End of year constructive receipt question

As to the first question, most likely the recipient should not be treated as having constructive receipt of the check in 2006. See, e.g., Treas. Reg. sec. 1.451-2(b)(corporation
that declares dividends payable on Dec. 31, and follows usual practice of mailing dividend checks so that shareholders do not receive them until January - such dividends are not considered to have been constructively received in December). As a result, the amount should not be treated as income for 2006 or reported as such; instead, the taxpayer should put a note on the return beside the line item for reporting that income stating that the reader should see the attached statement. The attached statement should recite that the taxpayer did not receive the payment reflected in the Form 1099 filed by so-and-so and issued to the taxpayer until after the close of the taxable year, that such payment was received through the mails, was posted on DATE1 and received by taxpayer on DATE2, and that therefore, pursuant to Section 451 and Treas. Reg. Sec. 1.451-2, the taxpayer did not have actual or constructive receipt of such payment for the tax year 2006. Attach a copy of the Form 1099 to the statement, but clearly mark it as a copy to be used for informational purposes only. For 2007, the item of income is reported, and another statement is attached to the 2007 return indicating the taxpayer's position on the proper treatment of the item (as above), and including the copy of the Form 1099 received from the payor that is supposed to accompany the return. As to the second question, no. The issue of depositing the check in an ATM is a red-herring because, even if the taxpayer deposited the check in an ATM, he could get access to no more than $100 of the funds immediately. As a result, it is more likely that a court would conclude that the taxpayer did not have unfettered control over the funds, that they were not available for his use, and that therefore there was no constructive receipt. Of course, given that the taxpayer could, by depositing the check in an ATM on December 31, get access to up to $100 of the funds immediately, the technically persnickety answer is, the taxpayer has constructive receipt of $100 of the payment on December 31, 2006, and does not have actual or constructive receipt of the remainder until 2007. However, if you just stay home and enjoy the holidays, I rather doubt if the IRS is going to audit you or assess deficiencies against you if you just report the entire amount as received for 2007. << ======================================================= >> << The foregoing was not intended or written to be used, >> << nor can it used, for the purpose of avoiding penalties >> << that may be imposed upon the taxpayer. >> << >> << The Charter and the Guidelines for submitting posts >> << to this newsgroup as well as our anti-spamming policy >> << are at www.asktax.org. >> << Copyright (2006) - All rights reserved. >> << ======================================================= >>
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What we need is a definition of constructive receipt! That can be found Treas. Reg. (26 C.F.R.) 1.451-2(a).
"Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions."
A check not received until after midnight on the first day of the New Year is not constructively received in the prior tax year because it is NOT "made available so that he may draw upon it at any time".
I am going to concede a point to Ed Zollars on lottery winnings. A jackpot prize winner who has six months to claim the winners and times it into the next tax year on the claim that they couldn't find the ticket is SOL.
Dick
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But if I'm holding a winning ticket, I _can't_ "draw upon it at any time". At best, I can draw upon it at any time that the Lottery Office is open.
(What happens if someone has a winning ticket and doesn't cash it, and it expires? Is he still on the hook for income tax on the money he now can't get?)
Seth
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snipped-for-privacy@panix.com (Seth Breidbart) wrote:

It's like a check - it's considered money even when the banks are closed. In theory you could find someone to buy it at any time, so it has value.

Probably. If he voluntarily put it out of his ability to receive the money, it will probably be treated as constructively received. He may get an offsetting deduction if it goes back to a governmental entity. Reminds me of a case several years ago when the IRS had a large underpayment case but let the statute of limitations lapse. So not wanting to screw it up completely, the IRS charged him with constructive receipt of the taxes he should have paid in the year the statute lapsed. And the Service was upheld in court!
Stu
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Ability to sell is irrelevant; I have a book that I paid $20 for which is now worth about $200. In theory I could find someone to buy it at any time, but there's no tax due until I actually sell it.
What about this year's last drawing on Saturday night, December 30? The winner can't get paid until January 2nd.
(Or a special lottery drawn on December 31, with the same issue, and the drawing at 11 PM.)
Seth
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snipped-for-privacy@panix.com (Seth Breidbart) wrote:

There's a big difference in the treatment of capital assets as opposed to cash equivalents. As I have said elsewhere I don't know how the lottery people treat this - they may well not treat it as constructively received when the drawing is done. But they could and it wouldn't be legally inconsistent.

