                  T.C. Memo. 2006-240



                UNITED STATES TAX COURT



        ROLAND AND MARIE WOMACK, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent

   ANASTASIOS AND MARIA SPIRIDAKOS, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket Nos. 13434-03, 19829-03.    Filed November 7, 2006.



   We consider two test cases that involve the purely
legal question of whether gain from the sale of the
right to receive future annual lottery payments is
taxable as ordinary income or capital gains. This
Court and three Courts of Appeals have consistently
held that gain from such a sale is taxable as ordinary
income. R relies on established precedent, and Ps
contend, as a matter of law, that prior opinions on
this question are in error. Ps advance four categories
of legal arguments, as follows: (1) Lottery rights are
capital assets because they are denominated “accounts
receivable” under the Florida Uniform Commercial Code
and, as such, are not in the category “business
accounts receivable” so as to be excluded from the
statutory definition of capital asset under sec.
1221(a)(4), I.R.C.; (2) the substitute for ordinary
income doctrine (doctrine) has been misinterpreted by
                               - 2 -

     the courts with respect to its origins and application
     to the sale of a lottery right; (3) to the extent that
     the doctrine continues to have vitality, the Supreme
     Court’s holding in Ark. Best Corp. v. Commissioner, 485
     U.S. 212 (1988), by establishing a definitive analysis
     or test has limited the effect of the doctrine; and (4)
     a lottery right falls within the definitions of a “debt
     instrument” and a “bond” under secs. 1275 and 1286,
     I.R.C., respectively, and its sale would result in
     capital gain.

        Held: Ps have failed to show that established legal
     precedent is in error, and the gains are taxable as
     ordinary income.



     Steven M. Kwartin, for petitioners.

     Timothy Maher, for respondent.



                          MEMORANDUM OPINION


     GERBER, Judge:   These consolidated cases are part of a

larger group of cases1 all with the common legal issue of whether

gain from the sale of a right to receive future annual lottery

payments is taxable as capital gain or as ordinary income.

Respondent issued separate notices of deficiency to petitioners

in the above-captioned cases determining the following income tax

deficiencies:




     1
       There are 57 related cases in the group that were not
consolidated for trial, briefing, and opinion with the above-
captioned cases. The parties in the 57 related cases have agreed
to be bound by the outcome of these consolidated cases.
                                - 3 -


         Petitioners              Year         Deficiency

     Roland & Marie Womack        2000         $235,852

     Anastasios & Maria
                                               1
      Spiridakos                  2000          425,678
     1
       For the Spiridakoses’ 2000 tax year, respondent also
determined that because of their failure to timely pay the amount
shown as tax on the return, they were liable for an addition to
tax under sec. 6651(a)(2), but the amount was left for
computation at a later date.

     All section references are to the Internal Revenue Code,

and all Rule references are to the Tax Court Rules of Practice

and Procedure, unless otherwise indicated.


                           Background

     Roland and Marie Womack--The Womacks resided in Hilliard,

Florida, at the time their petition was filed.     On or about

January 20, 1996, Roland Womack won a portion of an $8 million

prize from the Florida State Lottery.    Consequently, he became

entitled to receive 20 annual $150,000 payments, less mandatory

Federal withholding tax, from the Florida State Lottery.     The

first payment was scheduled for January 20, 1996, and 19

subsequent installments were to be made on February 15 of each

successive year.   Mr. Womack paid $1 to purchase his lottery

ticket, which entitled him to participate in the biweekly Florida

State Lottery drawing.    The selection of the number on his

lottery ticket entitled him to a share of that drawing’s jackpot.
                                - 4 -

     Some of the money received by the Florida State Lottery is

invested in U.S. Treasury zero coupon bonds that, upon maturity,

provide the funding to pay lottery winners.    The Florida State

Lottery is both owner and beneficiary of the investments used to

fund payments to lottery winners.   The Florida State Lottery did

not offer winners the option of a lump-sum payment at the time

Mr. Womack won the lottery.   Under Florida law, Mr. Womack was

required to obtain the approval of the Circuit Court of the

Second Judicial Circuit, in and for Leon County, Florida, to

transfer his right to receive future lottery winnings.

