                      119 T.C. No. 1



                UNITED STATES TAX COURT



  JAMES F. DAVIS AND DOROTHY A. DAVIS, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 6389-01.               Filed July 3, 2002.



     Ps assigned to S their right to receive a portion
of each of certain future annual lottery payments in
exchange for a lump-sum payment to them by S of
$1,040,000.

     Held: S paid Ps a lump-sum amount for the right
to receive certain future ordinary income. Held,
further, Ps’ right to receive certain future annual
lottery payments does not constitute a capital asset
within the meaning of sec. 1221, I.R.C. Held, further,
the $1,040,000 that Ps received from S is ordinary
income.



Donald J. Gary, Jr., for petitioners.

Thomas J. Fernandez, for respondent.
                                 - 2 -

                                OPINION


     CHIECHI, Judge:   Respondent determined a deficiency in

petitioners’ Federal income tax (tax) for 1997 in the amount of

$210,166.

     We must determine whether the amount that petitioners

received in exchange for the assignment of their right to receive

a portion of certain future annual lottery payments is ordinary

income or capital gain.1   We hold that that amount is ordinary

income.

                            Background

     This case was submitted fully stipulated.   The facts that

have been stipulated are so found except as stated herein.

     Petitioners resided in Lake Arrowhead, California, at the

time they filed the petition.

     On July 10, 1991, petitioner James F. Davis (Mr. Davis) won

$13,580,000 in the California State Lottery’s On-Line LOTTO game

(lottery).   Pursuant to certain rules and regulations governing


     1
      Petitioners paid and claimed as basis $7,009 in legal fees
in connection with the assignment in question (assignment cost).
In the notice of deficiency (notice) issued to petitioners for
their taxable year 1997, respondent disallowed the assignment
cost as basis but determined that cost to be a miscellaneous
itemized deduction. In the petition, petitioners contested
respondent’s determination in the notice with respect to the
assignment cost. On brief, petitioners make no arguments or
contentions with respect to that cost. We conclude that peti-
tioners have abandoned contesting respondent’s determination in
the notice with respect to the assignment cost. See Rybak v.
Commissioner, 91 T.C. 524, 566 n.19 (1988).
                              - 3 -

the California State Lottery (CSL) in effect during 1991, Mr.

Davis became entitled upon winning the lottery to receive the

$13,580,000 in 20 equal annual payments of $679,000 (annual

lottery payments), less certain tax withholding.   At the time

that Mr. Davis won the lottery, CSL did not offer to any lottery

winner the option to elect to receive a single lump-sum payment

of the lottery prize.2

     On December 13, 1991, CSL sent Mr. Davis a letter which

stated, inter alia:

     This letter certifies that on July 10, 1991 you won
     $13,580,000 [sic] the California State Lottery’s On-
     Line LOTTO game. You have already received your first
     payment of $679,000, less 20% for Federal tax withhold-
     ing. In addition, you will receive nineteen (19)
     subsequent annual payments of $679,000 each, as near as
     possible to the anniversary of the day on which you won
     your prize, $13,580,000. Please maintain this letter
     for your permanent record.

     In accordance with Internal Revenue Service regula-


     2
      The parties stipulated that both petitioners won the lot-
tery. That stipulation is not accurate. On July 10, 1991, Mr.
Davis won the lottery, and sometime thereafter he assigned the
right to receive the annual lottery payments to himself and his
spouse, petitioner Dorothy A. Davis (Ms. Davis), as cotrustees of
James and Dorothy Davis Family Trust dated Feb. 6, 1990 (Davis
Family Trust). Mr. Davis and Ms. Davis took all subsequent
actions with respect to the annual lottery payments discussed
herein in their capacity as cotrustees of that trust. They
apparently have taken and continue to take the position, which
respondent does not dispute, that all income of Davis Family
Trust is includable in their income. Thus, as discussed below:
(1) Petitioners reported in their tax return for the taxable year
1997 that they received (a) the $1,040,000 payment at issue and
(b) the $514,000 annual lottery payment that they were entitled
to receive for that year, and (2) respondent determined that
petitioners have a deficiency for that year.
                              - 4 -

     tions, all payments are subject to appropriate Federal
     tax withholdings. Deductions authorized by California
     statutes, if such are appropriate, will also be made.

