## Facts

- Two married couples won Florida lottery prizes payable in 20 annual installments and reported each received installment as ordinary income.
- After a change in Florida law permitted assignment of lottery payment rights, each couple sold its remaining right to future installments to a finance company for a discounted lump sum.
- On their 2000 joint federal returns, the couples reported the lump-sum proceeds as long-term capital gain from the sale of a capital asset.
- The IRS issued notices of deficiency, asserting the proceeds were ordinary income because the transaction converted a future stream of ordinary income into a present lump sum.
- The U.S. Tax Court consolidated the cases and ruled for the Commissioner, holding the proceeds were ordinary income.
- The taxpayers appealed to the Eleventh Circuit.

## Issues

1. Whether lump-sum proceeds from selling rights to future state lottery installment payments are taxable as capital gain from the sale of a “capital asset” under I.R.C. § 1221.
2. Whether the substitute-for-ordinary-income doctrine requires treating the lump-sum proceeds as ordinary income.

## Decision

- The Eleventh Circuit affirmed the Tax Court.
- The court held the lump-sum proceeds were taxable as ordinary income, not capital gain.
- The court concluded the rights sold were not “capital assets” within the meaning of I.R.C. § 1221 because they represented only a right to receive future ordinary income.
- The court applied the substitute-for-ordinary-income doctrine, characterizing the lump sum as an acceleration of ordinary income rather than gain from appreciation of an investment asset.

## Legal Principles

- Capital-gain treatment under I.R.C. § 1221 is limited and does not apply when the sold property is merely a right to receive future ordinary income.
- Under the substitute-for-ordinary-income doctrine, a lump-sum payment received in exchange for the right to future ordinary-income payments is taxed as ordinary income.
- A taxpayer generally may not convert ordinary income into capital gain by assigning or selling an income stream for a present payment.
- Discounting future payments to present value reflects time value and risk, not appreciation of a capital investment, and does not transform the proceeds into capital gain.

## Conclusion

The Eleventh Circuit held that selling rights to future lottery installments for a discounted lump sum produces ordinary income because the transaction substitutes a present payment for future ordinary-income receipts, and the rights sold do not qualify as capital assets under I.R.C. § 1221.


Womack v. Comm'r, 510 F.3d 1295 (11th Cir. 2007)