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.