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Lottery pool winners often a payday for lawyers

bizO-Hamil_James_BizO-640x255In the summers of my undergraduate years in college I worked as a janitor at a hospital. The housekeeping department convened for breaks and lunch in the hospital cafeteria.

One frequent topic of conversation was the Pennsylvania state lottery. More than half of the workers regularly purchased lottery tickets. Some won small prizes on occasion, but all were net losers.

People had their own “systems,” so there was no pooling of money. Many years later lotteries have realized the marketing benefits of megaprizes that far exceed the now-meager winnings that excited my hospital co-workers.

The era of megaprizes seems to have also spurred a growth in two areas. First, families or co-workers pooling resources to buy into a chance to win the super prize. Second, legal disputes as to who is entitled to what when the lottery partners actually win a big prize.

As I meander through life, I increasingly realize that many of life’s questions don’t have definitive answers. And yet, there are some universal truths. One such truth is this: People who might otherwise coexist in peace will, figuratively, tear one another limb from limb when a large amount of money is placed between them.

Benjamin Franklin advised us that there are only two things in life that are certain – death and taxes. The certainty of taxes means that tax practitioners get a front-row seat to many of the nastiest disputes between people, simply because such disputes have tax consequences to the combatants.

So taxes remain our topic of the day, but taxes as they relate to lottery winnings. More specifically, taxes when people fight over how lottery winnings will be split, if split at all.

The 1994 movie “It Could Happen to You” is described as a romantic comedy. A patron of a diner offers to split a lottery ticket with his waitress because he did not have funds for a tip. The next day he wins the lottery and romance and comedy results.

In 1999 a waitress at a Waffle House in Alabama received a lottery ticket as a tip. She won $10 million. Other Waffle House workers claimed they had an agreement to split any winning five ways. Neither romance nor comedy resulted.

The Waffle House dispute went to trial and later to the Alabama Supreme Court. (Imagine the excitement of being appointed to the Alabama Supreme Court being utterly destroyed by the realization that the appointment involves contract disputes between Waffle House workers).

Well, as noted above (see Franklin, Benjamin), the Waffle House dispute created a stir that also led to the U.S. Tax Court. Such legal-to-tax disputes continue.

In 2012 a worker at a Chicago bakery won $118 million in the Illinois state lottery. A group of co-workers, who named themselves the Dirty Dozen – there was a 1967 movie by this name that did not involve romance, comedy or lottery tickets – argued for a share of the winnings based on a claimed agreement.

The problem was exacerbated by almost a dozen (apparently non-dirty) other bakery workers who claimed they were in the agreement. In a show that seems uniquely American, a two-year dispute involving 23 individuals and six law firms unfolded.

If the Bible were written today, perhaps the two women in 1 Kings seeking the judgment of King Solomon would also be represented by six law firms. Our bakery dispute ended with the winnings split 18 ways, and not all the same. The court no doubt asked that a special sword be brought in to settle the dispute.

Well, all’s well that ends well. Oops. Forgot about the tax issues. Is the award taxed in 2012, when the winning numbers were selected? If so, taxed to whom?

Is it taxed in 2014, when the court entered its judgment and the lottery actually disbursed the funds?

Are the participants’ legal fees deductible? If so, where do they go on the tax return? What about the fees paid by the workers who did not get any of the winnings?

These are the questions that excite the tax practitioner. They have no clear answers. But so long as people will fight over money, we tax practitioners will get a ringside seat to the dispute.

James R. Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.

 

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