Estate of Paul C. Gribauskas v. Commissioner

116 T.C. No. 12UNITED STATES TAX COURT
ESTATE OF PAUL C. GRIBAUSKAS, DECEASED,
ROY L. GRIBAUSKAS AND CAROL BEAUPARLANT,
CO-EXECUTORS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3107-98. Filed March 8, 2001.
In late 1992, D and his former spouse won a
Connecticut LOTTO prize payable in 20 annual
installments. At the time of his death in 1994, D was
entitled to receive 18 further annual payments of
$395,182.67 each.
Held: The lottery payments must be included in
D’s gross estate and valued for estate tax purposes
through application of the actuarial tables prescribed
under sec. 7520, I.R.C.
Michael J. Kopsick and William J. Dakin, for petitioner.
Carmino J. Santaniello, for respondent.
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OPINION
NIMS, Judge: Respondent determined a Federal estate tax
deficiency in the amount of $403,167 for the estate of Paul C.
Gribauskas (the estate). The sole issue for decision is whether
an interest held at his death by Paul C. Gribauskas (decedent),
in 18 annual installments of a lottery prize, must be valued for
estate tax purposes through application of the actuarial tables
prescribed under section 7520.
Unless otherwise indicated, all section references are to
sections of the Internal Revenue Code in effect as of the date of
decedent’s death, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
Background
This case was submitted fully stipulated pursuant to Rule
122, and the facts are so found. The stipulations of the
parties, with accompanying exhibits, are incorporated herein by
this reference. Decedent was a resident of West Simsbury,
Connecticut, when he died intestate in that State on June 4,
1994. His estate has since been administered by the probate
court for the District of Simsbury. Roy L. Gribauskas and Carol
Beauparlant, decedent’s siblings, are named co-executors of his
estate. At the time the petition in this case was filed, Roy
Gribauskas resided in Southington, Connecticut, and Carol
Beauparlant resided in Berlin, Connecticut.
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The Connecticut LOTTO
In September of 1983, the State of Connecticut (the State)
commenced running a biweekly “LOTTO” drawing. During all
relevant periods, this lottery was administered by the State of
Connecticut Revenue Services, Division of Special Revenue (the
Division), in accordance with regulations promulgated to govern
the game’s operation. Individuals participate in the lottery by
purchasing for $1.00 a ticket on which they select six numbers.
If the six numbers so chosen match those randomly selected at the
next LOTTO drawing, the ticketholder becomes entitled to a prize
of $1,000,000 minimum, with a potentially greater award available
if ticket purchases have increased the size of the jackpot.
LOTTO prizes in excess of $1,000,000 are paid in 20 equal annual
installments, each made by means of a check from the State
payable to the prizewinner and drawn on funds in the custody of
the State Treasurer. Winners are not entitled to elect payment
in the form of a lump sum. As in effect during the year of
decedent’s death, the following administrative regulations
prohibited a LOTTO prizewinner from assigning or accelerating
payment of the installments:
(d) Prizes non-assignable. A prize to which a
purchaser may become entitled shall not be assignable.
(e) Payments not accelerated. Under no circumstances,
including the death of a prize winner, shall installment
payments of prize money be accelerated. In all cases such
payments shall continue as specified in the official
procedures. The division shall make such payments payable
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to the fiduciary of the decedent prize winners’[sic] estate
upon receipt of an appropriate probate court order
appointing such fiduciary. The division shall be relieved
of any further responsibility or liability upon payment of
such installment prize payments to the fiduciary of the
estate of a deceased installment prize winner or the heirs
or beneficiaries thereof named in an appropriate probate
court order. [Conn. Agencies Regs. sec. 12-568-5(d) and (e)
(1993).]
The Division was authorized to, and did, fund its LOTTO
obligations through the periodic purchase of commercial
annuities. The Division was named as owner of these contracts,
and all payments made thereunder were remitted to the State. No
specific prizewinner was either a party to or a named beneficiary
of the annuity contracts. The record does not reflect the cost
of these contracts, presumably because the State typically
acquired a combined annuity to provide for payment of all LOTTO
prizes won during a specified period of time. Additionally,
payment of awards to lottery winners was not guaranteed by any
State agency. However, at no time through the submission of this
case had the State ever defaulted on amounts due to the
approximately 2,000 persons who had won LOTTO jackpots since the
game’s inception in 1983.
Decedent’s LOTTO Prize
In late 1992, decedent and his wife won a Connecticut LOTTO
prize in the amount of $15,807,306.60. The award was payable in
20 annual installments of $790,365.34 each, commencing on
December 3, 1992. After receipt of the first such installment,
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decedent and his wife were divorced. In conjunction with the
ensuing settlement and division of the property rights of the
couple, each spouse was to receive one-half of the remaining
lottery installment payments. Accordingly, $395,182.67, less
applicable Federal and State withholding taxes, was remitted to
each on December 3, 1993. Thereafter, on June 4, 1994, decedent
died unexpectedly while still entitled to 18 further annual
payments of $395,182.67 each. Since obtaining an appropriate
court order as required by the Connecticut LOTTO regulations,
these installments have been remitted yearly to the estate.
The Estate Tax Return
A United States Estate (and Generation-Skipping Transfer)
Tax Return, Form 706, was timely filed with respect to decedent’s
estate on September 11, 1995. Therein, the estate elected to
report the value of assets as of the December 3, 1994, alternate
valuation date. Decedent’s interest in the lottery installments
was characterized on the return as an “Unsecured debt obligation
due from the State of Connecticut arising from winning the
Connecticut Lottery” and was included in the gross estate at the
alleged present value of $2,603,661.02. Respondent subsequently
determined that the present value of the payments should have
been reported as $3,528,058.22 in accordance with the annuity
tables prescribed under section 7520, resulting in the $403,167
deficiency in estate tax that is the subject of this proceeding.
