Two recent district court decisions have been handed down on the issue of whether an estate’s rights to a decedent’s remaining series of annual lottery prize payments should be valued using the Sec. 7520 annuity tables. Although both courts held that the lack of marketability of remaining lottery payments may justify the use of a valuation method other than the tables in certain circumstances, the decisions show that it may be difficult for a taxpayer to prove to a court that it is entitled to use an alternate method of valuation.
general, the value of any annuity for estate tax purposes must
be determined under annuity valuation tables provided by the IRS
in accordance with Sec. 7520. A series of lottery prize payments
is an annuity that is potentially subject to valuation according
to Sec. 7520 (see Estate of Gribauskas, 116 TC 142
(2001)). However, if a taxpayer can prove that the value
produced by the tables is unreasonable and unrealistic and that
there is an available alternate valuation method that produces a
more reasonable and realistic value, the alternate method may be
used (O’Reilly, 973 F2d 1403 (8th Cir. 1992)).
The circuits have split on the issue of whether the value of remaining lottery prize payments for estate tax purposes must be determined using the Sec. 7520 annuity tables. The key issue in these cases is the effect of the lack of marketability of remaining lottery prize payments on their value in general and their value as determined using the Sec. 7520 annuity tables.
The Second and Ninth Circuits have held that the lack of marketability of remaining lottery prize payments may justify the use of a valuation method other than the Sec. 7520 annuity tables (Estate of Gribauskas, 342 F3d 85 (2d Cir. 2003), rev’g 116 TC 142 (2001); Shackleford, 262 F3d 1028 (9th Cir. 2001)). Both courts found that the right to transfer property is one of the most important aspects in determining the value of property and that an asset is worth less if it is nontransferable than if it is freely transferable. Both courts also found that the Sec. 7520 annuity tables do not take lack of marketability into account. Therefore, they concluded that it is possible that the use of the tables might (but not necessarily would) produce an unreasonable or unrealistic value in the case of remaining lottery prize payments. In both Gribauskas and Shackleford, the courts held that the tables did produce unrealistic and unreasonable valuations based on the facts before them and that a different method of valuation was justified.
In contrast, the Fifth Circuit has held that the annuity tables should be used in all cases to value remaining lottery payments (Cook, 349 F3d 850 (5th Cir. 2003)). While marketability is an important factor in the valuation of assets when capital appreciation is an element of the assets’ value or the value of the asset is otherwise difficult to ascertain, the court held it was not important in the case of remaining lottery payments because lack of marketability does not alter or jeopardize the recipient’s entitlement to receive them. In addition, their value is readily ascertainable by simply aggregating the payments to be received. Although the value must be discounted because the payments are received over time, the court noted that the annuity tables account for this by discounting a stream of annuity payments to present value. Therefore, the annuity valuation tables produce a reasonable and realistic value for remaining lottery payments, and the use of a different valuation method for them is not warranted.
In Mary C. Davis, Ex’x, D. NH, 6/13/07, the decedent won the Massachusetts lottery, entitling him to receive a series of annual prize payments. The decedent (who was then a resident of New Hampshire) died before he received all of the annual payments, and the remaining lottery prize payments became payable to his estate. The estate reported the remaining lottery prize payments as an asset on his estate tax return at a value determined by using the Sec. 7520 annuity tables. The estate later decided that, because the right to receive the remaining lottery prize payments is nontransferable under state law, the value of the remaining lottery prize payments was considerably less than the amount it had determined using the annuity tables, and it filed an informal claim for refund based on the lower value. The IRS denied the refund claim, and the estate filed a refund suit in district court.
The district court held that lack of marketability likely reduced the value of the taxpayer’s remaining lottery prize payments and that the Sec. 7520 annuity tables did not take into account lack of marketability. However, it further held that lack of marketability probably resulted in a minimal (if any) reduction of the value of the remaining lottery prize payments; at most, their true value was 5% less than their value would be if freely transferable (in which case they would be valued using the Sec. 7520 annuity tables). The court found that a 5% difference between the true market value for the remaining lottery prize payments and the value determined for them using the Sec. 7520 annuity tables would not render the value determined using the tables unreasonable or unrealistic, and it noted that in the cases in which an alternate method of valuation was allowed, the differences were in excess of 25%. Although the court did not hold that lack of marketability could never cause the value determined under the Sec. 7520 annuity tables for remaining lottery prize payments to be unreasonable and unrealistic, based on the expert testimony in the case, it expressed skepticism that lack of marketability would ever cause a large enough reduction in the true value of remaining lottery prize payments for this to occur.
In Carol Negron, Ex’x, N.D. OH, 6/4/07, the decedent also died with remaining lottery prize payments (in this case, from Ohio). The estate elected to take a lump-sum payment, calculated using a 9% discount rate, in lieu of the remaining annual prize payments. On the decedent’s estate tax return, the estate reported the remaining lottery prize payments as an asset with a value equal to the gross amount of the lump-sum payment. On audit, the IRS determined a substantially higher value for the remaining lottery prize payments (based on the Sec. 7520 annuity tables) and assessed additional tax to the estate. The estate paid the additional tax and filed a suit for refund in district court.
The district court specifically stated that it agreed with the Second and Ninth Circuits that lack of marketability reduced the value of the remaining lottery prize payments, and that the use of the Sec. 7520 annuity valuation tables might therefore not be appropriate in the case (despite the fact that the taxpayer had not specifically based its value of the payments on their marketability). However, the court held that it could not approve the taxpayer’s use of the amount of the actual lump-sum payment it received from the state lottery commission. The taxpayer had not provided sufficient evidence (in the form of expert testimony) to prove that this method of valuing remaining lottery prize payments was more reasonable and realistic than using the Sec. 7520 annuity tables.
Although the Fifth Circuit and the Tax Court (in a case in which it was overruled) have held otherwise, the clear consensus among the courts that have decided remaining lottery prize payment cases is that (1) the lack of marketability of these payments has an effect on the value of the payments, (2) the Sec. 7520 annuity tables do not adequately (or do not at all) account for the reduction in value due to lack of marketability, and (3) under certain circumstances, the tables may produce a result that is so unreasonable and unrealistic that the use of an alternate method of valuation that produces a more reasonable and realistic result is justified. However, all the courts have held that a taxpayer seeking to use an alternate method must prove that the alternate method produces a better result. In addition, there must be a significant percentage difference between the value using the tables and the value using the alternate method.
As the Davis case shows, even if a court is open to the idea that lack of marketability can be grounds for using an alternate method, and the difference in values produced by using the Sec. 7520 tables and the estate’s proposed alternate method is great, it can be difficult in the face of IRS opposition to convince a court that an alternate method is valid and produces a better result than the tables. In order to prevail in a remaining lottery prize payment case, an estate must be prepared to present credible expert testimony as evidence that the lack of marketability of the remaining payments causes the claimed difference in values.
Mary C. Davis, Ex’x, D. NH, 6/13/07; Carol Negron, Ex’x, N.D. OH, 6/4/07.