September 23, 2014

In 1999, Tonda Lynn Dickerson was a waitress at a Waffle House near Mobile, Alabama. A regular customer gave her what turned out to be a winning lottery ticket. The winnings totaled $10,015,000, with a cash payout amount of $5,075,961.71. Tonda Lynn stated that when she realized she held a winning ticket, she knew she was duty-bound to share it with her family, which had a long history of sharing. In the litigation that later ensued, this family sharing arrangement became known as the “Reece Family Agreement.”

Unsure of how to split the money, Tonda Lynn turned to her father, Bobby Reece, for advice. Mr. Reece called an attorney and had incorporation papers prepared for an S corporation to be named 9 Mill, Inc. (“9 Mill”). A meeting of the prospective family stockholders of 9 Mill was held. However, Mr. Reece himself stated that he was the one who worked out the shareholder percentages. He decided to allocate 49% to Tonda Lynn and her then husband and the rest of the shares were split equally amongst other family members.

On Friday, March 12, Tonda Lynn signed the lottery ticket claiming the lottery prize in the name of 9 Mill as president of the corporation. She also made an irreversible election to receive the lottery winnings in 30 annual installments of $354,000 each. At that time, however, the Florida Lottery Commission notified the family that a competing claim for the prize had been filed.

Tonda Lynn’s four coworkers at the Waffle House thought she was obligated to share with them because they had all agreed to split lottery winnings if any of them won. They obtained counsel before the prize was awarded and filed a claim for 80% of the proceeds. They then filed a lawsuit against Tonda Lynn.

After trial, the Circuit Court of Mobile County found that the Waffle House claimants had a valid and enforceable joint ownership agreement and that they were entitled to 80% of the proceeds.  9 Mill filed a notice of appeal with the Alabama Supreme Court which reversed the trial court. The Court concluded that, while the Waffle House claimants had presented sufficient evidence to support a finding that an oral agreement existed, the agreement was unenforceable on public policy grounds because it was “founded on gambling consideration.”

In 2007, when Tonda Lynn finally filed a gift tax return for the 1999 tax year, she reported that no taxable gift had been made. The IRS disagreed and alleged she had made a gift of $2,412,388 as a consequence of her transfer of the lottery ticket to 9 Mill. The IRS issued a notice of deficiency of $771,570.

The IRS contended that Tonda Lynn’s transfer of the lottery ticket to 9 Mill was an indirect gift to the extent that 51% of the shares of 9 Mill were, at the time the transfer of the lottery ticket took place, owned by her other family members. Tonda Lynn argued that no taxable gift occurred since, by virtue of the Reece Family Agreement, there had previously existed and remained in effect a binding and enforceable contract under Alabama State law requiring the transfer. Alternatively, the family members were all members of an existing partnership under Federal tax law which was the true owner of the lottery ticket.  If either condition was true, the transfer would not be a gift under Federal Tax law.

The Tax Court disagreed that the family agreement was an enforceable contract because it was too vague and indefinite. Further, even if valid, it was unenforceable because the issue at hand, a gambling receipt, rendered any contract void.

The Tax Court stated that a partnership is created “when persons join together their money, goods, labor, or skill for the purpose of carrying on a trade, profession, or business and when there is community of interest in the profits and losses.”  Essentially what the Reeces had was a familial sense of duty to care for each other. The Tax Court ruled that is simply not enough to find that a partnership existed.

Having decided a gift had been made, the Court then turned its attention to valuing that gift. The petitioner argued that the claim filed by the other Waffle House waitresses for 80% of the winnings would have had a hugely depressing effect on the value of the gift. The IRS argued that no discount should be applied since the gift was made prior to filing of the claim by the Waffle House employees.

At trial a legal expert opined that the (1) costs of litigation, (2) hazards of litigation, and (3) time delay in receiving funds due to the Waffle House waitresses’ claim, would cause the lottery ticket’s value to be discounted 65-80%. He further opined that, under Alabama law, family members had the ability to sue the petitioner on the basis that they jointly owned the ticket. For this reason, he believed the value of the ticket should be discounted by a total of 80-85%.

The Court reasoned that a hypothetical buyer would have investigated the potential cloud on title before purchasing the lottery ticket. In that investigation, the hypothetical buyer would have determined a lawsuit by the Waffle House employees was likely and would not have paid full value for the disputed portion of the lottery ticket.

The Court stated that the appropriate discount for 80% of the lottery ticket proceeds disputed by the Waffle House claimants was 67%. The Court did not agree, however, that any discount was appropriate based on the potentiality that the other family members might sue Tonda Lynn for a pro-rata share of the winnings.

Tonda Lynn gifted to 9 Mil 51% of the present value of the annual installments to be received from the lottery winning. That amount equaled $2,412,388. The Tax Court held that the value of the gift was $1,119,348. The effective total discount applied to the undiscounted value was about 54%.