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Discussion
I. General Rules
As a general rule, the Internal Revenue Code imposes a
Federal tax on “the transfer of the taxable estate of every
decedent who is a citizen or resident of the United States.”
Sec. 2001(a). Such taxable estate, in turn, is defined as the
“value of the gross estate”, less applicable deductions. Sec.
2051. Section 2031(a) then specifies that the gross estate
comprises “all property, real or personal, tangible or
intangible, wherever situated”, to the extent provided in
sections 2033 through 2045.
Section 2033 broadly states that “The value of the gross
estate shall include the value of all property to the extent of
the interest therein of the decedent at the time of his death.”
Sections 2034 through 2045 then explicitly mandate inclusion of
several more narrowly defined classes of assets. Among these
specific sections is section 2039, which reads as follows:
SEC. 2039. ANNUITIES.
(a) General.--The gross estate shall include the
value of an annuity or other payment receivable by any
beneficiary by reason of surviving the decedent under
any form of contract or agreement entered into after
March 3, 1931 (other than as insurance under policies
on the life of the decedent), if, under such contract
or agreement, an annuity or other payment was payable
to the decedent, or the decedent possessed the right to
receive such annuity or payment, either alone or in
conjunction with another for his life or for any period
not ascertainable without reference to his death or for
any period which does not in fact end before his death.
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(b) Amount Includible.--Subsection (a) shall apply
to only such part of the value of the annuity or other
payment receivable under such contract or agreement as
is proportionate to that part of the purchase price
therefor contributed by the decedent. For purposes of
this section, any contribution by the decedent’s
employer or former employer to the purchase price of
such contract or agreement * * * shall be considered to
be contributed by the decedent if made by reason of his
employment.
An interest included in the gross estate pursuant to one of
the above-referenced provisions must then be valued. As to this
endeavor, the general rule is set forth in section 20.2031-1(b),
Estate Tax Regs.:
The value of every item of property includible in a
decedent’s gross estate under sections 2031 through
2044 [now 2045 due to addition and renumbering] is its
fair market value at the time of the decedents’s death,
except that if the executor elects the alternate
valuation method under section 2032, it is the fair
market value thereof at the date, and with the
adjustments, prescribed in that section. The fair
market value is the price at which the property would
change hands between a willing buyer and a willing
seller, neither being under any compulsion to buy or to
sell and both having reasonable knowledge of relevant
facts. * * *
However, section 7520, enacted as part of the Technical and
Miscellaneous Revenue Act of 1988, Pub. L. 100-647, sec. 5031(a),
102 Stat. 3342, 3668, provides a specific rule for valuing
enumerated forms of property interests, as follows:
SEC. 7520. VALUATION TABLES.
(a) General Rule.--For purposes of this title, the
value of any annuity, any interest for life or a term
of years, or any remainder or reversionary interest
shall be determined--
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(1) under tables prescribed by the Secretary,
and
(2) by using an interest rate (rounded to the
nearest 2/10ths of 1 percent) equal to 120 percent
of the Federal midterm rate in effect under
section 1274(d)(1) for the month in which the
valuation date falls. * * *
(b) Section Not To Apply for Certain Purposes.--
This section shall not apply for purposes of part I of
subchapter D of chapter 1 [relating to qualified plans
for deferred compensation] or any other provision
specified in regulations.
For transfer tax purposes, regulations promulgated under
section 7520 provide that the relevant actuarial tables for
valuing interests covered by the statute are contained in section
20.2031-7, Estate Tax Regs. See sec. 20.7520-1(a)(1), Estate Tax
Regs.; sec. 25.7520-1(a)(1), Gift Tax Regs.; see also sec.
20.2031-7T(d)(5), Example (4), Temporary Estate Tax Regs., 64
Fed. Reg. 23187, 23214 (Apr. 30, 1999) (with effective date May
1, 1999, but illustrating the calculation for valuing an annuity
of $10,000 per year payable to a decedent or the decedent’s
estate).
The regulations also delineate exceptions to the mandatory
use of the tables. In the estate tax context, paragraph (a) of
section 20.7520-3, Estate Tax Regs., lists exceptions effective
as of May 1, 1989, while paragraph (b) gives additional
limitations effective with respect to estates of decedents dying
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after December 13, 1995. See sec. 20.7520-3(c), Estate Tax Regs.
These exceptions, where pertinent, will be discussed in greater
detail below.
II. Contentions of the Parties
The fundamental disagreement between the parties concerns
whether the stream of lottery payments constitutes an annuity
which must be valued pursuant to the actuarial tables prescribed
under section 7520.
The estate concedes that the prize’s value is properly
included in calculating decedent’s gross estate under the general
rule of section 2033, as “an unsecured debt obligation” in which
decedent had an interest at death. However, the estate denies
that the payments are similarly includible as an annuity under
section 2039. According to the estate, the lottery prize fails
to meet the specific requirements set forth in section 2039(a)
for classification as an annuity under that section. Moreover,
even if such criteria were deemed satisfied, the estate maintains
that operation of section 2039(b) would result in including only
that portion of the asset equal to the $1.00 purchase price, a de
minimis amount.
From these propositions, and to a significant degree
apparently equating the term “annuity” in section 2039 with use
of the word in section 7520, the estate argues that the LOTTO
payments need not be valued under the prescribed actuarial
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tables. Rather, it is the estate’s position that the broader
willing-buyer, willing-seller standard should control, with
factors such as lack of marketability taken into account in
discounting the prize to present value.
In the alternative, the estate contends that even if the
lottery award is held includible in decedent’s gross estate as an
annuity under section 2039, deviation from the prescribed tables
is warranted in this case. The estate claims that the tables may
be disregarded when their use would produce an unreasonable
result and that, due to restrictions on the asset in question,
such a situation is present here.
