|Doeren Mayhew |
Transfer of winning lottery ticket to S Corp is taxable gift
A lottery winner recently tried to get lucky twice by beating the IRS on taxes owed on the winnings. Unfortunately, she lost that round with lady luck, with the Tax Court ruling that she was liable for gift tax on a maneuver with an S corporation designed to spread some of the winnings out to certain family members.
An Alabama waitress had received the lottery ticket as a tip, as she had regularly received from a particular patron on a regular basis. The state courts after protracted litigation ruled in her favor that the winning ticket belonged to her rather than either the patron or her fellow employees under a claimed sharing agreement.
While those matters were still in the courts, however, she took steps to spread some of her new-found wealth to family members, assuming she would win in state court. She did so by forming an S corporation under the Tax Code with herself as the president and several family members listed as shareholders. What she didn't count on by that maneuver was the IRS issuing a deficiency notice for $771,000 for gift tax owed (income tax liability was not a part of this case). The taxpayer appealed to the Tax Court for relief.
Gift tax due, with a discount
The Tax Court eventually determined that the taxpayer's transfer of a winning lottery ticket to a family-controlled S corp was a gift. The court found there was no enforceable contract among family members to transfer the lottery ticket to the S corp.
Code Sec. 2501(a)(1) generally imposes a tax irrespective of whether the gift is direct or indirect. 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 court rejected the taxpayer's argument that there was no gift because a family contract required transfer of the ticket. The court found that there was no pooling of money. There were no predetermined sharing percentages. There was no implied partnership. At most, the family had an unenforceable "agreement to agree."
Although the court found for the IRS, the decision was not a total loss for the taxpayer. At the time the gift was made to the S corp, there was that competing claim to the lottery prize made by her co-workers. The court found that a hypothetical buyer would not have paid full value for the ticket. The court concluded that an appropriate discount for the portion of the ticket subject to the competing claim would be 67 percent, which resulted in a $1.1 million gift to the S corp and not the $2.4 million gift determined by the IRS.
Doeren Mayhew is a Michigan Financial Firm located in Troy, MI.