Clopton v. Commissioner
| Decision Date | 06 April 2004 |
| Docket Number | Dkt. No. 4627-03. |
| Citation | 87 T.C.M. 1217 |
| Parties | Alden L. Clopton and Yolanda Y. Clopton v. Commissioner. |
| Court | U.S. Tax Court |
Frank Sommerville, for petitioners.
W. Lance Stodghill, for respondent.
Respondent determined a deficiency in petitioners' 1999 Federal income tax of $221,269.96. The sole issue for decision is whether a lump-sum amount received in exchange for an interest in a trust holding the right to receive future annual lottery payments is ordinary income or capital gain. We hold under the substitute for ordinary income doctrine that the lump-sum amount is ordinary income.
The parties submitted this case fully stipulated under Rule 122.1 The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners, Mr. Clopton and Mrs. Clopton, resided in Pearland, Texas, at the time they filed their petition.
Mr. Clopton and two coworkers participated in a lottery pool to purchase 60 tickets costing $1 each for the June 4, 1997, Texas Lottery drawing. One of the purchased tickets was the winning ticket for the lottery drawing. The prize for the lottery drawing was valued at $9 million and was payable in 25 annual installments of $360,000.
In June 1997, Mr. Clopton, R.L. Littleton, III, Freddie Lofton, Joseph Hill, and Sally Hill, as trustors, established the "June 4, 1997 Lottery Trust" (the trust). Under the terms of an amended trust agreement (trust agreement), Mr. Clopton and the other trustors granted, assigned, and delivered all their rights, title, and interests in the lottery ticket to the trust. Mr. Clopton held a one-third beneficial interest in the trust and each of the other trustors held a one-sixth beneficial interest. The trust agreement provides that the trust shall within 5 business days after the receipt of any cash amount from the Texas Lottery Commission, distribute all cash amounts received by the trust to the beneficiaries in proportion to their respective beneficial interests in the trust. A portion or all of each beneficial interest could be assigned to any other person or to any organization. The first prize payment was made in June 1997, with subsequent installments to be paid on or about June 15 of every year continuing through June 15, 2021. There is no evidence that the trust has held any other property or has been involved in any other activity.
On July 28, 1999, Mr. Clopton and Singer Asset Finance Co., LLC (Singer) entered into a "Sale Agreement for Lottery Prize Payments of Alden Clopton" and "Terms Rider to Sale Agreement for Lottery Prize Payments of Alden Clopton" (the sale agreements), which provided that Mr. Clopton's interest in the rights, title, and interest in the lottery prize were sold and assigned to Singer. Under the terms of the sale agreements, 20 annual payments of $120,000, payable on or about June 15 of the years 2000 through 2019, were sold to Singer for $1,155,000. The sale agreements provided that the law of Texas required the parties to consummate an agreement and to obtain a court order directing the Texas Lottery Commission to make the payments to Singer. The record is unclear whether Singer ultimately received the payments from the trust or directly from the Texas Lottery Commission. The sale agreements also provided that Mr. Clopton was the sole owner of the portion of the lottery prize being assigned to Singer free and clear of any right, interest, or claim of any other person or entity, and Mr. Clopton had not previously assigned, pledged, or otherwise encumbered his rights in the lottery prize. Finally, the sale agreements stated:
1) The lottery law in Texas has been interpreted as not permitting voluntary assignments of lottery prize payments. However, the lottery law does not prohibit the voluntary assignment of a beneficial interest in a trust. The record owner of the Lottery Prize is the June 4\th/ Lottery Trust. Lottery Winner [Mr. Clopton] is a beneficiary of the June 4\th/ Lottery Trust and desires to assign his entire beneficial interest in said trust to Purchaser [Singer].
The right to receive the 2020 and 2021 payments was not sold or assigned.
