Magazine article The CPA Journal

Tax Implications of Providing Cash Buyout Options

Magazine article The CPA Journal

Tax Implications of Providing Cash Buyout Options

Article excerpt

A taxpayer is generally required to include an item of income no later than the time of its actual or constructive receipt, unless the item is properly accounted for in a different period. If a taxpayer has an unrestricted right to demand the payment of an amount, he is in constructive receipt of that amount whether or not he makes the demand and actually receives the payment, as stated in Treasury Regulations section 1.451-2.

Under the doctrine of constructive receipt, the winner of a prize who is given the option at the time the prize is won of receiving either a single cash payment or an annuity, is required to include the value of the entire single cash payment in gross income, even if the annuity option is exercised. The Technical Correction to the Tax and Trade Release Extension Act of 1998 (P.L. 105-277) created IRC section 451(h). When a prizewinner is offered a "qualified prize option" that is exercisable within a limited time period after the individual becomes entitled to the qualified prize, the application of the constructive receipt doctrine can be removed.

IRC section 451(hX2XA) provides that the term qualified prize option means an option that-

* entitles an individual to receive a single cash payment in lieu of receiving a qualified prize, and

* is not exercisable later than 60 days after such individual becomes entitled to the qualified prize.

IRC section 451(h)(B) provides that the term qualified prize means any prize or award that

* is awarded as part of a contest, lottery, jackpot game, or other similar arrangement;

* does not relate to any past services performed by the recipient and does not require the recipient to perform any sub stantial future services; and

* is payable over a period of at least 10 years.

Under the transition rule for qualified prizes won on or before October 21, 1998, an 18-month window beginning July 1, 1999, and ending December 31, 2000, is established during which eligible persons may be given an option to accept a lump-sum buyout of the balance of their qualified prize.

IRC section 451(h) and the transitional rule concludes that Congress intended to remove the application of the constructive receipt doctrine when an existing qualified prize winner is offered an option to accept a lump-sum buyout of the balance of the qualified prize. Nevertheless, there are at least three classes of existing qualified prizewinners that may be ineligible to receive a qualified prize option to accept a lump-sum buyout of the balance. The following are three fact patterns suggesting that the doctrine should not apply in all cases.

Example 1. Qualified prize winners that won on or before October 22, 1998, and were not provided with an option to accept a lump-sum buyout of the balance of their qualified prizes which could be exercisable before December 31, 2000 (pre-effective date winners). Assume that the payer of a qualified prize later decides to provide a pre-effective date winner with an option to accept a lumpsum buyout of the balance. In this case, the option received by the pre-effective date winner would not be considered a qualified prize option under the transitional rule, because that option would not have been exercisable before December 31, 2000. The pre-effective date winner would be required to include the amount of the single-sum cash payment offered in gross income, even while receiving the annual annuity payout.

Example 2. Qualified prizewinners that won after October 21, 1998, and opted to receive a qualified prize are later granted an option to receive a lump-sum buyout of the remaining balance of their qualified prize (opted annuity winner). Assume that the payer of a qualified prize later decides to provide an opted annuity winner with an option to accept a lump-sum buyout of the balance of the qualified prize. The option would not qualify under IRC section 451(h)(2)(A)(ii)), because it would not have been exercisable within 60 days after the person became entitled to the qualified prize. …

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