     On or about November 10, 1999, Mr. Womack entered into an

agreement with Singer Asset Finance Co., L.L.C. (Singer), to sell

and assign all of his remaining rights to receive his 16

remaining annual lottery payments in the gross stated amount of

$2.4 million, payable in annual installments through the year

2016.   In exchange for Mr. Womack’s agreement to assign his

remaining lottery installments, Singer paid him a lump sum of

$1.328 million during the year 2000.    Mr. Womack obtained the

approval of the Florida Circuit Court in the form of a court

order dated December 5, 1999.   The Florida State Lottery

confirmed receipt of the court-approved assignment on December 9,

1999.

     The Womacks reported the first four $150,000 lottery

installment payments for 1996 through 1999 as ordinary income on
                               - 5 -

their Forms 1040, U.S. Individual Income Tax Return.   On their

Form 1040 for 2000, the Womacks reported, on Schedule D, Capital

Gains and Losses, the $1.328 million received from Singer as

long-term capital gain from the sale of a capital asset.

     Anastasios and Maria Spiridakos-–The Spiridakoses resided in

Clearwater, Florida, at the time their petition was filed.     On or

about January 6, 1990, Maria Spiridakos won a $6.24 million prize

from the Florida State Lottery.   Consequently, she became

entitled to receive 20 annual $312,000 payments, less mandatory

Federal withholding tax, from the Florida State Lottery.     The

first payment was scheduled for March 7, 1990, and 19 subsequent

installments were to be made on February 15 of each successive

year.   Mrs. Spiridakos paid $1 to purchase her lottery ticket,

which entitled her to participate in the biweekly Florida State

Lottery drawing.   The selection of the number on her lottery

ticket entitled her to a share of that drawing’s jackpot.

     The Florida State Lottery did not offer winners the option

of a lump-sum payment at the time Mrs. Spiridakos won the

lottery.   Under Florida law, Mrs. Spiridakos was required to

obtain the approval of the Circuit Court of the Second Judicial

Circuit, in and for Leon County, Florida, to transfer her right

to receive future lottery winnings.

     On or about July 28, 1999, Mrs. Spiridakos entered into an

agreement with Singer to sell and assign all of her remaining
                                - 6 -

rights to receive the 10 remaining annual lottery payments in the

gross amount of $3.12 million, payable in annual installments

through the year 2010.   In exchange for Mrs. Spiridakos’s

agreement to assign her remaining lottery installments, Singer

paid her a lump sum of $2.125 million during the year 2000.

Mrs. Spiridakos obtained the approval of the Florida Circuit

Court in the form of a court order dated September 27, 1999.

     The Spiridakoses reported the first 10 $312,000 lottery

winnings installment payments for 1990 through 1999 as ordinary

income on their Forms 1040.    On their Form 1040 for 2000, the

Spiridakoses reported $2,124,600 on Schedule D as proceeds from

the sale of a capital asset and $2,124,599 as long-term capital

gain after reduction by the $1 basis (cost of the lottery

ticket).

     The Spiridakoses filed their Form 1040 for 2000 on November

5, 2001.   They had requested and received an extension until

October 15, 2001, to file their 2000 return.    Because they failed

to timely pay the amount shown as tax on their 2000 return,

respondent determined an addition to tax under section

6651(a)(2).   The Spiridakoses filed an amended Form 1040 for 2000

on or about January 13, 2002.

                              Discussion

     These consolidated cases present a question that this and

other Federal courts have consistently decided for the
                                - 7 -

Government.   The precise question is whether gain from the sale

of the right to receive future annual lottery payments is taxable

as ordinary income or as capital gain.    It has been held that

gain from the sale of such rights is taxable as ordinary income.

The facts in the two cases under consideration are alike in every

material detail and are also indistinguishable from fact patterns

considered by this and other courts that have already decided

this question.

