Lottery payments are included in income when received.

In 1989, A, a foreign diplomat, won a New York State Lottery (NYSL) of $26 million. Under then-existing NYSL rules, A did not receive his entire winnings in 1989; rather, he received the right to approximately $1.2 million per year for 20 years. He later acquired U.S. permanent resident status, which he maintained through at least 1996.

As a cash-method taxpayer, A included the annual lottery payments in his 1989 and 1990 income. Nothing in the record indicates how A handled his annual payments for the next few years, but in 1996--the year at issue--he refused to include the annual payment in his return, claiming that the $1.2 million he received did not represent gross income. In support of his claim, A argues that he "constructively received" the entire jackpot in 1989, the year he won the lottery. In his view, the entire $26 million constituted income in 1989 when his diplomatic status insulated him from taxation (at least at the U.S. resident rate), and the IRS can no longer pursue a 1989 deficiency, because the statute of limitations has run; see Sec. 6501(a).

Rejecting A's argument, the Tax Court found constructive receipt inapplicable, because A lacked an "unqualified, vested right to receive immediate payment" in 1989; see Augustin Jombo, TC Memo 2002-273 (citing Richard A. Childs, 103 TC 634 (1994), aff'd w/o pub. op., 89 F3d 856 (11th Cir. 1996)).

Constructive Receipt

For cash-method taxpayers like A, "all items which constitute gross income are to be included for the taxable year in which actually or constructively received" (Kegs. Sec. 1.446-1(c)(1)(I)). "Gross income" includes lottery winnings; see Micheal Maginnis, 356 F3d 1179 (9th Cir. 2004) ("[l]ottery prizes are treated by the tax code as gambling winnings, which are taxed as ordinary income"). According to Regs. Sec. 1.451-2(a):

[i]ncome although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions.

Despite A's assertions that NYSL winners receive the legal fight to the total sum once lottery officials acknowledge and validate their winnings and the winners sign a certificate of term-payment, nothing in the record suggests that A could have obtained the entire $26 million other than through annual payments. Because A could not "draw upon [the entire jackpot] at any time," his control of the lottery winnings was "subject to substantial limitations and restrictions"; see Pegs. Sec. 1.451-2(a). As in the regulation's example, the NYSL credited A with the entire $26 million, but because the full amount was "not available until some future date," the "mere crediting on the books [did] not constitute receipt."

A claims that the NYSL would have permitted a sale of his rights to future payments, which demonstrates his unfettered access to the full $26 million. Even assuming that the NYSL would have allowed such a sale--a proposition for which A provides no support--the mere availability of the transaction would have left unchanged the "substantial limitations and restrictions" on his ability to "draw upon [the jackpot] at any time" (Regs. Sec. 1.451-2(a)). A's alleged ability to sell his rights in 1989 does not mean he constructively received his entire winnings in that year. As explained in Letter Ruling 200031031, a "lottery winner's power to assign his or her rights to a lottery prize does not accelerate the time in which the lottery is required to make prize payments. Accordingly, a lottery winner is not taxable on the value of an annuitized prize in the year it is won under the doctrine of constructive receipt."

Other Arguments

Given the conclusion that the annual payment was taxable in 1996, there is no need to address the parties' arguments about A's 1989 tax status as a consular employee. Also, A's physical absence from the U.S. in 1996 is irrelevant to the determination of his gross income; as he stipulated in Tax Court, he maintained status as a U.S. permanent resident during that year."[A]ll resident alien individuals are liable to the income taxes imposed by the Code whether the income is received from sources within or without the United States" according to Regs. Sec. 1.1-1(b). Further, under Sec. 7701(b)(1)(A)(I) and (b)(6), individuals qualify as resident aliens if their permanent residency status has not been revoked, regardless of their absence from or presence in the U.S. during a given year.

A also makes an alternative argument. Assuming the 1996 payment represented income in that year, he contends, the Tax Court erroneously held that his investment in the annuitized lottery payments was "at most $1." The court assumes, without deciding, that the NYSL's 1996 disbursement to A was an annuity governed by Sec. 72. However, in William Kute, 191 F3d 371 (3d Cir. 1999), the Third Circuit stated, "in general gross income includes any amount received as an annuity, but I.R.C. [section] 72(b) excludes amounts attributable to the taxpayer's investment in the contract." Thus, the Tax Court's determination that A's excludible investment was $1--the amount he paid for the winning ticket--is correct. The Tax Court's finding of a $503,105 deficiency for 1996 is affirmed.

AUGUSTIN JOMBO, DC Cir., 2/22/05