them
as being owned by the entire family.
Several of the children
also purchased tickets for themselves and considered
those tickets to be separate property. As one of the
family Lotto tickets had the winning numbers, Mrs.
Winkler announced to the family that all of them,
including the children, had won the Lotto. In the
initial meeting with their attorney, the parties agreed
( although the facts are not clear on how the percentages
were determined ) that Mr. and Mrs. Winkler should
receive 25 percent each and each of the five children
would receive 10 percent of the winnings. A partnership
agreement for the E & E Family Partnership was
prepared to reflect the percentages and memorialize
the family’s understanding concerning the purchase
of lottery tickets and subsequently the partnership
entity claimed the proceeds.
In 1990, Mr. and Mrs.
Winkler’s accountant filed a Form 709 for each
of them indicating gifts from Mrs. Winkler of $50,000.50
and gifts from Mr. Winkler of $51,861. Both parents
consented to split gifts.
Mr. Winkler died in
1992 with a will providing for a marital and residuary
trust. The Form 706, U.S. Estate Tax Return, reflected
on Schedule F a 25 percent interest in the partnership
which was valued at $714,750.55. Mrs. Winkler disclaimed
her interest in Mr. Winkler’s partnership interest.
In 1995, the Internal
Revenue Service issued a notice of deficiency to Mrs.
Winkler and to Mr. Winkler’s estate determining
that Mrs. Winkler made gifts to her children of 50
percent of the winning Lotto ticket and that Mr. Winkler
consented to split the gifts. The total gift was valued
at $1,514,000, and thus resulted in a corresponding
gift tax and estate tax deficiency.
The family argued
that the ticket was bought on behalf of a preexisting
family partnership even though the written partnership
was not signed until after the winning numbers were
announced. The oral partnership agreement existed
prior to the time Mrs. Winkler purchased the ticket.
The court analyzed
the case law regarding the validity of a partnership
for tax purposes and based upon Commissioner v. Culbertson,
337 U.S. 733 ( 1946 ), considered the following: agreement,
conduct of parties, statements, testimony of disinterested
persons, relationship of parties, abilities, capital
contributions, control of income, and any other facts
regarding intent. The absence of a specific agreement
was not fatal to the existence of the partnership
prior to the purchase of the ticket.
If, upon a consideration
of all the facts, it is found that the partners joined
together in good faith to conduct a business, having
agreed that the services or capital to be contributed
presently by each is of such value to the partnership,
that the contributor should participate in the distribution
of profits, that is sufficient.
The court cited IRC
704(e), which provides that a person is recognized
as a partner if capital is a material income-producing
factor and the person owns the partnership interest
in the enterprise. Because the Lotto ticket was capital
in the partnership and not services, and each member
of the Winkler family owned a capital interest in
the enterprise by contributing capital in the form
of dollar bills to purchase the Lotto ticket, each
member of the Winkler family would be recognized as
a partner.
The court then focused
on whether Mrs. Winkler purchased the winning Lotto
ticket on behalf of a preexisting family partnership.
The court determined that Mrs. Winkler did not normally
play games of chance and that she had never purchased
Lotto tickets other than the family tickets. In examining
all the facts the court determined that Mrs. Winkler
purchased the winning ticket on the family partnership’s
behalf.
Because no written
partnership agreement existed, the court determined
that the family members had not agreed to the specific
partnership interests. Quoting Treasury Regulation
1.761-1( c ) " (as) to any matter on which (a)
partnership agreement, or any modification thereof,
is silent, the provisions of local law shall be considered
to constitute part of the agreement," the court
determined under Illinois law ( the domicile of the
Winklers ) if no written partnership agreement existed
each partner would have an equal distribution of partnership
profits and interest. Because seven individuals participated,
each received a 1/7 or 14.29 percent interest. As
the Winklers reported a 25 percent interest, the court
determined that the Winklers did not make a gift to
their children and therefore no gift or estate tax
deficiency resulted.
Based upon Winkler,
it appears the relevant factors to review for your
discussions with the Gotrichs are:
1) Intent of Mr.
and Mrs. Gotrich and their children;
2) Actual circumstances surrounding the purchase of
the winning ticket;
3) Agreement between Mr. and Mrs. Gotrich and their
children;
4) Statements between Mr. and Mrs. Gotrich and their
children;
5) Control of income and capital.
