Negron v. United States: the Sixth Circuit Improperly Applied the Eighth Circuit's Unreasonable and Unrealistic Results Exception Resulting in Its Conclusion That the Irs Annuity Tables Must Be Used to Value an Annuity With a Marketability Restriction

• Publication year: 2022

43 Creighton L. Rev. 945. NEGRON V. UNITED STATES: THE SIXTH CIRCUIT IMPROPERLY APPLIED THE EIGHTH CIRCUIT'S UNREASONABLE AND UNREALISTIC RESULTS EXCEPTION RESULTING IN ITS CONCLUSION THAT THE IRS ANNUITY TABLES MUST BE USED TO VALUE AN ANNUITY WITH A MARKETABILITY RESTRICTION

NEGRON V. UNITED STATES: THE SIXTH CIRCUIT IMPROPERLY APPLIED THE EIGHTH CIRCUIT'S UNREASONABLE AND UNREALISTIC RESULTS EXCEPTION RESULTING IN ITS CONCLUSION THAT THE IRS ANNUITY TABLES MUST BE USED TO VALUE AN ANNUITY WITH A MARKETABILITY RESTRICTION

Michael Schmidt

I. INTRODUCTION

In Negron v. United States,(fn1) the United States Court of Appeals for the Sixth Circuit added its opinion to the federal circuit court split on the proper method to determine the value of a stream of future lottery payments for estate tax purposes.(fn2) Every federal circuit court that has considered the issue has used the same test to determine whether deviating from the standardized Internal Revenue Service's ("IRS") annuity tables is warranted.(fn3) The federal circuit courts use IRS annuity tables to value an annuity unless the proponent of departure can prove two things.(fn4) First, the proponent must prove that the IRS annuity tables produced an unreasonable and unrealistic result.(fn5)Second, the proponent must prove that a more realistic and reasonable valuation method was available.(fn6) The federal circuit courts are split, however, regarding how to value future lottery payments when a marketability restriction applies to those future payments.(fn7) The United States Court of Appeals for the Second and Ninth Circuits have held that the IRS annuity tables produced an unrealistic result.(fn8)The Second and Ninth Circuits reasoned that those tables do not take into account marketability restrictions because a marketability restriction placed upon the right to receive future lottery payments reduced the lottery payments' fair market value.(fn9) On the other side of the federal circuit court split, the United States Court of Appeals for the Fifth Circuit has concluded that the IRS annuity tables do not produce unreasonable and unrealistic results when valuing future lottery payments with marketability restrictions.(fn10) The Fifth Circuit reasoned that the IRS annuity tables assume the non-marketability of an annuity and so a marketability factor is not needed to value a fixed income stream.(fn11)

In Negron v. United States, (fn12) the Sixth Circuit agreed with the Fifth Circuit and found that the IRS annuity tables were used properly for estate tax purposes to value the future lottery payments.(fn13) In Negron, Carol Negron ("Negron"), on behalf of the estates of Mildred Lopatkovich and Mary Susteric (collectively the "Estates"), brought suit against the IRS after the IRS assessed an additional tax on each estate and then denied the Estates' refund claims.(fn14) The IRS argued that it properly used its tables to value the Estates' annuities, while Negron argued that the IRS annuity tables did not take into account the marketability restrictions on the payments, which resulted in excessive valuation.(fn15) The United States District Court for the Northern District of Ohio agreed with Negron, and found that the IRS annuity tables produced an unreasonable and unrealistic result.(fn16)

On appeal, the Sixth Circuit reviewed the reasoning on both sides of the federal circuit court split as to whether the IRS annuity tables produced an unreasonable and unrealistic result when valuing the Estates' future lottery payments.(fn17) Agreeing with the Fifth Circuit, the Sixth Circuit analyzed the unreasonable and unrealistic results exception to when the IRS annuity tables can be used and determined that the IRS properly used its tables to value the Estates' future lottery payments.(fn18) The Sixth Circuit reasoned that the IRS annuity tables assume non-marketability, and thus a marketability factor is not needed to value a guaranteed stream of income.(fn19) The Sixth Circuit also determined that the district court did not err when it failed to address the codified restricted beneficial interest exception to the use of the IRS annuity tables to value the Estates' future lottery payments because Negron did not argue that the exception applied.(fn20)