Conversely, respondent asserts that decedent’s right to 18
fixed annual payments constitutes an annuity which must be valued
pursuant to section 7520. With respect to section 2039,
respondent maintains that the lottery installments satisfy all
elements for inclusion in the gross estate under subsection (a)
and that no grounds are provided in subsection (b) for limiting
such inclusion. However, regardless of the specific
applicability of section 2039, it is respondent’s position that
the LOTTO prize is an interest to which section 7520 applies.
Respondent avers that the statute cited for inclusion in the
gross estate is not dispositive of whether tabular valuation is
mandated. Rather, it is the nature of the payment stream at
issue that controls, and respondent contends that the periodic
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installments here exhibit characteristics consistent with rights
properly valued under the section 7520 tables. Moreover,
respondent alleges that neither any general regulatory exceptions
nor particular features such as lack of marketability permit
departure from the tables in the circumstances of this case.
Hence, in essence the parties agree that the value of the
lottery installments is to be included in decedent’s gross estate
and that the appropriate methodology for ascertaining such value
is to discount the stream of payments to present value. They
advance opposing theories, however, for arriving at the relevant
discount rate. Section 7520 mandates use of a 9.4-percent
discount rate for annuities valued as of December 3, 1994, and
respondent contends that this statute is applicable to the facts
before us. In contrast, the estate argues that the discount rate
should be determined by consideration of what a willing buyer
would pay a willing seller for the asset at issue and, further,
apparently finds that a discount rate of approximately 15
percent, adjusting for risk, inalienability, illiquidity, and
lack of marketability, is proper here. Lastly, we note that for
purposes of disposing of the legal issues raised by this
proceeding, the parties have stipulated that if the Court
determines departure from the annuity tables is warranted, the
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value of the lottery installment payments as of the alternate
valuation date will be deemed to be the $2,603,661.02 claimed in
the estate tax return.
III. Analysis
A. Relevance of Section 2039
As a threshold matter, this case presents a preliminary
question regarding the relationship among sections 2033, 2039,
and 7520. Specifically, is finding that an interest fails to
meet the criteria for inclusion in the gross estate as an annuity
under section 2039, and is so included only under section 2033,
determinative of whether the interest is an annuity within the
meaning of section 7520? We answer this inquiry in the negative
for the reasons detailed below.
The purpose of section 2039, by its terms, is to effect
inclusion in the gross estate of annuity or payment rights
meeting certain enumerated criteria. At the same time,
regulations promulgated under the statute indicate that section
2039 does not provide the exclusive definition of interests which
may be considered an annuity for purposes of the Internal Revenue
Code. Section 20.2039-1(a), Estate Tax Regs., recites the
following: “The fact that an annuity or other payment is not
includible in a decedent’s gross estate under section 2039(a) and
(b) does not mean that it is not includible under some other
section of part III of subchapter A of chapter 11 [comprising
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sections 2031 through 2046].” The inference to be drawn from
this statement is that certain interests properly characterized
as an “annuity” within the meaning of the estate tax laws may not
fall within the purview of section 2039.
This inference is further supported by consideration of the
rationale underlying enactment of section 2039. It has been
recognized that “Congress intended to include in the gross estate
of a decedent for estate tax purposes the value of interests
which under traditional common law concepts were never part of
the ‘estate.’” Gray v. United States, 410 F.2d 1094, 1097 (3d
Cir. 1969). Yet an annuity payable to a decedent’s estate would
have been considered an estate asset and subject to probate.
Additionally, examples contained in both the legislative history
and the current regulations reveal a focus on nonprobate assets
such as annuities payable to a designated surviving beneficiary,
joint and survivor annuities, and employer-provided retirement
annuities payable to a named beneficiary. See S. Rept. 1622, 83d
Cong., 2d Sess. (1954); H. Rept. 1337, 83d Cong., 2d Sess.
(1954); sec. 20.2039-1, Estate Tax Regs. It therefore would seem
reasonable to conclude that section 2039 did not and does not
purport to cover the universe of potential annuities that may be
subject to inclusion and valuation for estate tax purposes.
Case law also comports with this interpretation. For
instance, in Arrington v. United States, 34 Fed. Cl. 144, 145-146
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(1995), affd. without published opinion 108 F.3d 1393 (Fed. Cir.
1997), the court described the interest at issue in that case, a
stream of payments to be received by the decedent’s estate under
a lawsuit settlement agreement, as follows:
This settlement agreement also provided for the
funding of an annuity “for the sole use and benefit of
WILLIAM ARRINGTON.” Specifically, the annuity would be
for
the sum of Two Thousand Twenty Seven and 86/100
($2,027.86) Dollars per month beginning on January
7, 1990 for the remainder of WILLIAM ARRINGTON’s
life, guaranteed for a minimum of three hundred
and sixty (360) months. In the event of WILLIAM
ARRINGTON’s death prior to the expiration of three
hundred and sixty (360) months, the remaining
monthly payments in the guaranteed period shall
continue to be paid as they fall due on a monthly
basis to the estate of WILLIAM ARRINGTON and not
in a lump sum.
The court then went on to hold the installments includible in the
decedent’s gross estate under section 2033 on the grounds that
the decedent was “the beneficial owner of the annuity”. Id. at
147-148, 150. Arrington v. United States, supra, thus
illustrates that an annuity classification and a section 2033
inclusion are not mutually exclusive concepts.
Consequently, based on the foregoing authorities, we are
satisfied that the particular section under which an interest
might be included in the gross estate is not dispositive of the
interest’s status as an annuity which potentially must be valued
under section 7520. Since the estate has conceded, and we
concur, that the subject lottery payments are includible under
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section 2033, we find it unnecessary to probe whether the
installments would also satisfy all of the specific criteria for
inclusion under section 2039. Because an interest need not meet
each of the particular requirements of that section to be
considered an annuity, the only arguments made in connection with
section 2039 that are directly relevant to the dispositive
section 7520 issue are those concerning the meaning of “annuity”
as a stand-alone term. Accordingly, we proceed to analysis of
these contentions, and we do so in the context of section 7520’s
use of the word.