On August 4, 1999, the parties to the sale agreements filed with the Probate Court for Travis County, Texas (Travis County Probate Court), a joint petition for a declaratory judgment allowing Mr. Clopton to assign all or a portion of his beneficial interest in the trust. On October 5, 1999, the Travis County Probate Court issued a final declaratory judgment (the declaratory judgment) allowing the assignment of Mr. Clopton's beneficial interest in the trust for the years 2000 through 2019. Singer issued to Mr. Clopton a Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, for 1999. The Form 1099-B showed proceeds from the sale of "Stocks, bonds, etc." of $1,155,000.10.
Petitioners jointly filed a Form 1040, U.S. Individual Income Tax Return, for 1999. On Schedule D, Capital Gains and Losses, petitioners reported the assignment of the 20 future annual payments of $120,000 to Singer as a sale of a capital asset held more than 1 year. Petitioners reported a sales price of $1,155,000, a cost or other basis of $10,334,2 and a long-term capital gain of $1,144,666.
On December 24, 2002, respondent issued a notice of deficiency to petitioners for the year 1999. In the notice, respondent determined that the $1,155,000 received from Singer was ordinary income. Respondent determined that the cost or other basis reported on petitioners' return with respect to the amount received from Singer was zero.
Petitioners reported on their joint return for 1999 a short-term capital loss of $9,088 on Schedule D, Capital Gains and Losses, for unrelated transactions. Due to a scrivener's error, the notice of deficiency failed to state the proper adjustment, thereby denying petitioners the benefit of this capital loss. The parties agree that petitioners are entitled to a short-term capital loss adjustment, subject to the limitations on the amount of such adjustment, if respondent ultimately prevails in this case.
The parties dispute whether the $1,155,000 received by Mr. Clopton from Singer is ordinary income or capital gain. Our resolution of the issue presented does not depend on who has the burden of proof in this case. Resolution of this issue depends on whether the sale to Singer involved a capital asset within the meaning of section 1221.
Section 1221 provides the following definition of the term "capital asset":
SEC. 1221. Capital Asset Defined.
(a) In general.
For purposes of this subtitle, the term "capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include—
(1) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;
(2) property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in section 167, or real property used in his trade or business;
(B) in the case of a letter, memorandum, or similar property, a taxpayer for whom such property was prepared or produced, or
(C) a taxpayer in whose hands the basis of such property is determined, for purposes of determining gain from a sale or exchange, in whole or part by reference to the basis of such property in the hands of a taxpayer described in subparagraph (A) or (B);
(4) accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or from the sale of property described in paragraph (1);
(5) a publication of the United States Government (including the Congressional Record) which is received from the United States Government or any agency thereof, other than by purchase at the price at which it is offered for sale to the public, and which is held by—
(A) a taxpayer who so received such publication, or
(B) a taxpayer in whose hands the basis of such publication is determined, for purposes of determining gain from a sale or exchange, in whole or in part by reference to the basis of such publication in the hands of a taxpayer described in subparagraph (A). * * *
Petitioners contend that capital gains treatment is appropriate because a beneficial interest in the trust was assigned and the future annual lottery payments were payable to the trust and not to Singer. Petitioners claim that because an interest in a trust not used in a taxpayer's trade or business is not excluded from capital asset status, the sale of an interest in a trust results in capital gain.
This Court and the Court of Appeals for the Ninth Circuit have previously addressed the issue of whether a lump-sum amount received in exchange for the assignment of the right to receive future annual lottery payments is ordinary income or capital gain. Respondent contends that these cases are controlling for purposes of deciding the present issue.3
In Davis v. Commissioner [Dec. 54,804], 119 T.C. 1 (2002), the taxpayer won a California State lottery prize and assigned his right to receive annual lottery payments to a trust. Id. at 2 n. 2. He and his wife took all subsequent actions with respect to the lottery payments and took the position that all income of the trust was includable in their income. Id. A portion of each of 11 of the future annual lottery payments was subsequently assigned to Singer in exchange for a lump-sum payment. Id. at 3. We held that the right to receive such future annual payments does not constitute a capital asset within the meaning of section 1221 and, therefore, the lump-sum payment...
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