This Note will first review the facts and holding of Negron and the rationale the Sixth Circuit utilized to reach its conclusion that the IRS annuity tables did not produce an unreasonable and unrealistic result in valuing the Estates' future lottery payments.(fn21) This Note will then provide a summary of the relevant sections of the United States Code and Treasury Regulations.(fn22) Next, this Note will discuss the United States Court of Appeals for the Eighth Circuit, Fifth Circuit, Second Circuit, and Ninth Circuit decisions that addressed the exception to the use of the IRS annuity tables and the federal circuit court split as to whether departure from those tables is warranted when the asset to be valued is a decedent's future lottery payments with a marketability restriction.(fn23)

Next, this Note will show the Sixth Circuit erred when it found that the results produced by the IRS annuity tables in Negron were reasonable and realistic.(fn24) This Note will first establish that had the Sixth Circuit considered the issue, it would have found that the future lottery payments with marketability restrictions qualified under the codified restricted beneficial interest exception.(fn25) This Note will explain that the Sixth Circuit would have found that the lottery payments qualified as a restricted beneficial interest because (1) the IRS annuity tables do not assume non-marketability, and (2) a marketability restriction qualifies under the "other restriction" language of the relevant Treasury Regulation.(fn26) Second, this Note will demonstrate that the Sixth Circuit decided incorrectly that the IRS annuity tables produced a reasonable and realistic result when valuing the Estates' annuities and concluded erroneously that departure was unwarranted.(fn27) This Note will explain that the Sixth Circuit was incorrect for three reasons: (1) it found incorrectly that the facts of the case did not undermine the assumptions underlying the IRS annuity tables; (2) it found incorrectly that the marketability restriction did not affect the relevant value of the Estates' annuities because the relevant value is the ultimate value of the annuity and the marketability restriction affected the annuities' ultimate fair market value; and (3) had it reached the issue, the Sixth Circuit would have found that a more reasonable and realistic valuation method was available.(fn28) Thus, this Note will conclude the Sixth Circuit erred in Negron when it found that departure from the IRS annuity tables was unwarranted because those tables produced an unreasonable and unrealistic value for the Estates' future lottery payments.(fn29)

II. FACTS AND HOLDING

In 1991, Mildred Lopatkovich ("Lopatkovich"), Mary Susteric ("Susteric"), and another unidentified individual, collectively won the Ohio Super Lotto jackpot of $20 million.(fn30) The Ohio Lottery Commission ("Commission") was to pay each winner a total of $6,666,666.67 by way of twenty-six annual payments of $256,410.26.(fn31) The payments could not be used as collateral or assigned.(fn32) Lopatkovich and Susteric each received their first annual installment payment around January 19, 1991.(fn33) In 2001, both Lopatkovich and Susteric died after receiving only nine lottery payments.(fn34) The Lorain County Probate Court designated Carol Negron ("Negron") executrix for the estates of both Lopatkovich and Susteric (collectively the "Estates").(fn35)

In August 2002, Lopatkovich's estate filed a federal estate tax return, which reported a tax due of $772,172.00.(fn36) Lopatkovich's estate assessed the remaining lottery payments at $2,275,867.00 on the estate tax return.(fn37) At that time, the Ohio Lottery Regulations permitted Lopatkovich's estate an option to select a lump sum distribution of $1,547,045.00, the net amount after Ohio and federal income tax withholdings.(fn38) The Commission used a nine percent discount rate to compute the amount of the distribution.(fn39) Lopatkovich's estate used the gross sum established by the Commission to conclude that the value of the lottery annuity was $2,275,867.00 and therefore paid $772,172.00 in federal estate taxes.(fn40) After auditing Lopatkovich's estate tax return, the Internal Revenue Service ("IRS") valued the remaining payments at $2,775,209.00 using Internal Revenue Code ("Code") section 7520(fn41) and the IRS annuity tables in that section.(fn42) The IRS annuity tables used a five percent discount rate.(fn43) The audit and changes made by the IRS increased Lopatkovich's estate's tax liability by $330,302.00.(fn44) Lopatkovich's estate paid the additional tax, including an increase of $36,995.00 in estate tax, for a total tax increase of $367,297.00.(fn45)

In July 2002, Susteric's estate filed a federal estate tax return, paying $949,872.00 in federal estate taxes on Susteric's future lottery payments.(fn46) The Ohio Lottery Regulations also permitted Susteric's estate the option to elect a lump sum distribution of $1,547,045.00, which the Commission derived from the remaining payments.(fn47) The Commission again used a nine percent discount rate to compute the distribution.(fn48) Susteric's estate used the gross sum of...