B. Meaning of Annuity as Used in Section 7520
We are now faced squarely with the question of what is meant
by the term “annuity” in section 7520. The statute itself
contains no definition beyond the phrase “any annuity, any
interest for life or a term of years, or any remainder or
reversionary interest”. Sec. 7520(a). The regulations under
section 7520, as in effect on December 3, 1994, are equally
devoid of explicit guidance. Furthermore, we are aware of no
cases offering a definition of the word in the context of section
7520’s use thereof. In such circumstances, the general rule is
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that “a statutory term should be given its normal and customary
meaning.” Ashland Oil, Inc. v. Commissioner, 95 T.C. 348, 356
(1990).
Black’s Law Dictionary 88 (7th ed. 1999) defines annuity as
“An obligation to pay a stated sum, usu. monthly or annually, to
a stated recipient” and as “A fixed sum of money payable
periodically”. Webster’s Third New International Dictionary 88
(1976) provides that an annuity is “an amount payable yearly or
at other regular intervals (as quarterly) for a certain or
uncertain period”. We likewise pointed out in Estate of Shapiro
v. Commissioner, T.C. Memo. 1993-483, that “An ‘annuity’ is
commonly defined as a fixed, periodic payment, either for life or
a term of years.” Additionally, although not directly applicable
here due to the December 14, 1995, effective date, we note that
section 20.7520-3(b)(1)(i)(A), Estate Tax Regs., now contains the
analogous statement that “An ordinary annuity interest is the
right to receive a fixed dollar amount at the end of each year
during one or more measuring lives or for some other defined
period.”
In the instant case, the estate acknowledges that the LOTTO
installments are consistent with these definitions. However, the
estate further maintains that such definitions, standing alone,
are overinclusive, in that they focus solely on the payment
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stream without taking into account the nature of the underlying
corpus or asset giving rise to the right to payments. According
to the estate:
An annuity is generally defined as a right to receive
fixed, periodic payments, either for life or a term of
years, but an annuity exists only by virtue of a corpus
invested to produce an income stream for a specified
term pursuant to a contract or other agreement.
Contrary to the suggestion made by the Commissioner
that the Stipulation of Facts regarding the source and
reason for the payments is immaterial, any
determination of the nature of this asset requires an
analysis of the underlying characteristics and factors
that create the right to those payments. * * *
The estate proceeds to offer a litany of features which
would characterize what, in the estate’s estimation, would
customarily be understood as an annuity. As described by the
estate, an annuity is purchased for a premium substantially
greater than $1. The annual installments are then derived from
this corpus invested by or for the recipient, such that an
annuity contract provides for the liquidation of an asset. The
amount of the installments, in turn, is a function not only of
the invested contribution but also typically of the annuitant’s
age, gender, health, and the type of annuity contract purchased.
With respect to contract type, options available to the
purchaser, each with a consequent impact on benefit level,
include an immediate or a deferred benefit, a single or an annual
premium, a fixed or a variable payment, and a termination of
benefits on death or a guaranteed minimum number of installments.
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In addition, an annuity contract will usually provide the owner
with specific rights during the period the agreement remains in
force. The contract can generally be alienated and assigned, and
the owner can elect to name a beneficiary of the contract.
In contrast, the estate emphasizes that a LOTTO prize is the
result of a $1 wager, not a substantial invested premium. The
annual installments are derived from the income and investments
of the State, not from the corpus supplied by the purchaser. The
winner’s age, gender, or health play no role in determining the
benefit level. Additionally, the winner lacks any ability to
make choices regarding payment commencement, amount, duration, or
termination, and cannot assign the installments or elect a
beneficiary to receive installments upon the winner’s death.
Having thus attempted to demonstrate that the lottery prize
does not resemble a typical annuity valued under actuarial
tables, the estate then goes on to cite a variety of assets
yielding payment streams which, according to the estate, are
valued not under section 7520 but rather by taking into account
the unique characteristics of and restrictions on the asset. The
implicit invitation is that we determine that the installments
here are more analogous to these alternatives and that similar,
item-specific fair market principles should be used in the
prize’s valuation.
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The estate discusses notes receivable, leasehold payments,
patents, and royalties. We recount features of these assets and
their valuation as stipulated by the parties, without opining as
to the validity thereof, for purposes of framing the parties’
respective positions. A note receivable represents the promise
of the maker to pay the holder a definite sum of money. Notes
receivable, although exhibiting a wide array of discrete terms
and conditions, generally are the product of an agreement that
provides for a series of payments over a period not necessarily
determined by reference to the holder’s life. Pursuant to
section 20.2031-4, Estate Tax Regs., the fair market value of a
note is presumed to be its unpaid principal amount plus accrued
interest. However, this presumption can be refuted by evidence
that the interest rate, maturity date, collection risk, maker
solvency, collateral sufficiency, or other causes warrant a
lesser value.
A leasehold interest is the product of an agreement
providing for a lessor to receive payment for a lessee’s use of
property. Valuation of the resultant payment stream typically
relies upon an income capitalization approach to discount the
rental installments to present value. Factors considered in
calculating an appropriate capitalization rate include the nature
of the property, the positive and negative physical attributes of
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the property, the term of the lease, the market rate of rent for
similar properties, and any risk factors that could affect
receipt of payments.
A patent is an exclusive right to make, use, and sell a
patented item. As in the case of a leasehold, the payment stream
available to the holder of a patent is valued by quantifying a
variety of factors to reach an appropriate discount or
capitalization rate. Such elements include the age of the
patent, its economic and legal life, the income it generates, the
products with which the underlying item competes, the risks of
the relevant industry, and the status of the economy.
