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Cook v. Comm'r of the Internal Revenue Serv. - 349 F.3d 850 (5th Cir. 2003)

Rule:

The tables in 26 U.S.C.S. § 7520 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. The party challenging applicability of the tables has the substantial burden of demonstrating that the tables produce an unreasonable result.

Facts:

Gladys Cook and her sister-in-law Myrtle Newby had a longstanding informal agreement under which they jointly purchased Texas lottery tickets and shared the winnings. On July 8, 1995, Cook bought a winning ticket valued at $17 million, payable in 20 annual installments. The initial payment of $ 858,648 was made July 10, 1995, and the remaining payments of $853,000 each would be made on July 15th of the next 19 years. Texas law prohibited the assignment, other than by court order, of the right to receive the lottery payments. Cook and Newby converted their informal partnership to a formal limited partnership, MG Partners, Limited ("MG Partners" or the "partnership"), and each assigned her interest in the lottery winnings to the partnership. In exchange, each received a 48% limited partnership interest and a 2% general partnership interest. Cook died November 6, 1995. The partnership's assets on that date, the valuation date for estate tax purposes, were $391,717 in cash and the right to receive 19 annual lottery payments of $853,000 each. The parties stipulated that, because of the prohibition on transfer of the lottery prize, no market for the right to lottery payments existed in Texas at the time of Cook's death. Cook's executor hired a valuation expert, Peter Phalon. Phalon valued the partnership's right to lottery payments at $4,575,000, using a discounted cash flow method and including a discount for non-marketability. He valued the estate's interest in the partnership at $1,529,749, which amount the estate included on its tax return. The Commissioner assessed a deficiency based on the value of the partnership interest. Rejecting the expert valuation relied on by the estate, the Commissioner valued the partnership's right to the lottery payments using 26 U.S.C. § 7520 and the accompanying regulations (the "annuity tables"), which govern the valuation of private annuities. The value under the annuity tables was $8,557,850, yielding a deficiency in the tax paid by the estate of $873,554. The estate petitioned the Tax Court for a redetermination of the deficiency, contending that the Commissioner erred in using the annuity tables to value the lottery prize held by the partnership. The Tax Court held that it was bound under a previous Tax Court case, Estate of Gribauskas v. Comm'r, 116 T.C. 142 (2001), to value the lottery payments using the annuity tables. Gribauskas held that a lottery prize is a private annuity that must be valued under the annuity tables. The estate appealed, asserting that the Tax Court erred in valuing the lottery prize rather than the partnership, and alternatively, in determining that the annuity tables do not assign an unreasonable value to the lottery prize.

Issue:

Did the Tax Court err in valuing the lottery prize when it used the annuity tables?

Answer:

No

Conclusion:

The United States Court of Appeals for the Fifth Circuit affirmed the judgment. It held that the lottery prize, an unsecured right to a series of fixed payments for a certain term with virtually no risk of default, fell within the definition of a private annuity, valuable under the § 7520 tables. The result produced by the valuation tables was not unreasonable because the factor accounting for the disparity between the expert and the table valuation, i.e., a marketability discount, was not properly applied to the lottery prize. The non-marketability of a private annuity was an assumption underlying the annuity tables. Non-marketability did not alter or jeopardize the essential entitlement to a stream of fixed payments. The Tax Court was correct in holding that departure from the annuity tables was not warranted for valuation of the lottery prize. The value of the partnership's assets was but one component in the valuation analysis since the parties stipulated to alternate values of the partnership interest, depending upon whether the annuity tables in § 7520 applied to the prize or did not apply. Therefore, the balance (value of partnership interest) had been agreed upon. 

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