MEMORANDUM FINDINGS OF FACT AND OPINION
This case is before the Court on a petition for redetermination of a $771,570 gift tax deficiency for the tax year 1999. There are two issues. First, did petitioner make a taxable gift when she contributed a winning lottery ticket to a newly formed corporation in which she owned only 49% of the stock and other family members owned the rest? Second, if petitioner did make a gift, what was the value of the gift?
FINDINGS OF FACT
Some of the facts have been stipulated. The stipulations of the parties, with accompanying exhibits, are incorporated herein by this reference. Petitioner resided in Alabama at the time she filed her petition.
She's Got a Ticket To Ride
Petitioner is a former waitress of the Waffle House in Grand Bay, Alabama. Edward Seward was a regular customer, coming to the Waffle House almost daily. Mr. Seward had a reputation of giving away lottery tickets, frequently giving tickets to individuals including petitioner and her coworkers. As Alabama did not have a lottery, Mr. Seward would travel to neighboring Florida to procure the tickets.
On March 7, 1999, Mr. Seward went to the Waffle House and, while there, handed petitioner an envelope containing a lottery ticket. Unbeknownst to Mr. Seward at that time, the ticket he gave petitioner was one of two winning tickets that had been drawn for the Saturday evening, March 6, 1999, drawing of the Florida Lotto Jackpot. The ticket was, if paid out over 30 years, valued at $10,015,000, with a cash payout amount of $5,075,961.71.
Petitioner did not open the envelope until shortly after she left work. At that time, she realized the numbers on her ticket matched the ones a coworker told her had been drawn the day before. Thinking someone was playing a joke on her, she called her father, Bobby Reece, and asked him to confirm whether she was indeed holding a winning ticket. He did and she was.
According to petitioner, when she realized she held a winning ticket, because of her family's prior existing agreements, "immediately I knew that I was sharing with my family." Which brings us to an integral aspect of this case—the alleged "Reece Family Agreement".
According to petitioner, "it was well-known that we were in to lotteries." The Court will take judicial notice that the Florida lottery began on January 18, 1988. Shortly thereafter, Mr. Reece began a tradition of buying lottery tickets using petitioner's, her sister's, and her brother's birthdays as the number sequence. Petitioner obtained her first lottery ticket in high school, when she and her brother, Johnny Reece, started giving their father money so that he could purchase tickets on their behalf (one must be 18 to legally purchase a ticket).
At trial petitioner stated: "our family had always talked about if anyone had won any big amount of money in a lottery, that we would take care of each other or share in the family". Similarly, Mr. Reece and Johnny also testified extensively about the sharing attitude of the Reece Family and the alleged lottery proceeds sharing agreement.
While the Court concludes there was a general vague lottery proceeds sharing agreement, this sharing agreement was never written down and there is no documentation to support its existence or its terms. There was never an understanding that each family member had to buy a certain number of tickets (or even buy tickets at all). Johnny, for example, stated he does not "regularly participate or even think of it * * *. Just whenever I think about it, at a convenience store, I might pick up five bucks here and there, nothing standard or any kind of pattern." In fact, from the record, it appears that the only family member who frequently bought lottery tickets was Mr. Reece.
Before the winning ticket at issue here, there were never any discussions or consistent course of dealing about specific percentages each family member would get of any winning ticket. When questioned at trial, petitioner stated there were no specifics and that they "just said that we would share, we would take care of each other."
There is no doubt that the Reece family was a very close and sharing family. Mr. Reece prepares all of the family members' tax returns. The family gathers at Mr. and Mrs. Reece's house almost daily. When petitioner first married and moved to Mississippi for a short time, she would still return to her parents' house, which she characterized as "the hub of our family", almost every day.
Mr. Reece once won $80 and took the Reece family to dinner. And there are more examples of the family's sharing attitude. In 1996 Mr. and Mrs. Reece bought approximately 6-1/2 acres of land. Mr. Reece took the acreage and plotted it out into four equal lots so that he and Mrs. Reece as well as each child would have a plot on which to build a house or place a mobile home. Then there is the per diem. Mr. Reece traveled for work, receiving a per diem for food while away. He would do his own cooking in order to save money; and the per diem he did not use he divided among his children.