A royalty is the income received from another for the
other’s use of property, and the term is usually employed in
reference to mineral rights, copyrighted works, trademarks, and
franchise interests. The value of a right to royalty payments is
again based upon the particular characteristics and risks
associated with the payment stream, taking into account the
annual income produced, the length of the agreement’s term, the
payment history, the possibility of sales or volume reduction
with respect to the underlying asset, any pertinent governmental
and industrial restrictions, and the nature of the underlying
asset (including the quantity and quality of reserves for mineral
and oil interests).
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Thus, we have been presented, on one hand, with elements the
estate believes characterize the type of asset that should be
considered an annuity subject to valuation under prescribed
tables and, on the other hand, with features exhibited by other
assets yielding payment streams and used to derive an appropriate
fair market value apart from mere reference to actuarial tables.
The estate’s position is that the LOTTO prize involves a unique
bundle of rights and restrictions which, like those inherent in
notes, leaseholds, patents, and royalties, warrants an
individualized approach to valuation. Respondent, in contrast,
maintains that there exist no pertinent differences between the
lottery payments and other payment streams valued using the
standardized tabular approach.
Taking into account the above body of information and the
parties’ contentions with respect thereto, we conclude that
decedent’s lottery winnings constitute an annuity within the
meaning of section 7520. In reaching this decision, we first
consider the characteristics of an annuity, both as portrayed by
the estate and as reflected in case law. Second, we focus on
comparing these annuity features with those of assets which the
parties agree are valued other than as annuities. Third, we
examine how the lottery payments fit within the framework so
developed.
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1. Analysis of Annuity Characteristics
We begin with a few comments on the relevance of the
estate’s submissions regarding the characteristics of a typical
annuity. While we do not dispute that the features cited may be
widely present in commercially purchased annuity contracts, we
point out that to the extent these elements are not also
representative of so-called private annuities, they offer little
insight into the nature of interests intended to be treated under
the section 7520 tables.
Section 7520(b) states that the section shall not apply for
purposes “specified in regulations.” Section 20.7520-1, Estate
Tax Regs., directs generally that annuities be valued in
accordance with section 20.2031-7, Estate Tax Regs., and the
tables therein. However, section 20.2031-7(b), Estate Tax Regs.,
expressly excepts commercial annuities from its operation, as
follows: “The value of annuities issued by companies regularly
engaged in their sale * * * is determined under § 20.2031-8.”
Section 20.2031-8(a)(1), Estate Tax Regs., in turn provides that
the value of such contracts “is established through the sale by
that company of comparable contracts.” Since the State of
Connecticut is not in the business of selling annuity contracts,
we clarify that the attributes of a commercial annuity are
relevant here only in so far as they parallel what would be found
with respect to a private annuity.
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Although there are few cases applying section 7520 to such
private annuities, this Court in Estate of Cullison v.
Commissioner, T.C. Memo. 1998-216, affd. without published
opinion 221 F.3d 1347 (9th Cir. 2000), characterized an
arrangement as a private annuity and required its valuation under
section 7520. The agreement at issue there provided that the
decedent would convey all of her interest in certain farmland to
her grandchildren by warranty deed and that the grandchildren
would pay to her $311,165 annually for the remainder of her life.
See id. The agreement further specified that the decedent would
have no further interest in the land after the date the agreement
was signed and that the land would not be security for the
annuity payments. See id.In addressing whether any portion of the land transfer
constituted a gift, the estate argued that the annuity was
properly valued apart from the section 7520 tables, on the basis
of an interest rate supposedly reflecting that available on land
sale contracts in the area. See id. We, however, pointed out
that “Unlike a seller under a land sale contract, decedent under
the private annuity would have only an unsecured right to receive
a specified annual payment during her life.” Id. (fn. ref.
omitted). We then held that such an interest was within the
scope of section 7520. See id.- 24 -
In addition, cases decided under law preceding section
7520’s effective date offer a degree of guidance on the concept
of a private annuity for transfer tax purposes. Even prior to
the enactment of section 7520, estate and gift tax regulations
had long contained actuarial tables for use in valuing private
annuities, life estates, and terms of years. See Simpson v.
United States, 252 U.S. 547, 549 (1920); Dix v. Commissioner, 46
T.C. 796, 800 (1966), affd. 392 F.2d 313 (4th Cir. 1968); Estate
of Cullison v. Commissioner, supra; Estate of Shapiro v.
Commissioner, T.C. Memo. 1993-483. While no statute mandated
their application, courts generally approved of and often
required their use. See Dix v. Commissioner, supra at 801;
Estate of Shapiro v. Commissioner, supra.
For instance, in Dix v. Commissioner, supra at 798-801, we
concluded that the regulatory tables were to be used in valuing a
lifetime “private annuity” paid pursuant to an agreement stating
as follows:
WHEREAS, THE transferor is willing to bargain,
sell, and transfer to the transferees all the
securities so listed in Schedule ‘A’, provided however
that transferees, and each of them, will agree to pay
the transferor a sum certain annually, as hereinafter
set forth, regardless of the value of the securities so
transferred and regardless of the income therefrom
received by transferees * * *
Similarly, in Estate of Shapiro v. Commissioner, supra, the
will of the decedent’s predeceased wife had established a trust
and instructed the trustee “pay to my husband or apply for his
- 25 -
benefit an annuity of Three Hundred Thousand ($300,000.00)
Dollars per year from my date of death during his life”. We held
that the bequest was “properly characterized as a lifetime
annuity under section 20.2031-7(a)(2), Estate Tax Regs.”, and
properly valued by the tables prescribed thereunder. Id.
Given such cases, we are satisfied that the definition of
annuity for purposes of section 7520 is broader than the estate
suggests. Estate of Cullison v. Commissioner, supra, involved
neither a payment stream derived from an invested corpus nor the
liquidation of an asset. The payments in Dix v. Commissioner,
supra, were equally independent of any underlying corpus. The
bequest in Estate of Shapiro v. Commissioner, supra, bears little
resemblance to the contractual relationship described by the
estate--purchase premiums, benefit options, beneficiary
elections, etc., played no role in the annuity’s genesis or
operation.