You're making a distinction that courts don't like to draw. They prefer when possible (though don't always make) clear rules that are easy to follow, as opposed to those that rely on fine factual distinctions. Stu
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Seth Breidbart wrote:

And what of a mid to late December winner who, before cashing the ticket, must find and consult with a financial adviser/lawyer, draw up a family trust or other such documentation and travel to the state capital (Florida) to cash it -- but cannot accomplish all of the above until early January? Which raises another tax question. Say a winner sets up a trust with a bank as fiduciary to receive and distribute thirty annual payments to family members. The state of Florida withholds twenty five percent of each payment for federal income tax. How does credit for the withheld tax flow from the state through the bank to the individual recipients who will pay the income tax? << ======================================================= >> << The foregoing was not intended or written to be used, >> << nor can it used, for the purpose of avoiding penalties >> << that may be imposed upon the taxpayer. >> << >> << The Charter and the Guidelines for submitting posts >> << to this newsgroup as well as our anti-spamming policy >> << are at www.asktax.org. >> << Copyright (2006) - All rights reserved. >> << ======================================================= >>
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That raises another question in my mind. In California you can elect to take lottery winnings in 20 annual installments, or the present value as a lump sum immediately. Is that constructive receipt? Apparently it's treated as if it's not.
And if that's not constructive receipt, why would it be if actual receipt were delayed until the next calendar year?
Stu
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First, the general rule is to take the lump sum and not the annuity.
Second, the trust should be set-up to disburse the funds needed to pay the taxes.
Dick
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Dick Adams wrote:

Respectfully disagree. The lump sum payment is about half the total winning amount. For example, a $30 million win would yield about a $!5 million lump sum -- about $10 million after taxes. Invested at 5%, this yields $500,000 taxable dollars per annum. On the other hand, a 30 payment annuity yields $1 million taxable dollars per annum. In addition -- I'll let the experts opine -- would the annuity arrangement eliminate estate tax liability for the uncollected portions of a deceased beneficiary's payments, which are thence paid to other trust beneficiaries?

Perhaps I did not make this clear. The _state_ withholds 25% against federal taxes. The trust does not have said funds. The question is: How does the individual trust beneficiary -- whose identity is unknown to the state -- get credit for his/her portion of the withheld taxes. portion of said withheld taxes. << ======================================================= >> << The foregoing was not intended or written to be used, >> << nor can it used, for the purpose of avoiding penalties >> << that may be imposed upon the taxpayer. >> << >> << The Charter and the Guidelines for submitting posts >> << to this newsgroup as well as our anti-spamming policy >> << are at www.asktax.org. >> << Copyright (2006) - All rights reserved. >> << ======================================================= >>
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The lump sum is supposed to be the present value of the income stream - or perhaps the amount it would cost to purchase an annuity. So the numbers are roughly equivalent in terms of real value.

The estate tax would be on the present value of the future income stream.

Under IRS regulations, as I recall, nothing happens until the identity of the winner is made known (by his claiming his winnings, I assume). But at that point income recognition is retroactive to the date of the drawing. Stu
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William Brenner wrote:

(balance snipped and not responded to here)
Dick said the "general rule" is to take the money and run. Most people do. However the correct answer is "it depends." Yep.
I would do a present value analysis of lump sum versus pay outs over the time horizon in order to compare the two sums. Then I would modify it for the recipient's life expectancy, and figure in any estate tax consequences. And I'd charge my client about.... oh.... guess i'd have to figure that out, too! (grin) Holiday ChEAr$, Harlan Lunsford, EA n LA
Moderator: How could I forget to include "It depends"?
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You forgot to go to law school - that's the only thing they teach there. Stu
Moderator: I taught my students "It depends" to the point that one student tried to use it as the answer to an essay question.
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If your investment rate assumption is interest (or short term capital gains) at the now-prevailing rate (the same one as the lottery buys from a bank), then you're better off taking the annuity. If you can do better than that rate, especially if it's in long term capital gains, you're better off with a lump sum.