     Essentially, petitioners in each case won the lottery and,

for a time, reported each annual installment payment as ordinary

income.   At some point, petitioners sold the right to their

remaining installment payments and claimed that the resulting

gain was reportable as capital gain, rather than ordinary income,

as respondent contends.    Case precedent has consistently held

that the sale of the remaining installments does not convert what

would have been ordinary income payments into income taxable as

capital gain.    Petitioners contend, as a matter of law, that

precedent on this question is in error.

     Petitioners’ legal arguments fall into the following four

broad categories:    (1) Lottery rights are capital assets because

they are denominated “accounts receivable” under the Florida

Uniform Commercial Code and, as such, are not in the category

“business accounts receivable” so as to be excluded from the

statutory definition of capital asset under section 1221(a)(4);
                               - 8 -

(2) the substitute for ordinary income doctrine (doctrine) has

been misinterpreted by the courts with respect to its origins and

application to the sale of a lottery right; (3) to the extent

that the substitute for ordinary income doctrine continues to

have vitality, the Supreme Court’s holding in Ark. Best Corp. v.

Commissioner, 485 U.S. 212 (1988) (Arkansas Best), by

establishing a definitive analysis or test has limited the effect

of the doctrine so that lottery rights would not come within the

reach of the doctrine; and (4) a lottery right falls within the

definitions of a “debt instrument” and a “bond” under sections

1275 and 1286, respectively.   Consequently, the sale of a lottery

right would result in capital gain.

     Respondent points out that the premise underlying

petitioners’ contentions is that the right to receive future

lottery payments is “considered ‘property’ under certain

provisions of Federal and state law * * * [and that therefore]

the right must be considered ‘property’ for purposes of * * *

[section 1221)(a)]”; i.e., a capital asset.   Respondent contends

that petitioners’ premise “has been squarely rejected by every

Federal court which has considered the issue.”

     Petitioners recognize that they are swimming against a

rising tide of precedent.   However, they remain undaunted and

have strongly urged us to reconsider our holdings and those of
                               - 9 -

three Federal Courts of Appeals.   We proceed to consider their

arguments.

     Background/Case Development--A large part of this Court’s

analysis in prior opinions focused on whether a taxpayer’s right

to receive future annual lottery payments constitutes a capital

asset within the meaning of section 1221.   Generally, respondent

acknowledges that the definition of “capital asset” in section

12212 is broad and that the right to receive future annual

lottery payments is a property right.   Respondent, however,

relying on an established line of cases,3 contends that the

property we consider should not be treated as a capital asset or

taxed at the preferred capital gain tax rate.   Other taxpayers

have generally countered respondent’s position by contending that

the Supreme Court’s opinion in Arkansas Best in some manner

obviated or lessened the effect of the line of cases respondent

relies on.   This Court has consistently held that the Supreme

Court’s interpretation of section 1221 in Arkansas Best did not

modify the principle of the prior line of cases as applicable to


     2
       Sec. 1221 broadly defines the term “capital asset”, as
follows: “For purposes of this subtitle, the term ‘capital
asset’ means property held by the taxpayer (whether or not
connected with his trade or business), but does not include”.
None of the exceptions listed in sec. 1221 appears to be directly
relevant to the type of property we consider here.
     3
       United States v. Midland-Ross Corp., 381 U.S. 54 (1965);
Commissioner v. Gillette Motor Transp., Inc., 364 U.S. 130
(1960); Commissioner v. P.G. Lake, Inc., 356 U.S. 260 (1958);
Hort v. Commissioner, 313 U.S. 28 (1941).
                               - 10 -

the question of whether the sale of the right to receive future

annual lottery payments is entitled to capital gain treatment.4

     Three Federal Courts of Appeals have also held that

taxpayers are not entitled to capital gain treatment on gain from

the sale of their right to receive future annual lottery

payments.    In United States v. Maginnis, 356 F.3d 1179 (9th Cir.

