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Lottery Winnings as Capital Gains |
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Matthew S. Levine [View as PDF]
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114 Yale L.J. 195 (2004)
Pity J. Michael Maginnis. In 1991, he had the misfortune to win $9 million in the lottery. Five years later, he sold his remaining winnings--fifteen annual payments of $450,000 each--to Woodbridge Financial Corporation for a $3.95 million lump sum. He reported this payment on his tax return as ordinary income, but he changed his mind several years later and sought a refund of some $305,000, claiming that the lottery payment was a capital gain. Strangely, the IRS agreed and refunded his money. Then the IRS had its own change of heart--again several years later--and, in 2001, sued Maginnis, claiming that the refund was erroneous. An Oregon district court agreed with the Service, the Ninth Circuit affirmed, and poor Maginnis had to return his refund.
There is little debate that this is the right result: Maginnis's attempt to convert gambling income into capital gain was a fairly transparent ploy. Nonetheless, Judge Fisher's opinion for the Ninth Circuit, which sets out a two-factor test for whether a gain is ordinary income under the "substitute for ordinary income" doctrine, is problematic. This Comment argues that an alternative approach that analyzes the transaction by which Maginnis received his lottery right may better explain and confine the use of the notoriously murky "substitute for ordinary income" doctrine.
Part I of the Comment discusses the "substitute for ordinary income" doctrine. Part II describes Maginnis's two-pronged test for applying the doctrine and points out the economic and doctrinal difficulties with that test. Part III proposes an alternate analysis that better achieves the policies of the "substitute for ordinary income" doctrine.
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