     Your rights under this agreement cannot be assigned,
     but all remaining rights do become a part of your
     estate. This document is not negotiable.

     On June 16, 1997, at a time when petitioners3 were entitled

to receive 14 future annual lottery payments of $679,000 (less

certain tax withholding) during the years 1997 through 2010,

petitioners and Singer Asset Finance Company, LLC (Singer),

entered into an agreement pursuant to which, in exchange for a

lump-sum payment to petitioners by Singer of $1,040,000, peti-

tioners assigned to Singer their right to receive a portion

(i.e., $165,000 less certain tax withholding) of each of 11 of

the future annual lottery payments that they were entitled to

receive during the years 1997 through 2007.   (We shall refer to

the foregoing assignment as petitioners’ assignment.)   Petition-

ers thus assigned to Singer the portions of those future annual

lottery payments at a discount of $775,000 (i.e., $1,815,000

(total of 11 future annual payments of $165,000) less $1,040,000

(total of the amount that Singer paid to petitioners)).   After

petitioners’ assignment, petitioners were entitled to receive

from CSL for each of the years 1997 through 2007 only $514,000



     3
      For convenience, and consistent with the parties’ stipula-
tions, we shall hereinafter refer to “petitioners”, and not to
“petitioners as cotrustees of Davis Family Trust”. See discus-
sion supra note 2.
                               - 5 -

(less certain tax withholding) of each of the $679,000 future

annual lottery payments (less certain tax withholding) to which

they had been entitled prior to that assignment.   After that

assignment, CSL was to pay the balance of each of those future

annual lottery payments (i.e., $165,000 (less certain tax with-

holding)) to Singer.

     At all relevant times, the laws of the State of California

precluded a lottery winner from assigning such person’s right to

receive future annual lottery payments without obtaining Califor-

nia Superior Court approval.   On or about July 22, 1997, peti-

tioners and Singer filed with the California Superior Court for

the County of Sacramento (Sacramento County Superior Court) a

joint petition “FOR AN ORDER APPROVING VOLUNTARY ASSIGNMENT OF

LOTTERY WINNINGS”.   On August 1, 1997, Sacramento County Superior

Court issued an order approving petitioners’ assignment.

     Singer issued to petitioners Form 1099-B, Proceeds From

Broker and Barter Exchange Transactions (Form 1099-B), for 1997.

That Form 1099-B showed gross proceeds from the sale of “Stocks,

bonds, etc.” in the amount of $1,040,000.

     CSL issued to petitioners Form W-2G, Certain Gambling

Winnings (Form W-2G), for 1997.   That Form W-2G showed “Gross

winnings” from “STATE LOTTERY” of $514,000 and tax withheld of

$143,920.

     On March 13, 1998, petitioners signed Form 1040, U.S.
                               - 6 -

Individual Income Tax Return, for their taxable year 1997 (peti-

tioners’ 1997 joint return).   In petitioners’ 1997 joint return,

they reported petitioners’ assignment as a sale of a capital

asset held for more than 1 year, a sale price of $1,040,000, a

cost basis of $7,009, and long-term capital gain of $1,032,991.

In that return, petitioners also reported as ordinary income the

$514,000 payment that they received in 1997 from CSL.

     In the notice that respondent issued to petitioners with

respect to their taxable year 1997, respondent determined, inter

alia, the following:

     b) It is determined that you [petitioners] received the
     amount of $1,040,000.00 from Singer Asset Finance
     Company, for the tax year ended December 31, 1997, in
     payment of assignment of rights to future lottery
     payments from the State of California. This amount is
     determined to be ordinary income because rights to
     future annual lottery payments do not meet the defini-
     tion of a capital asset according to the provisions of
     the Internal Revenue Code. Therefore, income is in-
     creased $1,040,000.00 for the year 1997.

