Opinion
Civil No. 01-368-KI
May 28, 2002
Michael W. Mosman, Portland, OR, Henry C. Darmstadter, Jeremy N. Hendon, Washington, D.C., Attorneys for Plaintiff.
David G. Hosenpud, John H. Gadon, Lane Powell Spears Lubersky LLP, Portland, OR, Glenn J. MacGrady, New Milford, CT, Attorneys for Defendants.
OPINION AND ORDER
Before the court is the motion for summary judgment (#14) by plaintiff United States of America and the motion for summary judgment (#23) by defendants J. Michael Maginnis and Janet Y. Maginnis. For the reasons set forth below, I grant the government's motion and deny the defendants' motion.
FACTS
In 1991, the defendants, along with their sons, were multi-million dollar winners in the Oregon State Lottery. The share held by J. Michael Maginnis ("Maginnis") totaled $9,000,000, which was payable in twenty equal annual installments of $450,000. After receiving five annual payments, Maginnis agreed in 1996 to assign his right to receive the remaining fifteen annual payments to a third-party for a lump sum payment of $3,950,000.
For the five annual payments that Maginnis received, defendants included that money as ordinary gross taxable income on their joint federal income tax returns. Likewise, on their original 1996 federal income tax return, defendants reported the $3,950,000 received for the assignment as ordinary income and paid the corresponding tax.
On or about October 30, 1998, the defendants filed an amended income tax return for 1996. In this amended return, defendants requested a refund in the amount of $305,043.00, plus interest. The principal reason given by defendants for the refund was that they had decided to reclassify the proceeds from the assignment from ordinary income to long-term capital gains. As a result of the filing of the 1996 amended return, the IRS issued to defendants a refund check in the amount of $352,517.16 (which included $47,222.16 in interest). The government now seeks to recover that amount, plus interest, and its costs and fees in bringing this lawsuit.
LEGAL STANDARD
Summary judgment is appropriate when there is no genuine issue as to any material fact and the moving party is entitled to a judgment as a matter of law. Fed.R.Civ.P. 56(c). The initial burden is on the moving party to point out the absence of any genuine issue of material fact. Once the initial burden is satisfied, the burden shifts to the opponent to demonstrate through the production of probative evidence that there remains an issue of fact to be tried. Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986). On a motion for summary judgment, the evidence is viewed in the light most favorable to the nonmoving party. Robi v. Reed, 173 F.3d 736, 739 (9th Cir.), cert. denied, 528 U.S. 375 (1999).
DISCUSSION
I. Positions of the Parties
At the outset, I note that there is only one legal question at issue in the cross motions for summary judgment, although worded somewhat differently by the parties:
Plaintiff's Version: Whether a lump-sum payment obtained in consideration of an assignment of a right to receive future state lottery payments constitutes ordinary income or capital gains for federal income tax purposes?
Defendants' Version: Whether, for federal income tax purposes, the proceeds from the sale of a Lottery Right that is completely disposed of in an arm's-length transaction after being held for more than one year constitute long-term capital gain?
According to the government, if a stream of lottery payments constitutes ordinary income, the same tax treatment should apply to the proceeds received for the assignment of the right to collect that future stream of payments. In making this argument, the government relies on the "substitution for ordinary income doctrine." Defendants characterize the government's argument as outdated and based on stale case law.
Defendants take a somewhat hyper-technical approach and argue that the "Lottery Right" held by Maginnis is a capital asset under Section 1221 of the Internal Revenue Code. They also draw an analogy between a "Lottery Right" and other assets that provide a stream of income to an investor, such as corporate bonds. The point of this analogy is to show that a "Lottery Right" is really no different than other types of financial assets that produce capital gain upon complete sale.
In making their arguments, defendants provide a lengthy discussion of "Lottery Rights as Routinely Traded Financial Instruments in Capital Marketplaces" (see pp. 3-16 of Memorandum in Support of Defendants' Motion for Summary Judgment). Much of this discussion is based on the opinions of expert witnesses. The government objects to such material as irrelevant and also cries foul at being caught off guard that defendants would be using expert testimony at this stage of the litigation. The government requests that, if I desire to rely on such expert opinions, I allow a continuance, under Fed.R.Civ.P. 56(f), so that it can conduct expert witness discovery. Because I do not rely on the expert testimony I offered by defendants, there is no need for such discovery or a continuance.
The government asks that I reject the arguments presented by defendants, in part because defendants took a contrary position in a proceeding before the Oregon Tax Court (i.e., before that court, defendants argued that the character of Maginnis' lottery prize income did not change by reason of the assignment). The government points out that, in the state proceeding, the defendants relied heavily on the same case law that defendants now characterize as old and irrelevant.
II. Analysis
From what I can determine, this is a case of first impression, although other district courts are also currently grappling with the issue presented. Because this debate can only be truly settled by a federal appellate court, I do not belabor the issue and, instead, provide a brief explanation of my reasoning for granting the government's motion and lay the foundation for an expeditious appeal of this case.
I find it telling that Maginnis' winnings would have been treated as ordinary income (gambling winnings) if he had the option to take them as one lump sum and chose that option. Just because such winnings were, in fact, initially doled out over time and then anticipatorily assigned to a third party should not, in my view, alter the essential nature of the money as gambling winnings treated as ordinary income or present a tax-planning opportunity not available to lottery winners who choose a lump sum payment up front. Stated another way, capital gains treatment is not appropriate here because no asset appreciated. Instead, an established, noncontingent right to receive future payments of ordinary income was assigned.
Based on this reasoning, and in the absence of a case directly on point and in defendants' favor, I cannot hold that the assignment converted the character of the income from ordinary income to gains from the sale of a capital asset. Furthermore, I am reluctant to adopt defendants' arguments given the apparent inconsistency between those arguments and the position espoused by defendants before the Oregon Tax Court.
CONCLUSION
The motion for summary judgment (#14) by plaintiff United States of America is GRANTED. The motion for summary judgment (#23) by defendants J. Michael Maginnis and Janet Y. Maginnis is DENIED. Plaintiff shall submit an appropriate form of judgment for entry by the court.
IT IS SO ORDERED.