Opinion ID: 33212
Heading Depth: 2
Heading Rank: 3

Heading: Valuation of the lottery prize

Text: 13 The Internal Revenue Code taxes the transfer of the taxable estate, 26 U.S.C. § 2001(a), defined as the value of the gross estate less applicable deductions, 26 U.S.C. § 2051. The gross estate comprises all property, real or personal, tangible or intangible. 26 U.S.C. § 2031(a). 26 U.S.C. § 2033 requires inclusion in the gross estate of all property to the extent of the decedent's interest. 14 Treasury Regulations § 20.2031-1(b) governs valuation generally, providing that the value of every item of property includible in a decedent's gross estate under sections 2031 through 2044 is its fair market value at the time of decedent's death. Fair market value is defined as 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 sell and both having reasonable knowledge of relevant facts.... Id. 15 In the case of a private annuity, fair market value is determined not under the general willing-buyer-willing-seller test, but under the method prescribed by 26 U.S.C. § 7520 and the accompanying regulations. In general, the value of a private annuity is determined by a factor composed of an interest rate component and a mortality component. When the annuity is for a term of years rather than an interest for life, the mortality component is equal to the term of years. The interest rate component is determined using a rounded interest rate equal to 120 percent of the Federal midterm rate in effect for the month in which the valuation date falls. 26 U.S.C. § 7520; Treas. Reg. § 20.7520-1(b). 16 Thus, for the property interests subject to § 7520 and the accompanying regulations, the sometimes wide variation produced by experts' fair market valuation methods gives way to certainty provided by the valuation tables. In enacting § 7520(a)(1) and requiring valuation by the tables, Congress displayed a preference for convenience and certainty over accuracy in the individual case. Bank of California v. United States, 672 F.2d 758, 760 (9th Cir.1982); Continental Ill. Nat. Bank & Trust Co. v. U.S., 504 F.2d 586 (7th Cir.1974). These cases recognize that, in the aggregate, error costs will be small. The applicability of the annuity tables is not, however, unassailable. They must be used to value annuities `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.' O'Reilly v. Commissioner, 973 F.2d 1403, 1407 (8th Cir.1992)(quoting Weller v. Commissioner, 38 T.C. 790, 803, 1962 WL 1155 (1962)). The party challenging applicability of the tables has the substantial burden of demonstrating that the tables produce an unreasonable result. Id. at 1409. 17 Recently, the Ninth and Second Circuits have, surprisingly enough, dealt with cases in which facts very similar to those before us have arisen. Gribauskas, 342 F.3d 85, 2003 WL 22006241; Shackleford v. United States, 262 F.3d 1028 (9th Cir.2001). In previous cases, courts departed from valuation tables only when individual cases involved facts substantially at variance with factual assumptions underlying the tables. See, e.g., Berzon v. Commissioner, 534 F.2d 528, 532 (2d Cir.1976)(departure appropriate when income from an investment could be predicted to be zero but actuarial tables assumed a yield of 3.5%); O'Reilly, 973 F.2d at 1406 (very low dividends were historically paid, but tables assumed a substantially higher yield); Froh v. Commissioner, 100 T.C. 1, 5, 1993 WL 1869 (1993) (income stream was expected to be exhausted before expiration of the income term); Estate of Jennings v. Commissioner, 10 T.C. 323, 327, 1948 WL 147 (1948) (decedent's husband, a beneficiary for life, was not expected to live longer than a year from decedent's death); Hanley v. United States, 105 Ct.Cl. 638, 63 F.Supp. 73, 81-82 (1945)(actual interest rate was 3%, but tables assumed rate of 4%). 18 Now, however, the Second and Ninth Circuits have recognized limits to the policy of standardization and a concurrent breadth in the exception to applicability of actuarial tables. Gribauskas at , ; Shackleford at 1033. Both circuits held that marketability must be considered in valuing the enforceable right to receive a series of cash payments. 19
20 The Estate argues that the lottery prize is not a private annuity, and therefore it is not susceptible to valuation under the tables. The Tax Court relied on its previous decision in Gribauskas v. Commissioner, 116 T.C. 142, 2001 WL 227025 (2001), rev'd on other grounds, Gribauskas v. Commissioner, 342 F.3d 85, 2003 WL 22006241 (2nd Cir.2003), which addressed at length the same arguments presented by the Estate in this case, in holding that the lottery prize is a private annuity. Section 7520 does not define annuity, but we find the reasoning of the Tax Court in Gribauskas on this issue persuasive: a lottery prize is within the customary meaning of the term annuity, which is `An obligation to pay a stated sum, usually monthly or annually, to a stated recipient.' Id. (quoting Black's Law Dictionary). Gribauskas considered the characteristics of a non-transferrable lottery prize payable in yearly installments against those of notes receivable, leaseholds, patents, and royalty payments, none of which are valued under actuarial tables and all of which share some characteristics with the lottery prize. The court distinguished the non-annuity assets, however, as having value dependent on market forces that affect the value of the underlying asset or the likelihood of continued payments. In contrast, a private annuity may be defined broadly, as the right to a series of fixed payments independent of market forces. The lottery prize, an unsecured right to a series of fixed payments for a certain term with virtually no risk of default, falls within the definition of a private annuity, valuable under the § 7520 tables. 21
