John Caher
New York Law Journal
April 21, 2000

Lottery Winner Loses Tax Case

A former Bronx resident who won a $10 million state lottery jackpot payable in 21 installments
must pay New York City income taxes on the face value of the prize, even though that is
approximately double the amount the State invested to cover the annual payments.

The ruling from the New York State Tax Appeals Tribunal seemingly rejects the usual
realization and recognition method of assessing taxable income, and instead adopts a position in
which the future value controls.

While consistent with a long line of decisions issued by administrative law judges, Matter of the
Petition of Edison and Salvadora Blanco, DTA No. 815813, marks the first time the Tribunal has
spoken on the question, and clarifies an issue of law with a binding precedent, according to
Patricia Brumbaugh, an associate attorney in the State Attorney General's Office who prepared
the case along with Justine Clarke Caplan.

The case involves a couple who must continue to pay City income taxes on 1992 lottery
winnings even though they moved to Yonkers, N.Y. almost immediately, and have not lived in
the City in eight years. Yonkers, on the other hand, is not entitled to any of their winnings.

Edison Blanco was living in the Bronx on March 28, 1992, when he and a woman from
Poughkeepsie, N.Y. beat the 1-in-26 million odds and picked the winning numbers on a $20
million State Lotto game. They each won $10 million, payable through an initial installment of
$476,100 on April 15, 1992, and 20 additional annual installments of $476,195.

Blanco and his wife Salvadora moved to Yonkers on July 24, 1992, after receiving only the first
installment on the Lottery winnings.

The Blancos did not contest that they must continue to pay City income taxes on money they
receive after moving out of New York. What they contested in this case was the valuation of that
income.

After paying the Blancos the first installment of $476,000, the State spent approximately $4.7
million to purchase Treasury securities under the Separate Trading of Registered Interest and
Principal of Securities (STRIPS) program. That investment covers the State's liability for the
remaining $9.5 million of the Blancos' winnings.

WHAT SHARE FOR CITY?

At issue was how much of the prize remained taxable by the City of New York after the Blancos
moved to Yonkers, and a corollary: How much must be accrued under §11-1754(c)(1) of the
Administrative Code by a taxpayer who changes his or her status from a resident of New York
City to a nonresident?

The Blancos contended that once they left New York City they were required to accrue only the
present value of their annual lottery payments, not the face value. They argued that the City of
Yonkers was entitled to tax, if anything, only the interest that the State was earning on its
investment.

STOCK OPTIONS CASE

The Court of Appeals addressed a somewhat similar question in 1986 when it decided Matter of
Michaelsen v. New York State Tax Commn</I>., 67 NY2d 579. In that case, the Court
considered tax treatment in the matter of a nonresident who exercised stock options he had been
granted by his New York employer.

It held that the taxable gain should be based on the difference between the price of the option and
the value of the stock on the day the option is exercised. Further, it held that the gain realized
from the sale of the stock at a later date was not taxable because it was not derived from a New
York source.

Norman Levy of Lore & Levy, who represented the Blancos, argued that Michaelsen was
controlling in the Blanco case.

But the Tax Appeals Tribunal held that Michaelsen was not on point, "since it concerns
realization of investment income by a nonresident rather than accrual of income by a resident on
changing his status to a nonresident." It noted that the Blancos' right to receive the lottery income
was fixed at a time when they were living in New York City, as was the amount to which they
were entitled.

"The means used by the Lottery to fund the payment of petitioners' award is not relevant to the
amount which petitioners 'accrued' per section 11-11754(c)," the Tribunal said.

On the panel were President Donald C. DeWitt and Commissioners Carroll R. Jenkins and
Joseph W. Pinto Jr.

Levy said the ruling blurs realization and recognition principles. He said he is considering an
appeal on the constitutional issue of whether the tax on unrealized income constitutes a direct tax
on an intangible, which is prohibited under the New York State Constitution.