Under Florida law
a partnership agreement need not be written. Therefore,
Mr. and Mrs. Gotrich’s attorney must ascertain
whether the intent and factual circumstances would
create the partnership agreement prior to the purchase
of the lottery ticket and how the partnership interest
were held. If the intent and circumstances do not
indicate a partnership or if, upon audit, the Internal
Revenue Service determines no partnership exists,
the gift tax sequences could be disastrous. For example,
assume the present value of a $30 million lottery
annuity is $21 million and the partnership interest
are divided among seven individuals; then a gift of
$15 million would be considered made to the Gotrich
children resulting in a gift tax, together with interest
and penalties.
Probably the only
conclusive way to assert a partnership prior to the
purchase of the lottery ticket is by executing a written
partnership agreement prior to the date of the winning
lottery ticket. Because most clients who play the
lottery have not even thought of such an agreement,
the attorney must advise clients of tax exposure if
a partnership is asserted.
Mr. and Mrs. Gotrich
advise you that their intent was to form a partnership
with all the parties and want you to draft the partnership
agreement. The Gotrichs need to be advised clearly
of the income, gift, and estate tax consequences if
the Tax Court or Internal Revenue Service determines
no partnership actually existed prior to the ticket
purchase. The conservative approach is to create the
partnership, create the children’s interest of
a value equal to the gift tax returns for the amounts
of the children’s interest in the partnership.
Subsequent gifting of partnership interest to the
children then could be made. If the value of the gift
is fully disclosed on the gift tax return and is adequate
to apprise the Internal Revenue Service of the gift
and its value, then the three-year statute of limitations
will apply and a revaluation of the gift cannot be
made on an estate tax return.
The $30 million
less income taxes will be payable annually to the
partnership over 20 years. You must also advise the
Gotrichs that when either of them dies, an estate
tax of up to 55 percent may be payable on the value
of the partnership interest included in the decedent’s
estate. Generally, lottery winnings are treated as
an annuity for estate tax purposes. The valuation
of the annuity is made using the interest rates under
7520 of the Code. Thus, if the survivor of the Gotrichs
dies holding a partnership interest with a value of
$10 million, the children could owe approximately
$5.5 million in estate taxes with no cash to pay the
amount. Fortunately, the IRS can extend the time for
the payment of the estate tax for reasonable cause.
Furthermore, recent letter rulings have approved the
use of marital QTIP trusts in lottery planning. The
Gotrichs may also want to consider purchasing a life
insurance policy which could be held in an irrevocable
trust. The proceeds then could be available to provide
liquidity for the payment of the taxes.
Finally, the Gotrichs
should be advised of possible generation-skipping
transfer tax exposure. Planning for the allocation
of each of the Gotrich’s $1 million exemption
must be considered, but because the present value
of the lottery winnings exceeds the total exemption
available, the documents should be carefully drafted
to ensure that no generation-skipping transfers occur.
Assuming the partnership
agreement is drafted, the Gotrichs and their children
will be the partners. Prior to the trip to Tallahassee,
the attorney should obtain a federal identification
number for the partnership, open a bank account, and
obtain wiring instructions for such account.
The Florida statute
requires the names, addresses, and Social Security
numbers of all of the ultimate beneficiaries. For
example, if Mr. and Mrs. Gotrich each had a revocable
trust which would be named a partner of the partnership,
then the names of the ultimate trust beneficiaries
must be given to the state. The names and cities of
the winner, i.e., the partnership, is not confidential,
but street addresses and telephone numbers are confidential.
With the use of the computer and the Internet, however,
your clients should be advised that such information
probably could be obtained. You may want to advise
them to channel all calls through their attorney.
This article addresses only a portion
of the planning issues in collecting lottery proceeds.
Unfortunately, the individuals who really need assistance
usually are the ones who do not consult an attorney.
In many ways planning for the lottery winner is no
different than planning for any individual except
that the numbers ( and, therefore, your exposure )
are multiplied. The winners, however, often have no
concept of the taxes that may be incurred and the
attorney’s job is to advise them so as to preserve
as much of their winnings as possible.
All
Contents © Copyright Linda Suzzanne Griffin,
P.A.