Moreover, the authorities discussed above also make clear
that a private annuity may be nothing more or less than an
unsecured debt obligation. Consequently, the estate’s repeated
labeling of the LOTTO prize as such in no way disqualifies it
from annuity status. That said, we turn to those assets that the
parties have agreed are in fact not considered annuities for
valuation purposes.
- 26 -
2. Comparison of Nonannuity and Annuity Characteristics
In seeking to ascertain what might distinguish notes
receivable, leasehold payments, patent rights, and royalties from
the annuities previously examined, we look first at notes
receivable. Furthermore, our review thereof convinces us that
these assets differ from annuities in a fundamental respect. It
is the concept of interest which renders valuation of a note a
very different enterprise from valuation of an annuity. Because
an annuity involves a series of fixed payments which bear no
interest, it is actuarially valued by discounting the stream to
present value. The purpose of doing so is to account for the
time value of money. In contrast, because the vast majority of
notes are interest-bearing, no such calculation is required. The
issue of time value is addressed by charging interest on the face
amount, such that the outstanding principal typically corresponds
to the present value without need for further manipulation. This
idea, in turn, provides the rationale which supports the rule set
forth in section 20.2031-4, Estate Tax Regs., presuming a value
equal to the unpaid principal amount and listing the interest
rate (or, implicitly, lack of a market rate of interest) as a
potential basis for deviation. A similar approach presuming a
value equal to the “face” dollar amount of annuity installments
could not reasonably be suggested.
- 27 -
As regards leasehold, patent, and royalty payments, each of
these assets, unlike an annuity, derives from the use of an
underlying item of tangible or intangible property that exists
separate and apart from the agreement to make a series of
remittances. Consequently, the anticipated payment stream can be
affected by a wide variety of external market forces that operate
on and impact the worth of the underlying asset. This injects
into the valuation of these payment streams risks and
considerations beyond simply the time value of money.
Hence, our review of a sample of nonannuity assets leads us
to conclude that the common definition of an annuity is sound. A
promise to make a series of fixed payments, without more, may
generally be classified as an annuity. Conversely, if the
agreement is tied to something further, such as an independent
underlying asset or an interest rate, a different
characterization may well be more appropriate. With this
framework in mind, we next focus specifically on decedent’s
lottery prize.
3. Examination of Lottery Payments
Based on the principles formulated above, we conclude that
decedent’s LOTTO winnings are properly characterized for tax
purposes as an annuity. As the estate acknowledges, the asset at
issue here derives solely from the State’s promise to make a
series of fixed payments. The right to installments is not
- 28 -
dependent on any particular underlying asset, is not subject to
alteration as a result of external market forces, and does not
bear interest. Accordingly, while we see features which
distinguish the payment streams generated by each of the
nonannuity assets brought to our attention from the private
annuities reflected in case law, we find no such characteristics
weighing upon decedent’s right to the lottery installments.
Moreover, in probing what attributes might differentiate
some other form of payment from an annuity, we note a conspicuous
absence. The cases discussed above which declare certain payment
arrangements to be a private annuity never address the
contractual options available to the payee for taking advantage
of his or her right to the installments. Whether this right may
be transferred or assigned are elements which fail to enter into
the courts’ calculus. Likewise, of the stipulated factors that
apparently render note, leasehold, patent, and royalty payments
unique and individually valued, none reflects any concern with
the payee’s ability to manipulate the right to receive
installments. Additionally, because the estate so emphasizes the
concept of marketability, we observe as a parallel that the
parties provided by stipulation that notes come in a wide variety
of types including, among other things, nonassignable. Yet no
one could contend that lack of assignability converts a note into
some other form of asset. Hence, we are satisfied that such
- 29 -
issues are largely subsidiary to determining the basic
characterization, in the first instance, of a payment right.
Whether these features affect the value in a particular case of
an asset so classified is a question which we shall take up
below. At this juncture, we first hold that decedent’s lottery
winnings constitute an annuity for tax purposes and within the
meaning of section 7520.
C. Valuation of Lottery Installments Under Section 7520
Interests within the purview of section 7520 must be valued
in accordance with the prescribed actuarial tables unless they
can satisfy the requisites for an exception to the statute’s use.
As previously indicated, section 20.7520-3(a), Estate Tax Regs.,
provides a list of exceptions effective May 1, 1989, none of
which has been cited as on point here, and section 20.7520-3(b),
Estate Tax Regs., enumerates additional exceptions effective
after December 13, 1995. See sec. 20.7520-3(c), Estate Tax Regs.
While these latter limitations are not directly applicable to
1994, the preamble to T.D. 8630, 1996-1 C.B. 339, which adopted
paragraph (b) as an amendment to the final regulations under
section 7520, addressed the relationship of the new provisions to
prior law as follows:
One commentator suggested that the tables
prescribed by the regulations must be used for valuing
all interests transferred between April 30, 1989 (the
effective date of section 7520) and December 13, 1995
(the effective date of the regulations). However,
these regulations generally adopt principles
- 30 -
established in case law and published IRS positions.
* * * There is no indication that Congress intended to
supersede this well-established case law and
administrative ruling position when it enacted section
7520. Consequently, in the case of transfers prior to
the effective date of these regulations, the question
of whether a particular interest must be valued based
on the tables will be resolved based on applicable case
law and revenue rulings.
Accordingly, the estate references both case law and section
20.7520-3(b)(1)(ii), Estate Tax Regs., to establish that
decedent’s lottery winnings, even if considered an annuity under
section 7520, need not be valued by means of the prescribed
tables.
At the time section 7520 was enacted, this and other courts
had long accepted as a general rule that interests covered by
then-existing regulatory tables were to be valued thereunder
“‘unless it is shown that the result is so unrealistic and
unreasonable that either some modification in the prescribed
method should be made * * * or complete departure from the method
should be taken, and a more reasonable and realistic means of
determining value is available.’” Vernon v. Commissioner, 66
T.C. 484, 489 (1976) (quoting Weller v. Commissioner, 38 T.C.
