A New Twist to the Substitute for Ordinary Income Doctrine: Third Circuit Adopts 'Family Resemblance' Test to Characterize Sale of Lottery Proceeds as Ordinary Income

Abstract

In Lattera v. Commissioner the Third Circuit Court of Appeals recently held that the sale of the right to future lottery payments is ordinary income rather than capital gain. The Third Circuit agreed with the result reached by the Ninth Circuit in United States v. Maginnis and became the second federal appellate court to treat the sale of lottery proceeds as ordinary. Both the Third and Ninth Circuit used the substitute for ordinary income doctrine to classify the sale proceeds as ordinary. The substitute for ordinary income doctrine, which is well-established but subject to criticism, holds that lump-sum consideration substituting for something that would be treated as ordinary income in the future should be treated as ordinary rather than capital. Although they decided the case under the substitute for ordinary income doctrine, the Third Circuit did not adopt the Ninth Circuit's reasoning. Instead, in an opinion commentators have suggested is destined for law school casebooks, the Third Circuit adopted a family resemblance test to guide their analysis. If adopted by other courts, the family resemblance test will significantly impact the substitute for ordinary income doctrine. This article reviews the substitute for ordinary income doctrine and discusses the Third Circuit's family resemblance test.