2004), the Court of Appeals for the Ninth Circuit affirmed the

District Court’s holding that the sale of a right to receive

future annual lottery payments was taxable as an ordinary income

transaction.    The Court of Appeals, after acknowledging that the

section 1221 definition of “capital asset” was broad and seemed

all encompassing, held that Congress did not intend certain

property to be included in that definition.    As an example, the

court explained that an employee's right to be paid for work to

be performed in the future was not intended to be taxed as a

capital asset.    The court also explained that the broad

definition of section 1221 would permit taxpayers to treat most

assets as capital.    To avoid this, the Court of Appeals

referenced

            a series of cases that have established what
            is commonly known as the “substitute for
            ordinary income” doctrine, [where] the
            Supreme Court has narrowly construed the term


     4
       For petitioners’ 2000 tax year, the maximum capital gain
rate was 20 percent, whereas the maximum ordinary income rate was
39.6 percent. Obviously, the almost doubled rate for ordinary
income has motivated taxpayers to seek capital gain treatment.
                               - 11 -

            capital asset when taxpayers have made
            transparent attempts to transform ordinary
            income into capital gain in ways that
            undermine Congress’ reasons for
            differentially taxing capital gains. * * *

Id. at 1182.    After further discussion of the substitute for

ordinary income doctrine, the Court of Appeals held that the sale

of the right to receive future annual lottery payments was

taxable as an ordinary income transaction.

    In Lattera v. Commissioner, 437 F.3d 399 (3d Cir. 2006),

affg. T.C. Memo. 2004-216, the Court of Appeals for the Third

Circuit agreed with the result in and generally followed the

Court of Appeals for the Ninth Circuit’s rationale in United

States v. Maginnis, supra.    The Court of Appeals for the Third

Circuit also analyzed the effect of the Supreme Court’s holding

in Arkansas Best and whether the substitute for ordinary income

doctrine survived the Supreme Court’s holding.    The Court of

Appeals, to address a perceived weakness in the Maginnis

analysis, performed a several-part analysis drawn from its

understanding of the analysis performed in the line of cases that

provided the basis for the substitute for ordinary income

doctrine.    That more detailed analysis led the Court of Appeals

to the conclusion that gain from the sale of the right to receive

future annual lottery payments is taxable as ordinary income.

     The Court of Appeals for the Tenth Circuit recently affirmed

two of this Court’s decisions to like effect.    The Court of
                              - 12 -

Appeals relied on the substitute for ordinary income doctrine,

the same doctrine as had been invoked by the Courts of Appeals

for the Ninth and Third Circuits.   See Watkins v. Commissioner,

447 F.3d 1269 (10th Cir. 2006), affg. T.C. Memo. 2004-244; Wolman

v. Commissioner, 180 Fed. Appx. 830 (10th Cir. 2006), affg. T.C.

Memo. 2004-262.

     With that background, we proceed to evaluate each of

petitioners’ arguments.   Although petitioners’ arguments fall

into four general categories, we need address only three of them.

Their argument that lottery rights are “accounts receivable”

under the Florida law so as to be property rights and included in

the section 1221 definition of a capital asset need not be

addressed.   That argument is part of petitioners’ attempt to

include the rights they sold within the definition of “capital

asset”.   Petitioners go to great lengths to build a syllogism by

means of premises that State law defines lottery rights as

property and/or that such rights are assignable.   Assuming

arguendo that petitioners are correct, the application of the

doctrine obviates the need to address that question.   Although

State law may define the nature or ownership of property, Federal

law addresses the incidence of Federal tax.   See Aquilino v.

United States, 363 U.S. 509 (1960); United States v. Bess, 357

U.S. 51 (1958).   The substitute for ordinary income doctrine

caselaw, applying a substance over form approach, is
                              - 13 -

determinative of whether gains from the sale of such property

will be taxed as ordinary or capital gain income.   Petitioners

question whether the substitute for ordinary income doctrine

should apply to their circumstances.   They contend that the

doctrine is the sole legal impediment that could prevent their

right to future lottery payments from qualifying for capital gain

treatment.5

     The basic principle of the doctrine was expressed in

Commissioner v. P.G. Lake, 356 U.S. 200, 266 (1958):

     The substance of what was assigned was the right to
     receive future income. The substance of what was
     received was the present value of income which the
     recipient would otherwise obtain in the future. In
     short, consideration was paid for the right to receive
     future income, not for an increase in the value of the
     income-producing property.