True to these sharing beliefs, after petitioner realized she held the winning ticket, she wanted to share it. And conversations immediately started taking place among certain members of the Reece family about how they were going to "split the money". But just how could this be accomplished? She turned to her father for advice.
"Inc."—ing the Deal
On Monday, March 8 (after learning on the previous day that his daughter had won the lottery), Mr. Reece contacted Louisa Warren, the general counsel for the Florida Lottery Commission. Ms. Warren told Mr. Reece: "Don't sign that ticket, period. Don't sign the ticket", and she further stated that a single entity would have to be formed to claim the prize for the family. Because of Ms. Warren's express instructions not to sign the ticket, petitioner put the ticket away while her father decided what to do.
Immediately after talking to Ms. Warren, Mr. Reece called Dwight Reid, a lawyer he had consulted before. That same day, Mr. Reid prepared incorporation papers for an S corporation to be named 9 Mill, Inc. (9 Mill). Also on March 8, a meeting of the prospective family stockholders of 9 Mill was held and shares of stock in the proposed corporation issued in the following percentages:
From the record it is evident that it was Mr. Reece who determined these percentages, not petitioner and not the Reece family as a group. Mr. Reece himself stated that he was the one who worked out the percentages and that he did it at his kitchen table alone while petitioner and her then husband, James Dickerson,
The reasons petitioner and Mr. Dickerson received 49% appear twofold: (1) so no one person had majority ownership and control and (2) so petitioner could help her husband's family and Mr. Seward (apparently he wanted a new truck).
The articles of incorporation for 9 Mill were signed on Thursday, March 11, by petitioner, Mr. Dickerson, and Mrs. Reece. On March 18, 1999, the articles of incorporation were filed with the Alabama secretary of state. On May 10, 1999, a savings account was opened at Mobile County Bank in the name of 9 Mill with petitioner, Mr. Dickerson, and Mrs. Reece listed as having signatory power in the account and with two signatures being required to withdraw funds from the account.
Eye on the Booty
The rules of the Florida lottery required all tickets valued over $599 to be claimed at the lottery headquarters. On Friday, March 12, petitioner, Mr. Dickerson, and Mr. and Mrs. Reece met with Florida lottery officials. Petitioner signed a Florida Lottery Winner Claim Form, claiming the lottery prize in the name of 9 Mill as president of the corporation. Petitioner also signed a Winner Claim Form Addendum on behalf of 9 Mill, making an irreversible election to receive the lottery winnings in 30 annual installments of $354,000 each, with the first annual payment date being scheduled for June 2000. While there, petitioner, Mr. Dickerson, and Mr. and Mrs. Reece also signed an affidavit stating they knew of the option to receive a lump-sum payout but that 9 Mill had elected to receive the prize in 30 annual installments.
That was not all the affidavit stated. It also stated that the Florida lottery had been notified of a competing claim to the winning lottery ticket. And on March 12, while in Tallahassee, the family was informed that no payment of the prize funds would be made until the disputed claim was resolved. That brings us to the quarrel over the ticket.
V. House of Waffling
Petitioner wanted to share with her family. Her coworkers at the Waffle House wanted her to share with them. In fact, they thought she was obligated to share with them because they had all agreed to split lottery winnings if any of them won. Petitioner first explicitly learned of this spat on Tuesday, March 9, when Sandra Deno called her claiming that petitioner was a party to a pooling agreement with other employees at the Waffle House.