No; that was discussed much earlier. It's income in respect of the decedent, and subject to two levels of taxation immediately. Seth
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First, as to constructive receipt of a 20-year payout on a lottery - provided that the lottery permits the winner to elect between lump sum and 20-year payout no later than 60 days after the date of the drawing, then the option to elect the lump sum does not result in constructive receipt thereof if the winner instead elects to take the 20-year payout. See Code Section 451(h). Thus, if you take the 20-year option, you will not have to report the full amount of the winnings as income in the year you won, but only report each payment as received. Second, as to the hypothetical trust arrangement and credit for withheld federal taxes. If the trust is a simple trust (i.e., all fiduciary income must be distributed annually, and no other amounts are distributed), then each beneficiary must report his/her respective share of the trust's tax income (in proportion to the amount of fiduciary income distributed to that beneficiary). See Code Section 652. The trust gets an offsetting deduction, Code Section 651, with the result that, typically, the trust has no taxable income. However, to the extent that the fiduciary income is less than the taxable income of the trust the trust may have some residual income tax liability. The beneficiary is then permitted to claim a proportionate share of the credit for the taxes withheld by the State of Florida from out of the winnings. See Section 31. Section 3402(q) extends wage withholding to lottery winnings, so the amount would be withheld under Chapter 24, and would therefore be permitted as a credit to the "income recipient" who, in this case, would be the beneficiary to whom such income is taxable under Section 652. In the case of a complex trust (i.e., a trust that has discretion to distribute income and/or corpus) the Code sections are more complicated, but they basically get you to the same end result. If the trust itself owes income tax for a particular year, any credit that relates to the income taxed to the trust is claimed by the trust, generally speaking. << ======================================================= >> << The foregoing was not intended or written to be used, >> << nor can it used, for the purpose of avoiding penalties >> << that may be imposed upon the taxpayer. >> << >> << The Charter and the Guidelines for submitting posts >> << to this newsgroup as well as our anti-spamming policy >> << are at www.asktax.org. >> << Copyright (2006) - All rights reserved. >> << ======================================================= >>
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Dick Adams wrote:

speaking of which, I never could understand how someone who bought a ticket from just his funds, and won the million, could after the fact go to a lawyer and "arrange his affairs" (a quote!) to even out taxes among family members. I always thought that what's done is done.
Can any lawyer here explain that to me?
Santa ChEAr$, Harlan Lunsford, EA n LA
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Technically you're right. But if someone comes in and says that six people contributed to the ticket or had an enforceable agreement to share the winnings, the lottery folks can't prove it one way or another, so I suppose they don't even bother to try. Stu
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I'm not a lawyer.
Nobody knows whether or not the (hypothetical) lottery ticket in my pocket was intended, when I purchased it, as a shared asset in that I gifted 25% of it to each of my (hypothetical) children. Since its value at the time of purchase was $1, nobody cared, either. Now that I've won $umpteen million, it's time to see a lawyer to formalize the arrangement properly. Seth
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snipped-for-privacy@panix.com (Seth Breidbart) wrote:

Unfortunately the IRS has established rules about lottery winnings (I do not have a cite). These rules state that annuity lotteries are costructively received on the date of the drawing. I seriously doubt the Tax Court will agree with the IRS if someone challanged it.
I will look for the cite.
Dick
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Dick Adams < snipped-for-privacy@smart.net) wrote:

The regulations talk about this issue in 26 C.F.R. 31.3402(q)-1, saying (in an example) that there is constructive receipt when the drawing is done. But they don't discuss the issue of constructive receipt in more detail there. This regulation also answers my other question about taking a lump sum as opposed to the annuity. They want tax withheld based on the actuarial value of the annuity right away, as opposed to taxing each payment as it is made. Stu
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