Stated another way:   if a taxpayer merely transfers for

consideration the right to receive ordinary income in the future,

the right transferred will not be treated as a capital asset.

     Petitioners attempt to limit application of the doctrine to

the following four fact patterns derived from the seminal cases

and contend that none of them applies to their situation:   (1)

Carve-outs in which the taxpayer retains an interest in the

asset, citing Hort v. Commissioner, 313 U.S. 28 (1941), and



     5
       Petitioners’ argument assumes that the right to receive
future lottery installment payments does not fit within any of
the exceptions listed in sec. 1221 that would take it out of the
definition of a “capital asset”.
                              - 14 -

Commissioner v. P.G. Lake, Inc., 356 U.S. 260 (1958); (2) a

situation where no sale or exchange occurred (such as a

condemnation or taking), citing Commissioner v. Gillette Motor

Transp., Inc., 364 U.S. 130 (1960); (3) a situation where a

portion of the sale price of a debt instrument represents

original issue discount, citing United States v. Midland-Ross

Corp., 381 U.S. 54 (1965); and (4) the sale of a right to receive

payment in return for a taxpayer’s personal services (petitioners

provided no specific citation for this situation).

     Petitioners contend that their situation does not fit within

those specific situations, and therefore the doctrine does not

apply to them.   Respondent, on the other hand, contends that the

doctrine is a general principle that would apply to situations

where the property in question involved “a claim or right to

ordinary income.”   Respondent, contrary to petitioners, contends

that Arkansas Best did not obviate or limit that principle (as

espoused in the above-referenced pre-Arkansas Best Supreme Court

holdings).

     The Arkansas Best opinion is a major point of contention in

the parties’ arguments.   Petitioners contend that the Supreme

Court, in attempting to clarify the interpretation of the term

“capital asset” that had evolved from the holding in Corn Prods.

Refining Co. v. Commissioner, 350 U.S. 46 (1955), decided that

the five categories of property excluded from capital gains
                              - 15 -

status, as set forth in section 1221, are exhaustive and not

illustrative.   Petitioners also contend that Arkansas Best

admonishes courts not to fashion additional exceptions to those

expressed in section 1221.   See Ark. Best Corp. v. Commissioner,

485 U.S. at 217.

     Both parties, to some extent, focus on the following

footnote in Arkansas Best:

     Petitioner mistakenly relies on cases in which this
     Court, in narrowly applying the general definition of
     “capital asset,” has “construed ‘capital asset’ to
     exclude property representing income items or
     accretions to the value of a capital asset themselves
     properly attributable to income,” even though these
     items are property in the broad sense of the word.
     United States v. Midland-Ross Corp., 381 U.S. 54, 57
     (1965). See, e.g., Commissioner v. Gillette Motor Co.,
     364 U.S. 130 (1960) (“capital asset” does not include
     compensation awarded taxpayer that represented fair
     rental value of its facilities); Commissioner v. P.G.
     Lake, Inc., 356 U.S. 260 (1958) (“capital asset” does
     not include proceeds from sale of oil payment rights);
     Hort v. Commissioner, 313 U.S. 28 (1941) (“capital
     asset” does not include payment to lessor for
     cancellation of unexpired portion of a lease). This
     line of cases, based on the premise that § 1221
     “property” does not include claims or rights to
     ordinary income, has no application in the present
     context. Petitioner sold capital stock, not a claim to
     ordinary income.

Id. n.5.   Petitioners construe the Supreme Court’s statements in

that note as “pure dicta” with respect to the application of the

doctrine because of the seminal holding of Arkansas Best giving

effect to the express terms of section 1221.   Respondent contends

that the footnote indicates that the Supreme Court did
                                - 16 -

not intend to limit the application of the substitute for

ordinary income doctrine by the Arkansas Best holding.