Ms. Deno and three other Waffle House employees then obtained counsel, Stephen E. Clements. On or about March 11, 1999, but in any event before the prize was awarded, Mr. Clements, the lawyer representing the four former coworkers (Waffle House claimants), called Ms. Warren and informed her that a dispute existed regarding the proceeds of the Lottery ticket and that his clients were entitled to 80% of the proceeds. He followed up with a letter dated March 12 and sent by facsimile on March 15, 1999, which stated in part: "We would request that no commitments concerning distribution nor actual distribution of any funds be made to Ms. Dickerson or any person or firm on her behalf until such time as the issue of actual ownership of said ticket can be resolved between the parties".
On March 18, 1999, while petitioner was filing the articles of incorporation for 9 Mill with the Alabama secretary of state, Mr. Clements was initiating a lawsuit on behalf of the Waffle House claimants in the Circuit Court of Mobile County, Alabama (Waffle House complaint).
On March 19, 1999, the Circuit Court of Mobile County ordered that all parties refrain from any further efforts to collect, or attempt to collect, any funds from the State of Florida Department of Lottery which, were, or might be, the subject of the tiff. On April 30, 1999, after a trial before an advisory jury, the Circuit Court of Mobile County entered an order finding that the Waffle House claimants had a valid and enforceable joint ownership agreement with petitioner and that they were entitled to 80% of the proceeds of the lottery ticket or $4,060,769.20. Pursuant to the order of the Circuit Court of Mobile County, Alabama, to pay this amount, less any necessary Federal or State tax withholdings, into that court, the Florida Lottery Commission paid $2,923,753.82 into the Circuit Court of Mobile County.
On May 26, 1999, 9 Mill filed a notice of appeal with the Alabama Supreme Court. On February 18, 2000, the Alabama Supreme Court reversed the trial court.
After the decision of the Alabama Supreme Court was issued, Mr. Clements threatened an appeal to the United States Supreme Court and also raised the issue of a payout to his clients in exchange for their promise not to talk to the media. On December 8, 2000, Mr. Seward filed a complaint in the Circuit Court of Mobile County alleging that petitioner had breached her agreement to share the proceeds with the Waffle House claimants and that therefore he was entitled to the full proceeds. Sometime in December 2000, the Circuit Court of Mobile County entered an order denying his claim. Mr. Seward appealed to the Alabama Supreme Court, which affirmed the circuit court on September 20, 2002.
Looking a Gift Horse in the Mouth
Petitioner did not file a gift tax return for the 1999 tax year until she was asked to by Toya Sue Washington, an attorney in the Estate Tax Division of the Internal Revenue Service (IRS). Petitioner's Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, which was received on October 30, 2007, reported that no taxable gift had been made. The IRS disagreed with petitioner and alleged she had made a gift of $2,412,388 as a consequence of her transfer of the lottery ticket to 9 Mill.
Burden of Proof
In general, the Commissioner's determinations are presumed correct, and the taxpayer bears the burden of proving that they are incorrect. Rule 142(a);
Petitioner did not assert in her pretrial memorandum or at trial that respondent bears the burden of proof. Generally, we will not consider an issue that is raised for the first time on brief.
Regardless, we do not need to decide who bears the burden of proof because the parties have provided sufficient evidence for us to determine both that a gift occurred and the value of that gift, and that determination is unaffected by the burden of proof.
Whether a Taxable Gift Occurred
Section 2501(a)(1) generally imposes a tax for each calendar year on the transfer of property by gift during such year by an individual. The tax imposed by section 2501 applies whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible. Sec. 2511. Section 25.2511-1(h)(1), Gift Tax Regs., provides that a transfer of property to a corporation for less than adequate consideration represents gifts to the other individual shareholders of the corporation to the extent of their proportionate interests.
The arguments are straightforward. Respondent contends that petitioner's transfer of the lottery ticket to 9 Mill was an indirect gift to the extent that 51% of the shares of 9 Mill were, at the time transfer of the lottery ticket took place, owned by petitioner's mother, brother, sister, sister-in-law, and brother-in-law.
Whether a Binding and Enforceable Contract Existed Under Alabama State Law
"State law controls the determination of the nature of the property interest the taxpayer conveyed."