22 The Estate holds out the three results from valuation experts against the result from the tables as speaking for themselves on the question of reasonableness. The annuity-table valuation of the lottery prize exceeds the lowest expert valuation by $3,982,850, and the highest by $2,504,661. The difference in the numbers is attributable to non-marketability discounts applied by the experts to the lottery prize but not taken into account by the valuation tables. The Tax Court observed that the wide discrepancies between the three expert valuations made a compelling argument justifying use of the valuation tables, given Congress's policy of standardizing valuation. 23 The result produced by the valuation tables is not unreasonable because the factor accounting for the disparity between the expert and the table valuation, i.e., a marketability discount, is not properly applied to the lottery prize. The non-marketability of a private annuity is an assumption underlying the annuity tables. 6 For example, the value of survivor annuities payable under qualified plans (transfer of which is prohibited by ERISA); charitable remainder annuity trusts; and grantor retained annuity trusts (GRATS); which are not marketable, are determined by use of the tables. See, Treas. Reg. § 1.664-2(c); 20.2039-2(c)(1)(viii) and (c)(2). As discussed above, the cases in which courts have seen fit to depart from the valuation tables have involved facts that disproved assumptions underlying the tables. The holdings in Shackleford and Gribauskas depart from that longstanding trend based on the premise that the right to alienate is fundamental to the valuation of any property. 7 Gribauskas at ; Shackleford, 262 F.3d at 1032 (The right to transfer is `one of the most essential sticks in the bundle of rights that are commonly characterized as property.')(quoting Youpee v. Babbitt, 67 F.3d 194, 197 (9th Cir.1995), aff'd, Babbitt v. Youpee, 519 U.S. 234, 117 S.Ct. 727, 136 L.Ed.2d 696 (1997)). We agree that the right to alienate is necessary to value a capital asset; however, we think it unreasonable to apply a non-marketability discount when the asset to be valued is the right, independent of market forces, to receive a certain amount of money annually for a certain term. Youpee involved restrictions on the right to devise land, a capital asset. The remaining cases relied upon by the Ninth Circuit also involved capital assets, such as corporate stock, for which value is not readily ascertainable absent a transfer from buyer to seller. See Mailloux v. Comm'r, 320 F.2d 60, 62 (5th Cir.1963)(alienability restrictions reduce value of highly speculative stock); Bayley v. Comm'r, 624 F.2d 884, 885 (9th Cir.1980) (holding that stock transfer restrictions affect valuation); Trust Services of Am., Inc. v. United States, 885 F.2d 561, 569 (9th Cir.1989) (discount may be necessary to accurately value stock subject to resale restrictions); Estate of Jung v. Comm'r, 101 T.C. 412, 434, 1993 WL 460544 (1993) (marketability discount applied to minority shares in closely held corporations to reflect hypothetical buyer's concern that there will not be a ready market); Theophilos v. Comm'r, 85 F.3d 440 (9th Cir.1996) (lack of control discount for minority shares). 24 The Second Circuit recognized that previous cases departing from the tables involved not simply a disparity in numbers but factual assumptions in the tables that were inconsistent with the facts of an individual case. Gribauskas at . The court reasoned that the exception recognized by previous cases is broader than the Commissioner suggests, as evidenced by the standard of an unreasonable and unrealistic result. Id. While an extraordinary case whose facts are not duplicative of previous cases might justify departure, the exception is not so broad as to include a case involving a factor not necessary to determine the asset's value. We note that the Second Circuit relied in Gribauskas on the parties' stipulations that the non-marketability of the lottery prize reduced its value. Id. at  (Notably, the parties stipulated that a market for the Lotto winnings did exist at the time the return was filed [and] that the prize's market value was diminished considerably due to transfer restrictions....). In the case at bar, the parties stipulated that no market existed for the lottery prize. 25 Marketability is important to the valuation of an asset when capital appreciation is an element of value or when the value would otherwise be difficult to ascertain. Other kinds of private annuities are valued under the tables despite being non-marketable. 8 As the Tax Court stated, non-marketability does not alter or jeopardize the essential entitlement to a stream of fixed payments. The value of the lottery prize is readily ascertainable by simple aggregation of the payments to be received. The value of the prize must be discounted because it is payable over time, rather than in a lump sum; the tables account for that feature by discounting the payments to present value. We disagree with the Second and Ninth Circuits that a reasonable valuation of the lottery prize requires a discount for non-marketability. The Tax Court was correct in holding that departure from the annuity tables is not warranted for valuation of the lottery prize.