       This Court and three Courts of Appeals have consistently

held    that the substitute for ordinary income doctrine was not

obviated by the holding in Arkansas Best.    No court has attempted

to express a bright-line rule defining which property rights

might represent substitutes for ordinary income.    Each has

expressed the difficulties that exist in attempting to draw a

bright line.    Only one thing becomes clear in these analyses--the

process of defining which property or property rights fit within

the substitute for ordinary income doctrine is ad hoc and fact

specific.    Given that the doctrine has not been obviated or

limited, we see no reason to depart from the established and

uniform precedent.    We, accordingly, proceed to decide whether

the factual circumstances of the case we consider fall within the

doctrine’s embrace.

       Initially, we reject petitioners’ attempt to limit the

application of the doctrine to four general factual categories.

Neither the holding nor the rationale of the Supreme Court in

Arkansas Best changed the underlying principle of the substitute

for ordinary income doctrine.    Although the Arkansas Best holding

was intended generally to define “capital asset” in accordance

with the statute, as reflected in note 5 of the Arkansas Best

opinion, there was no intent to change or modify the holdings of
                                 - 17 -

the line of cases establishing the substitute for ordinary income

doctrine.   Accordingly, petitioners’ reliance on Arkansas Best

for a limited approach to the doctrine must fail.

     There can be no doubt that petitioners’ lottery installment

payments were ordinary income.    As those payments were received,

petitioners treated them as ordinary income on their returns

before selling the remaining right to future payments.   Under the

principle of the doctrine, the sale of the remaining right to the

ordinary income payments did not cause their conversion to a

capital asset.

     Petitioners also argue that Congress intentionally limited

the exceptions to the definition of “capital asset” in section

1221 for policy reasons.   Petitioners believe that the definition

was intended to create a dichotomy between business transactions

and transactions in property.    We cannot accept the incongruous

result of petitioners’ premise; i.e., that Congress intended to

allow the conversion of gambling winnings to capital gain by the

simple expedient of a sale of the right to future installments by

the lottery winner.

     Petitioners also argue that lottery rights have been labeled

or treated as property in Federal caselaw.   Petitioners cite

cases where lottery rights were treated as property for purposes

of bankruptcy, domestic relations, estate tax, gift, etc.    That,

however, does not convert ordinary income to capital gain.   The
                              - 18 -

doctrine trumps the fact that lottery rights may be considered

property for purposes other than deciding whether gain from their

sale is taxable at preferential capital gain rates.   The courts

have unanimously agreed that preferential tax rates are not

applicable to the sale of the right to future lottery payments.

     Petitioners also attempt to construe the true meaning of the

seminal cases underlying the doctrine in their endeavor to show

that the holdings of those cases were not intended to include the

type of factual situation we consider here.   In their analysis,

petitioners reach deep into the foundations of Federal tax law,

drawing upon cases, such as Lucas v. Earl, 281 U.S. 111 (1930),

and metaphorical language, such as “fruit/tree” and “horizontal

slice/vertical slice”, to make their point that the right to

lottery payments should not be snared in the substitute for

ordinary income net.   There is nothing in those opinions that

would support petitioners’ suppositions.   In the face of an

extensive body of caselaw, petitioners’ arguments are

unconvincing and without substance.

     Petitioners’ final argument is that lottery rights are

analogous or akin to debt instruments, such as State bonds.

Petitioners seek solace in the definition of a “debt instrument”

set forth in sections 1275(a)(1)(A) and 1286.   Although

petitioners may be able to show some factual similarity between a

right to future lottery payments and debt instruments, we are
                             - 19 -

unpersuaded that those statutes and definitions have any

relevance to the question we consider.    In addition, even if they

are analogous, petitioners’ intent is to show that such

definitions support their argument that lottery rights are

capital assets within the meaning of section 1221.    As we have

already observed, the substitute for ordinary income doctrine

applies to the lottery rights petitioners sold irrespective of

whether they may be comparable to the categories defined in

section 1221 as capital assets.    See also United States v.

Maginnis, 356 F.3d at 1187 n.10.

     We have considered petitioners’ remaining arguments.

Because of the extensive precedent to the contrary, there is no

need for any additional discussion in this opinion.

     To reflect the foregoing,


                                 Decisions will be entered for

                         respondent in docket No. 13434-03 and

                         under Rule 155 in docket No. 19829-03.
