If you’re lucky enough to win the lottery (tonight’s MegaMillions jackpot is somewhere around $225 Million), and you elect the annuity option (you’ll receive your winnings over an extended period of time, probably around 25 years), each of your payments is ordinary income (and may be exempt from your state’s income tax—California exempts lottery winnings from the California lottery). But there’s no exemption from federal income tax.
What happens if you take the annuity option but then convert it into a lump sum? Do you now magically have a capital gain? The 9th Circuit Court of Appeals ruled in United States v. Maginnis that such a sale was taxable as ordinary income. Today, the tax court decided another case where the petitioner received a 1099-B for her conversion. Not surprisingly, the Tax Court felt that it’s still ordinary income no matter what piece of paper is used for disclosing the transaction.