Academic journal article Journal of Accountancy

Valuing a Private Annuity

Academic journal article Journal of Accountancy

Valuing a Private Annuity

Article excerpt

As more states start using lotteries as revenue sources, CPAs will face an increased number of tax questions from winners. Recently the Fifth Circuit Court of Appeals considered how to value for estate purposes the prize a taxpayer had won. The decision has the potential to affect more than just lottery winners.

Gladys Cook and her sister-in-law had a long-standing agreement to jointly purchase Texas lottery tickets. On July 8, 1995, they bought a winner--the prize was $17 million, payable in 20 annual installments. The state made the first payment of $858,648 on July 10, 1995. Texas law prohibits assignment of the winnings, except by court order, as well as collection of the amount in a lump sum. On July 12, Gladys and her sister-in-law created a formal partnership to receive the winnings. Gladys died on November 6, 1995. The partnership interest was included in her estate with a value based on an appraisal. The IRS disagreed with this method and revalued the interest based on the annuity tables in the regulations. The Tax Court held for the IRS, supporting its use of the annuity tables. The taxpayer appealed.

Result. For the IRS, with one dissent. Normally the appeals courts do not review questions of value since they are questions of fact. In this case the issue was the proper method of valuation, a question of law, which the appeals court can review.

The initial inquiry was the correct classification of the lottery winnings. The Tax Court held they were a private annuity based on a broad reading of the definition of an annuity. The Fifth Circuit agreed.

Unlike other assets, private annuities are valued using tables from the regulations. Attempting to determine the price a willing buyer and willing seller would agree upon is not an appropriate valuation method. Congress approved the use of these tables because they provide convenience and certainty and the loss of accuracy is minor. …

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