                           Discussion

     The parties agree that an amount received as a lottery prize

constitutes ordinary income.   The parties’ dispute is over

whether the $1,040,000 that petitioners received in exchange for

petitioners’ assignment is ordinary income or capital gain.4


     4
      Our resolution of the issue presented does not depend on
who has the burden of proof in this case.

     On brief, respondent represents that an issue similar to the
one presented here is pending in certain other courts. See
                                                   (continued...)
                                 - 7 -

Resolution of that dispute depends on whether petitioners’ right

to receive future annual lottery payments constitutes a capital

asset within the meaning of section 1221.5

     Section 1221 defines the term “capital asset” as follows:

     SEC. 1221.    CAPITAL ASSET DEFINED.

          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--

               (1) stock in trade of the taxpayer or other
          property of a kind which would properly be in-
          cluded in the inventory of the taxpayer if on hand
          at the close of the taxable year, or property held
          by the taxpayer primarily for sale to customers in
          the ordinary course of his trade or business;

               (2) property, used in his trade or business,
          of a character which is subject to the allowance
          for depreciation provided in section 167, or real
          property used in his trade or business;

               (3) a copyright, a literary, musical, or
          artistic composition, a letter or memorandum, or
          similar property, held by--

                       (A) a taxpayer whose personal efforts
                  created such property,

                       (B) in the case of a letter, memorandum,
                  or similar property, a taxpayer for whom such
                  property was prepared or produced, or


     4
      (...continued)
United States v. Maginnis, No. 01-368-KI (D. Or. May 28, 2002)
(holding that the amount that the taxpayer received in exchange
for the taxpayer’s assignment to a third party of his right to
receive certain future annual lottery payments is ordinary
income).
     5
      All section references are to the Internal Revenue Code in
effect for the year at issue.
                                - 8 -

                    (C) a taxpayer in whose hands the basis
               of such property is determined, for purposes
               of determining gain from a sale or exchange,
               in whole or part by reference to the basis of
               such property in the hands of a taxpayer
               described in subparagraph (A) or (B);

               (4) accounts or notes receivable acquired in
          the ordinary course of trade or business for ser-
          vices rendered or from the sale of property de-
          scribed in paragraph (1);

               (5) a publication of the United States Gov-
          ernment (including the Congressional Record) which
          is received from the United States Government or
          any agency thereof, other than by purchase at the
          price at which it is offered for sale to the pub-
          lic, and which is held by--

                    (A) a taxpayer who so received such
               publication, or

                    (B) a taxpayer in whose hands the basis
               of such publication is determined, for pur-
               poses of determining gain from a sale or
               exchange, in whole or in part by reference to
               the basis of such publication in the hands of
               a taxpayer described in subparagraph (A).

     Petitioners6 contend that their right to receive future

annual lottery payments constitutes property held by them and

that such property meets the definition of the term “capital

asset” in section 1221.    Respondent acknowledges that petition-

ers’ right to receive future annual lottery payments is property

in the ordinary sense of the word.      However, respondent contends

that such right does not qualify as a capital asset within the

meaning of section 1221.    According to respondent, the $1,040,000


     6
      The parties agree that at all relevant times petitioners
were cash basis taxpayers.
                                - 9 -

that petitioners received from Singer constitutes ordinary income

because petitioners received that amount in exchange for their

future right to receive ordinary income.

     In support of petitioners’ position that the $1,040,000 that

they received from Singer constitutes capital gain, petitioners

rely on Ark. Best Corp. v. Commissioner, 485 U.S. 212 (1988).     In

support of respondent’s position that that amount constitutes

ordinary income, respondent relies on the principle established

in the following cases:    Hort v. Commissioner, 313 U.S. 28

(1941); Commissioner v. P.G. Lake, Inc., 356 U.S. 260 (1958);

Commissioner v. Gillette Motor Transp., Inc., 364 U.S. 130

(1960); and United States v. Midland-Ross Corp., 381 U.S. 54

(1965).

     Petitioners concede that, before the Supreme Court of the

United States (Supreme Court) decided Ark. Best Corp. v. Commis-

sioner, supra, the line of cases on which respondent relies would

have precluded characterizing petitioners’ right to receive

future annual lottery payments as a capital asset within the

meaning of section 1221.   However, according to petitioners, Ark.