The elements of a valid contract in Alabama are: (1) an agreement, (2) consideration, (3) two or more contracting parties, (4) a legal object, and (5) capacity.
Whether the terms of an agreement are sufficiently definite for it to constitute an enforceable contract is a question of law to be determined by the court.
While "`the law does not favor, but leans against the destruction of contracts because of uncertainty; it will, if feasible, so construe the contract as to carry into effect the reasonable intention of the parties if that can be ascertained.' But * * * the court `cannot set up a contract for the parties'."
We agree with respondent. The "terms" of the so-called Reece family agreement consist solely of offhand statements made throughout the years about sharing and taking care of one another in the event someone came into a substantial amount of money. This is not enough. There was no requirement that each family member buy lottery tickets. There was no pattern. There was no pooling of money. There were no predetermined sharing percentages. And while both petitioner and Mr. Reece testified that the agreement covered only "substantial" winnings, neither gave any indication as to what "substantial" was defined as.
Who was party to the agreement was also vague. Mr. Reece stated that the agreement included himself and his wife, his three children, and their spouses. Yet when asked what would have happened if his son-in-law had bought a winning ticket by himself, specifically whether this ticket would have been included in the deal, he stated: "Knowing this gentleman, I would assume, yes, it would be in the agreement." This testimony is simply further evidence of the very sharing nature of petitioner's family. But a feeling of moral obligation to take care of one's family and a few statements that one would do so in the hypothetical situation that one won the lottery simply does not rise to the level of an enforceable contract. What the family had at best was an unenforceable contract to agree on something if in fact one of them was the recipient of a substantial lottery prize.
The actions taken by petitioner and Mr. Reece after petitioner realized she had won the lottery also support a finding that all that existed was petitioner's desire to share her good fortune with her family. Conversations took place, but instead of collaborative discussions, Mr. Reece told the family what he had decided should happen. Not only did petitioner's sister and brother and their spouses not take an active role in these conversations; they did not travel to Florida to claim and celebrate their shared winnings. Petitioner, Mr. Dickerson, and Mrs. Reece were the only three listed as having signatory power over 9 Mill's bank account. And it is curious to this Court that the lottery proceeds were not divided equally if the family's intention was to share equally (as indicated by petitioner's reference to how her family shared equally in an $80 dinner and Mr. Reece partitioned land into four equal lots).
Contrary to petitioner's belief, the terms of the alleged Reece family Agreement are too indefinite, uncertain, and incomplete for enforcement.
Additionally, even if otherwise enforceable, the alleged Reece family agreement would be rendered void pursuant to Alabama's antigambling statute.
We disagree. We fail to see how a lottery ticket given to petitioner by a customer at the Waffle House where she worked could metamorphose into a lottery ticket owned by petitioner's entire family. Petitioner and her family did not pool their money to jointly purchase lottery tickets. They did not keep lottery tickets individually purchased (or acquired) in a place where all family members had access to the tickets. There is no evidence that a family member knew if another member had acquired a lottery ticket. There was no agreement as to exactly how the proceeds of any winning ticket would be shared. Mr. Reece testified that one reason petitioner and her then husband retained 49% of the stock in 9 Mill was that "Tonda is the one that received the ticket, so Tonda would get the larger amount." This statement directly contradicts petitioner's assertion that as soon as she received the ticket, it was "jointly owned" by her family.
In conclusion, there was no enforceable contract among the Reece family. First, the terms were too indefinite, uncertain, and incomplete. Second, the alleged agreement, even if otherwise enforceable under contract principles, would be rendered void pursuant to the Alabama antigambling statute.
Whether a Valid Partnership Existed Under Federal Tax Law
Whether a valid partnership exists for Federal tax purposes is governed by Federal law.
A partnership is created "when persons join together their money, goods, labor, or skill for the purpose of carrying on a trade, profession, or business and when there is community of interest in the profits and losses."
Recognition of a partnership for Federal tax purposes also requires that the parties conduct some business activity.