790, 803 (1962)); see also Berzon v. Commissioner, 534 F.2d 528,
531-532 (2d Cir. 1976), affg. 63 T.C. 601 (1975); Continental
Ill. Natl. Bank & Trust Co. v. United States, 504 F.2d 586, 594
(7th Cir. 1974); Froh v. Commissioner, 100 T.C. 1, 3-4 (1993),
affd. without published opinion 46 F.3d 1141 (9th Cir. 1995);
- 31 -
Estate of Christ v. Commissioner, 54 T.C. 493, 535-537 (1970),
affd. 480 F.2d 171 (9th Cir. 1973). It was equally well
recognized that the burden of proving that this standard was met
rested on the party seeking to deviate from the tables. See Bank
of Calif. v. United States, 672 F.2d 758, 759 (9th Cir. 1982);
Vernon v. Commissioner, supra at 489; Estate of Christ v.
Commissioner, supra at 535.
In the instant case, the estate maintains that the annuity
tables yield an unrealistic and unreasonable result for the
decedent’s winnings on the grounds that “tabular valuation fails
to consider (1) the unsecured nature of the LOTTO prize
obligation, (2) the lack of a corpus from which to draw upon, and
(3) the inability to assign, sell or transfer the interest.” The
estate asserts that the nearly $925,000 difference between an
appraised value which purportedly takes these features into
account and the section 7520 value shows failure by the tables to
produce a realistic result. Respondent’s position, on the other
hand, is that case law authorizes departure from the tables only
where one or more of the “assumptions on which the tables are
based, namely probability of survival of the measuring life,
assumed rate of return, or assumed continuous availability of the
source of funds for payment of the interest” differ significantly
- 32 -
from the actual facts presented. Respondent further emphasizes
that a quantitative comparison of values obtained under different
approaches is no basis for deviation.
As a preliminary matter in our assessment of the parties’
contentions, we reiterate a point made earlier. Precedent and
logic clearly establish that a private annuity, for purposes of
the tables, may be both unsecured and independent of any
particular corpus. See Dix v. Commissioner, 46 T.C. 796, 798,
800-801 (1966); Estate of Cullison v. Commissioner, T.C. Memo.
1998-216. Hence, our analysis here will focus on whether the
third of the estate’s alleged reasons for departure from the
tables, the lack of marketability, supports such a deviation.
A review of the cases addressing attempts to avoid use of
the tables reveals that those permitting departure have almost
invariably, with an exception to be discussed below, required a
factual showing that renders unrealistic and unreasonable the
return or mortality assumptions underlying the tables. In
general, it has been recognized that expert actuarial testimony
establishing the Commissioner’s tables to be old or outmoded may
be cause for deviation. See Estate of Christ v. Commissioner,
480 F.2d 171, 174 (9th Cir. 1973), affg. 54 T.C. 493 (1970);
Dunigan v. United States, 434 F.2d 892, 895-896 (5th Cir. 1970);
Estate of Cullison v. Commissioner, supra. As specifically
regards return, rights to income from assets shown to be
- 33 -
nonincome producing, see Maryland Natl. Bank v. United States,
609 F.2d 1078, 1081 (4th Cir. 1979); Berzon v. Commissioner,
supra at 531-532; Stark v. United States, 477 F.2d 131, 132-133
(8th Cir. 1973), or to be subject to depletion prior to
expiration of the term interest, see Froh v. Commissioner, supra
at 5, have been held properly valued apart from the tables. In
contrast, where known facts failed to establish a basis for
concluding that a previous average rate of return would remain
constant into the future, even a marked difference between past
experience and the prescribed rate has not justified an alternate
methodology. See Vernon v. Commissioner, supra at 490; Estate of
Christ v. Commissioner, 54 T.C. at 537-542. With respect to
mortality, a known fatal condition leading to imminent death has
been ruled to make use of actuarial tables unreasonable. See
Estate of Butler v. Commissioner, 18 T.C. 914, 919-920 (1952);
Estate of Jennings v. Commissioner, 10 T.C. 323, 327-328 (1948);
cf. Bank of Calif. v. United States, supra at 760; Continental
Ill. Natl. Bank & Trust Co. v. United States, supra at 593-594.
At the same time, the courts repeatedly have emphasized the
limited nature of these exceptions and the important role played
by the actuarial tables. See Bank of Calif. v. United States,
supra at 760; Continental Ill. Natl. Bank & Trust Co. v. United
States, supra at 593-594. In the words of the Court of Appeals
for the Ninth Circuit: “actuarial tables provide a needed degree
- 34 -
of certainty and administrative convenience in ascertaining
property values and prove accurate when applied in large numbers
of cases, although discrepancies inevitably arise in individual
cases.” Bank of Calif. v. United States, supra at 760. There is
also, in these cases specifically dealing with the standard for
departure, once again a salient absence of any consideration
regarding what rights the payee may have had to liquidate or
dispose of his or her interest. In fact, the income right at
issue in Estate of Christ v. Commissioner, 54 T.C. at 499, 542,
which was held subject to valuation under the tables of section
20.2031-7, Estate Tax Regs., was expressly made nonassignable.
The trust instrument provided:
The beneficiaries of this trust are hereby
restrained from selling, transferring, anticipating,
assigning, hypothecating or otherwise disposing of
their respective interests in the corpus of the said
trust, or any part thereof, and of their respective
interests in the income to be derived and to accrue
therefrom, or any part thereof, at any time before the
said corpus or the said income shall come into their
possession under the terms of said trust * * * [Id. at
499.]
Yet no deviation was permitted. See id. at 537, 542.