Best Corp. effectively overruled that line of cases and requires

the result in the instant case that they advocate.   Respondent

disputes petitioners’ reading of Ark. Best Corp. v. Commissioner,

supra.

     We agree with respondent’s reading of Ark. Best Corp. v.
                              - 10 -

Commissioner, supra.   In fact, we have previously concluded that

Ark. Best Corp. in no way affected the viability of the principle

established in the line of cases on which respondent relies.    See

Gladden v. Commissioner, 112 T.C. 209, 221 (1999), revd. on

another issue 262 F.3d 851 (9th Cir. 2001); FNMA v. Commissioner,

100 T.C. 541, 573 n.30 (1993).7   We based that conclusion on

footnote 5 of the Supreme Court’s opinion in Ark. Best Corp.,

which states:

          Petitioner [Ark. Best Corp.] 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. Gillet-
     te Motor Co., 364 U.S. 130 (1960) (“capital asset” does
     not include compensation awarded taxpayer that repre-
     sented fair rental value of its facilities); Commis-
     sioner v. P.G. Lake, Inc., 356 U.S. 260 (1958) (“capi-
     tal 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. [Ark. Best Corp. v. Commissioner,
     supra at 217 n.5.]

     We have reviewed Hort v. Commissioner, supra; Commissioner

v. P.G. Lake, Inc., supra; Commissioner v. Gillette Motor



     7
      See also Wachner v. Commissioner, T.C. Memo. 1995-88; Clark
v. Commissioner, T.C. Memo. 1994-278.
                               - 11 -

Transp., Inc., supra; and United States v. Midland-Ross Corp.,

supra, and certain of their progeny8 on which respondent relies.

As the Supreme Court stated in Commissioner v. Gillette Motor

Transp., Inc., supra at 134:

          While a capital asset is defined in § 117(a)(1)
     [of the Internal Revenue Code of 1939] as “property
     held by the taxpayer,” it is evident that not every-
     thing which can be called property in the ordinary
     sense and which is outside the statutory exclusions
     qualifies as a capital asset. * * *

     Petitioners assigned to Singer their right to receive a

portion of certain future annual lottery payments.   In exchange

for petitioners’ assignment, petitioners received the discounted

value (i.e., $1,040,000) of certain ordinary income which they

otherwise would have received during the years 1997 through 2007.

We hold that Singer paid petitioners $1,040,000 for the right to

receive such future ordinary income, and not for an increase in

the value of income-producing property.9   We further hold that



     8
      E.g., Furrer v. Commissioner, 566 F.2d 1115 (9th Cir.
1977), affg. T.C. Memo. 1976-331; Vaaler v. United States, 454
F.2d 1120 (8th Cir. 1972); United States v. Dresser Indus., Inc.,
324 F.2d 56 (5th Cir. 1963).
     9
      It is well established that the purpose for capital-gains
treatment is

     to afford capital-gains treatment only in situations
     typically involving the realization of appreciation in
     value accrued over a substantial period of time, and
     thus to ameliorate the hardship of taxation of the
     entire gain in one year. * * * [Commissioner v.
     Gillette Motor Transp., Inc., 364 U.S. 130, 134 (1960)
     (citing Burnet v. Harmel, 287 U.S. 103, 106 (1932)).]
                             - 12 -

petitioners’ right to receive future annual lottery payments does

not constitute a capital asset within the meaning of section 1221

and that the $1,040,000 that petitioners received from Singer is

ordinary income, and not capital gain.    See United States v.

Midland-Ross Corp., 381 U.S. at 57-58; Commissioner v. Gillette

Motor Transp., Inc., 364 U.S. at 134-135; Commissioner v. P.G.

Lake, Inc., 356 U.S. at 265-267; Hort v. Commissioner, 313 U.S.

at 31.

     We have considered all of petitioners’ arguments and conten-

tions that are not discussed herein, and we find them to be

without merit and/or irrelevant.

     To reflect the foregoing,



                                      Decision will be entered for

                                 respondent.