Petitioner relies on
One day, Mrs. Winkler, while with one of her daughters, purchased a ticket and put the ticket in the china cabinet. That Sunday, Mrs. Winkler realized the ticket was the winning ticket and immediately called each of her children and asked them to come to her home. Together, the family first met with an accountant and then an attorney to determine what to do with the winning ticket. Together, they decided the percentages each family member should receive.
We held that a valid partnership existed in
We also noted that each member of the family was treated at a partner at all times including attending the meetings with the accountant and the attorney and having a say in formulating the agreement.
Petitioner argues that "The facts of Winkler and the present case have many similarities." There are some factual similarities, but there are also factual differences which in this case are important to a proper resolution of the issues. The Winkler family had an established pattern of buying tickets on their way to and from medical clinics. In the words of the Court, they "conducted this activity on a regular and consistent basis".
Each member of the Winkler family met with the accountant and the attorney after they discovered they had a winning ticket. This did not happen in the Reece family. In the Reece family, it was Mr. Reece who ultimately made the decisions, not a joint effort among all of the family members. Petitioner and her family have nothing to rely on other than a family meal, offhand statements throughout the years, and a familial sense of duty to take care of each other.
Value of the Gift
Petitioner having made a gift in 1999 when she transferred the lottery ticket to 9 Mill, we must now determine the amount of the gift.
In general, for Federal tax purposes property is valued as of the valuation date on the basis of facts available on that date without regard to hindsight.
Here, the date of valuation is at issue. Respondent argues the gift was made on March 11, 1999. Petitioner argues the gift occurred on March 12, 1999. In her reply brief petitioner states: "Even if the transfer date was March 11, 1999, as Respondent argues, a hypothetical buyer researching the potential purchase of a $10 million dollar ticket would have discovered at a minimum, the claim made by the Waffle House Claimants." We agree with petitioner.
Respondent argues that "at the most what was reasonably foreseeable was that one disgruntled co-worker might take legal action to obtain a portion of the lottery winnings. At this point no legal claims had been made, formally or informally, to the petitioner." Respondent then argues that no discount should be applied. Contrary to respondent's assertion, we cannot overlook that as of March 9 and certainly by March 11 or 12, a hypothetical buyer would have known of the potential cloud on title.
In previous attempts to value claims subject to lawsuits,
The parties agreed in their briefs that the present value of the ticket proceeds, if there were no claims or discounts, was $4,730,172.
Steven Nicholas prepared an expert report for petitioner. Mr. Nicholas is a graduate of the University of Alabama School of Law and has been practicing law since his graduation in 1984 in Mobile where he specializes in litigation, principally commercial and class action litigation. Mr. Nicholas works for a law firm that is exclusively a plaintiffs' firm and earns fees on a contingency basis. In this regard, he has experience evaluating cases and claims in regard to the acceptance of cases on contingency basis and for settlement purposes. This is the first case where Mr. Nicholas has testified as an expert.
Mr. Nicholas testified that there were two sets of claims: (1) Waffle House claimants and (2) Reece family. For the first, he discounted by 65-80% (or to 20-35% of its otherwise FMV). For the first and second combined, he arrived at a total discount of 80-85% (arriving at a discounted FMV of 15-20% of undiscounted FMV). Finally, he testified that the costs of litigation would range between 2% and 5% of the total value of the ticket.
We start with the Waffle House claimants. Mr. Nicholas testified that the Waffle House case was an issue of first impression for the Alabama Supreme Court. He was of the opinion that as of March 11, 1999, the general consensus was that an agreement between the Waffle House claimants was legal—specifically, that an agreement to share lottery proceeds was legal even in a State where gambling had been declared illegal. We found Mr. Nicholas' testimony very credible. He was knowledgeable regarding both Alabama law and the valuation of potential claims. We recognize our general rule not to look past the date of valuation to subsequent events, yet petitioner's loss in the trial court followed by an appeal and win at the Alabama Supreme Court (with two justices dissenting) confirms our own litigation tree analysis of just how uncertain the law was at the time the gift occurred. We find no sound reason and respondent has not established one to discredit Mr. Nicholas' opinion that the value of the lottery ticket should be discounted by 65-80% on the basis of the potential Waffle House litigation. We choose a discount of 65% because suit had not yet been filed when petitioner made the gift and we believe the lower amount of his range is more appropriate here. We note petitioner could have prevailed on either the factual contract claim on the basis that there was no agreement with the other Waffle House employees or the legal claim that the contract was illegal.
