You Be The Tax Judge: A $9.6 Million Lottery Win And A Tax Dispute

Winning the lottery sounds like a pretty good problem to have. But what happens when you win millions of dollars, decide you’d rather have your money now than wait years to collect it, and the IRS disagrees with how you report the transaction?

That’s the question at the heart of this week’s You Be The Tax Judge.

The Facts

In June 1991, George and Angeline Lattera won $9,595,326 with a $1 Pennsylvania Lottery ticket.

There was a catch: The couple couldn’t collect their winnings all at once. Under the lottery’s rules at the time, the prize could only be collected in 26 annual installments of $369,051.

For several years, the Latteras collected their annual payments. But in 1999, rather than wait another 17 years to collect the remaining payments, they entered into an agreement with Singer Asset Finance Co., LLC, to sell their rights to the remaining payments for $3,372,342. The payments they gave up totaled more than $6.2 million, but the couple received a lump sum rather than collecting the payments over time.

Pennsylvania law required court approval for the transfer, which the Latteras obtained. The sale went through.

Then came tax time.

The Tax Dispute

On their joint federal income tax return, the Latteras reported the $3,372,342 as a long-term capital gain with a zero basis. Long-term capital gains generally qualify for preferential federal income tax rates, while ordinary income is subject to the regular graduated tax rates.

The Latteras argued that they had sold a capital asset: their right to receive future lottery payments. They had held that right for more than a year, and they believed the proceeds should qualify for long-term capital gains treatment.

The IRS saw things differently.

According to the IRS, the money wasn’t a capital gain at all. The couple had simply exchanged their right to receive future lottery income for a payment today. And because the original lottery winnings were ordinary income, the IRS argued that selling the rights to those payments didn’t change their character. As a result, the IRS issued a notice of deficiency for $660,784.

The Latteras challenged the IRS, and the dispute eventually reached the U.S. Court of Appeals for the Third Circuit.

You Be The Tax Judge

The Latteras had legally sold their rights to future lottery payments to a third party. They no longer received their regular lottery installments; they received proceeds from a sale.

But the IRS maintained that converting future payments into a lump sum didn’t magically turn ordinary income into capital gains.

So, who’s right?

Should the $3.37 million be taxed as a long-term capital gain because the couple sold their rights to future payments? Or should it be taxed as ordinary income because the money effectively replaced lottery winnings they would otherwise have received over time? Or is there something else?

You be the tax judge.

Cast your vote and share your reasoning. I’ll reveal how the court ruled—and why—in a follow-up post.