Below is the actual case I am working on.
I am preparing a memorandum for a graduate taxation
course. I have a lot of notes on it but I am unsure if I am correct.
Using the following problem, I have to identify and discuss the main issues, identify and discuss other issues, calculate the basis, identify and discuss the ethical issues and resolve the problem. Any guidance you can provide will be greatly appreciated.
I think some of the major issues are as follows:
1. What type of income is lottery prize money?
2. What is the tax
treatment for this type of income?
3. Was the capital gain properly reported?
4. Should the transfers between the sisters be treated as gifts?
5. Is Mary really the owner of the prize money?
6. Did Rose realize the value of her gift?
Was Ruth's transfer of the lottery ticket to Mary ethical? No
Were Mary's actions ethical? No
As a tax professional, what is my ethical responsibility? Do I have a responsibility to report the fraudulent activity to the IRS?
I am unsure how to calculate the basis.
Correctly amend returns back to the beginning
Seek an attorney
John and XXXXX XXXXX are U.S. taxpayers. The Smiths have resided in New State since 1995. In 2002 XXXXX XXXXX was declared the winner of a $ 6.24 million prize in the New State Lottery. $1.00 was paid for the winning Lottery ticket which entitled its holder to participate in the bi-weekly drawings. Under the Lottery Rules
, Mary became entitled to receive 20 annual payments of$ 312,000 each, less mandatory Federal Income Tax Withholding
. The first payment was made on May 1, 2002 and 19 subsequent installments of$ 312,000 (reduced by Federal Income Tax withholding) were scheduled to be paid on May 1 of each successive year.
The New State Lottery rules did not offer Mary the option of receiving a lump-sum payment at the time she claimed the Lottery prize. Under the New State Lottery Rules, Mary could not transfer her right to receive all or any portion of the future installment payments without first obtaining the approval of the Superior Court. This provision was included in the law
to insure against fraud.
On or about July 2, 2011, after obtaining the approval of the Superior Court, Mary entered into an agreement with Lottery Payment Finance Company, LLC ("Finance"). Under the Agreement, Mary sold all of her rights to receive the remaining 10 installment payments (10 x $ 312,000 = $ 3.2 million) in exchange for a lump-sum payment by Finance in the amount of$ 2.125 million. On the joint Form 1040 Return she filed with her husband John, Mary reported a long-term capital gain of$ 2, 124,599 from the transfer. The Internal Revenue Service
has asserted a deficiency assessment
, including penalties and interest. The Internal Revenue Service takes the position that the $ 2.125 million lump-sum payment is taxable at ordinary income rates.
John and Mary have requested your advice regarding the Internal Revenue
Service's position; they wonder whether they should they fight it? During your conference with them Mary tells you that the ticket was actually purchased by her sister, Rose. When Rose won she asked Mary to claim the prize money since Rose was about to declare personal bankruptcy (her assets were then valued at $ 250,000 and her liabilities were $ 1,800,000). Mary agreed and accepted the prize. Mary has kept track of the money received from the New State Lottery and accounted to Rose for any monies Mary used.
Rose has completed her bankruptcy action and receives money from Mary from time to time. Rose (and Mary) treat these transfers as "gifts" for Federal Income Tax purposes.