We now consider the Reece family claims. Petitioner states:
Respondent argues: "Based on * * * analysis of the family agreement, the agreement is not an enforceable contract under Alabama law. The gift should not be discounted based on any family members' ability to sue the petitioner on the basis that they jointly owned the ticket." We agree with respondent. As discussed
Lastly we address litigation costs. Mr. Nicholas testified that the cost of litigation would be 2-5% of the lottery ticket proceeds. Again, we find Mr. Nicholas' testimony credible and a 2% discount appropriate. We choose 2% because suit had not yet (and might never have) been filed at the time the gift occurred. In conclusion, the value of the disputed portion of the lottery ticket should be discounted by 67%. The Court has considered all of petitioner's and respondent's contentions, arguments, requests, and statements. To the extent not discussed herein, we conclude that they are meritless, moot, or irrelevant.
To reflect the foregoing,
In addition to objecting to the introduction of the Waffle House complaint, respondent also objected to numerous other stipulated facts regarding the lawsuit on the grounds of materiality and relevance. Fed. R. Evid. 401 defines "Relevant evidence" as "evidence having any tendency to make the existence of any fact that is of consequence to the determination of the action more probable or less probable than it would be without the evidence." These stipulated facts will be admitted and respondent's objections are overruled. These facts are both relevant and material in determining the value of the lottery ticket on the date petitioner gave it to 9 Mill and have proven to be helpful to the Court.
While petitioner characterizes these arguments as distinct, we believe they can be condensed into two arguments: (1) the alleged agreement was enforceable under State law and therefore resulted in no taxable gift and (2) even if not enforceable under State law, the alleged agreement resulted in no taxable gift pursuant to Federal tax law.
Even if we concluded there was a partnership among the Reece family involving the purchase of lottery tickets, petitioner (unlike Mrs. Winkler) was not acting on behalf of the partnership when she was
We recognize that in her petition, petitioner stated: "This was a transfer of a $5.00 lottery ticket to a legally formed family Sub-S corporation (Before it was claimed) under the direction of the legal department of the Florida Lottery, our corporate attorney, and the IRS". Petitioner, at the time she filed her petition, was proceeding pro se, and this statement is not necessarily inconsistent with a March 12, 1999, transfer date. The witnesses in this case were very forthright, credible, and honest. Petitioner is unsophisticated in matters concerning Federal tax laws, relying on others for advice. When Ms. Warren instructed Mr. Reece that no one should sign the back of the lottery ticket, we have no doubt petitioner followed those instructions and did not sign the ticket until March 12, 1999, immediately before it was formally presented to the Florida lottery officials.
Respondent asserts that "The use of the erroneous March 12, 1999, date would allow a whole new set of facts to be used and tend to send us down a slippery slope that would render the mandated date pursuant to IRS [sic] § 2512 meaningless." This might have been true if no evidence of a disagreement over who was entitled to the proceeds of the winning ticket existed before March 12. Respondent goes on to state that "The new facts as of March 12, 1999, was that some unknown claimants', possible hairdressers, attorney notified the Florida Lottery Commission that they had an interest in petitioner's lottery ticket." Mr. Clements called the Lottery Commission earlier on or before March 12, 1999, and it was known by a number of parties that there was a dispute as early as March 9, 1999. No knowledgeable reasonable buyer would have considered paying over $4 million for a lottery ticket without investigating the facts and receiving a warranty of good title after learning there was some dispute over ownership of 80% of the ticket proceeds.