Reprinted with permission from the September 27, 2016 issue of the New Jersey Law Journal. © 2016 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
The Tax Court of New Jersey has ordered a halt to aggressive collection of state income tax from certain winners of the state lottery.
New Jersey began taxing state lottery winnings in 2009, but the Tax Court has ruled that prize money collected after the law was enacted, based on drawings that took place before 2009, are not subject to state income tax. Chief Judge Patrick DeAlmeida of the Tax Court ruled in three related cases that imposing income tax on those who won before 2009 would be unfair because the lottery claimed in promotions before 2009 that winnings were not subject to state tax.
"To hold otherwise would ignore the State's obligations to act with integrity when engaging in financial transactions with members of the public," DeAlmeida said in Milligan v. Director, Division of Taxation.
The ruling cites the square corners doctrine, which says government agencies must deal with their citizens fairly.
DeAlmeida ruled in cases with slight variations on the facts. The lead ruling, Milligan, concerns plaintiffs who won the lottery in 2000, opted for an annuity, and were hit with state income tax on those payments beginning in 2009. In Harrington v. Director, Division of Taxation, plaintiffs took their winnings in a lump sum after the Jan. 1, 2009, effective date of the new tax, but before June 29, 2009, when the lottery tax was enacted. And in Leger v. Division of Taxation, plaintiffs won the lottery in December 2008 but received their winnings in a lump sum in March 2009.
The state lottery's representations to the plaintiffs that the state lottery was not subject to state income tax "became part of the contractual agreement" between the state and ticket buyers, DeAlmeida said.
"The judge felt it was unfair, because the winnings were advertised as tax free, to change the rules of the game midway through the annuity stream," said Steven Klein of Cole Schotz in Hackensack, who represented the plaintiffs in Milligan.
The fact that the plaintiffs had formed a contract with the state by purchasing lottery tickets was critical, said William Grand of Greenbaum, Rowe, Smith & Davis in Woodbridge, who represented the 12 plaintiffs in Harrington.
"Oftentimes, courts uphold retroactive taxation," but in the present case the court found the square corners doctrine applied because the state was "arguably breaching its own contract," said Grand.
In 2009, there were approximately 2,400 state taxpayers collecting lottery annuities, and if each paid an additional $3,334 per year after lottery winnings became taxable, the additional revenue generated would exceed $8 million, DeAlmeida said.
The rulings granted plaintiffs summary judgment on the question of whether the winnings in question were subject to tax, but reserved on other claims in the three suits, including breach of contract, claims under the manifest injustice doctrine and claims under the federal and state constitutions.
Joseph Buro of Zipp. Tannenbaum & Caccavelli in Edison, representing the plaintiffs in Leger, did not return a call. Treasury Department spokesman Joseph Perone declined to comment.
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