Moreover, it is noteworthy that other forms of annuity which
lack liquidity are expressly required by statutes and regulations
to be valued under the Commissioner’s prescribed tables. For
instance, in the context of a grantor-retained annuity trust,
section 2702(a)(2)(B) mandates valuation of a qualified retained
annuity interest under section 7520. Nonetheless, in order to
- 35 -
create such a qualified interest, the trust instrument must
prohibit both (1) distributions from the trust to or for the
benefit of any person other than the annuitant during the term of
the interest and (2) commutation (prepayment) of the annuity
interest. See sec. 25.2702-3(d)(2), (4), Gift Tax Regs.
Similarly, the present value of the annuity portion of a
charitable remainder annuity trust is computed under section
20.2031-7(d), Estate Tax Regs., notwithstanding that the trust
may not be altered to provide for payment to or for the benefit
of any noncharitable beneficiary other than the person or persons
named in the governing instrument. See sec. 1.664-2(a)(1)(i),
(a)(4), (c), Income Tax Regs. Hence, we find statutory and
regulatory support for the premise that lack of liquidity or
marketability is not taken into account in determining whether
tabular valuation is appropriate.
Given the foregoing precedent, we are convinced that there
exists no authority for the anomalous position taken by the U.S.
District Court for the Eastern District of California in Estate
of Shackleford v. United States, 84 AFTR 2d 99-5902, 99-2 USTC
par. 60,356 (E.D. Cal. 1999). Estate of Shackleford v. United
States, supra, involved facts nearly identical to those now
before this Court. Mr. Shackleford won a California lottery
prize to be paid in 20 nonassignable annual installments and then
died after receiving only three payments. See id. at 99-5902 to
- 36 -
99-5903. On the issue of valuing these payments for estate tax
purposes, the District Court accepted with little explanation
that the prize was an annuity within the purview of section 7520.
See id. at 99-5905 to 99-5906. However, the court concluded that
departure from the actuarial tables was warranted because failure
“to take into account the absolute lack of liquidity of the
prize” rendered tabular valuation unreasonable. Id. at 99-5906.
We cannot agree with the District Court for several reasons.
First, as indicated above, case law offers no support for
considering marketability in valuing annuities. (The only other
case cited by the estate for this proposition, Bamberg, Executor
under the Will of McGrath v. Commissioner of Revenue, No. 132709,
1985 WL 15773 (Mass. App. Tax. Bd. Sept. 20, 1985), is a State
tax case that affords no cogent analysis of the issue for Federal
tax purposes.)
Second, the enactment of a statutory mandate in section 7520
reflects a strong policy in favor of standardized actuarial
valuation of these interests which would be largely vitiated by
the estate’s advocated approach. A necessity to probe in each
instance the nuances of a payee’s contractual rights, when those
rights neither alter or jeopardize the essential entitlement to a
stream of fixed payments, would unjustifiably weaken the law.
- 37 -
Third, as a practical matter, we observe that an annuity,
the value of which consists solely in a promised stream of fixed
payments, is distinct in nature from those interests to which a
marketability discount is typically applied. As the estate
acknowledges, discounts for lack of marketability are most
prevalent in valuation of closely held stock or fractional
interests in property. Such is appropriate in that capital
appreciation, which can usually be accessed only through
disposition, is a significant component of value. The value of
an annuity, in contrast, exists solely in the anticipated
payments, and inability to prematurely liquidate those
installments does not lessen the value of an enforceable right to
$X annually for X number of years.
In connection with the foregoing, we further note that any
attempted comparison to the “small market of those willing to
purchase unassignable lottery winnings”, which the parties
stipulated to exist, would be inapposite. Decedent died owning
an enforceable right to a series of payments. Yet any purchaser
buys only an unenforceable right and so is necessarily valuing a
different species of interest. What a LOTTO prize might be worth
to such a speculator hardly reflects its value in the hands of a
legitimate owner. Hence, because there is no market for the
precise interest held by decedent, the need for a standardized
approach becomes even more apparent.
- 38 -
Lastly, we comment that section 20.7520-3(b)(1)(ii), Estate
Tax Regs., cited by the estate, does not cause us to reach a
different conclusion. Section 20.7520-3(b)(1)(ii), Estate Tax
Regs., deals with an exception to section 7520 for certain
restricted beneficial interests and states:
A restricted beneficial interest is an annuity, income,
remainder, or reversionary interest that is subject to
any contingency, power, or other restriction, whether
the restriction is provided for by the terms of the
trust, will, or other governing instrument or is caused
by other circumstances. In general, a standard section
7520 annuity, income, or remainder factor may not be
used to value a restricted beneficial interest. * * *
The regulation then goes on to cite two examples where its
provisions would be applicable, one of which involves a power to
invade corpus that could diminish the income interest to be
valued and the other of which addresses an annuity payment
measured by the life of one with a terminal illness. See id.;
sec. 20.7520-3(b)(2)(v), Example (4), Estate Tax Regs.; sec.
20.7520-3(b)(4), Example (1), Estate Tax Regs.
In light of the examples given and the previously quoted
preamble of T.D. 8630, 1996-1 C.B. 339, we are satisfied that the
intent of this provision was to formalize the existing case law
regarding the validity of the tabular assumptions in situations
where facts show a clear risk that the payee will not receive the
anticipated return. Thus, a restriction within the meaning of
the regulation is one which jeopardizes receipt of the payment
stream, not one which merely impacts on the ability of the payee
- 39 -
to dispose of his or her right thereto. We cannot realistically
accede to the view that an agreement for fixed payments backed by
the full faith and credit of a State government raises any such
concerns. Accordingly, even if applicable, this regulation would
not aid the estate.
We therefore hold that lottery payment installments at issue
here must be valued through application of the actuarial tables
prescribed under section 7520. Additional arguments by the
parties, to the extent not specifically addressed herein, have
been carefully considered but found unconvincing, irrelevant, or
moot.
To reflect the foregoing, and to take into account any
further allowable deduction under section 2053,
Decision will be entered
under Rule 155.