Is it fair for the state to induce lottery participants to buy tickets by promising that their winnings would be exempt from state income tax, then change its mind and tax winnings after a lottery winner has begun to receive payments? The New Jersey Tax Court does not think so. The Tax Court ruled in favor of three different lottery winners, holding that their winnings could not be subject to state income tax because they had made financial decisions based on the state’s representations about the tax free nature of any winnings. See Milligan v. Director, Div. of Taxation, 29 N.J. Tax 381 (Tax 2016).

Mr. Milligan had purchased a Big Game Lottery ticket in June 2000, which turned out to be the winning ticket for a $46 million jackpot. When he and his wife validated the ticket, the New Jersey Division of State Lottery offered them two options: an immediate lump sum payout of $23,748,052 net of federal tax withholdings, or an annuity with fixed annual installments of approximately $1.7 million, net of federal tax withholdings, for 26 years. When the Milligan’s claimed their prize, state law (N.J.S.A. 54A:6-11) excluded New Jersey lottery winnings from the state gross income tax, a fact that was well-advertised in brochures and on the State Lottery website. Those representations were meant to induce greater participation by the public and give the New Jersey Lottery a competitive advantage over neighboring states with lotteries.

In June 2009, New Jersey enacted a law making lottery winnings in excess of $10,000 taxable. As a result, in order to avoid fees, penalties and interest in each of the years from 2009 through 2013, the Milligans reported their installment winnings as taxable gross income and paid the tax due. In each of those years, the Milligans then filed an amended tax return and sought a refund of the tax due on the installments. After the Director of the Division of Taxation denied each of those refund requests, the Milligans filed complaints challenging the denials.

The Tax Court granted partial summary judgment to the Milligans, holding that the state could not renege on its promise. Under the “square corners doctrine,” the state was not allowed to reverse itself once the taxpayers had made financial decisions relying on a representation by state officials as to how tax laws were to be applied. Although it cited precedent for its ruling, the Tax Court held that it “does not take extended legal analysis, complex explanations of the details of a statute, or an in-depth exploration of judicial decisions to reach the common sense conclusion that the State should live up to the representations it makes in the marketplace.”

Last month, the Tax Court also granted another motion by the Milligans to declare that all future installment payments would also be not subject to state income tax, and to have the Division pay within 30 days over $1 million in past due refunds plus interest for the 2009-2015 tax years. Milligan v. Director, Div. of Taxation, Dkt. Nos. 007048-2011, et al. (Tax Dec. 16, 2016). The Court also denied the Division’s request to stay the effect of the decision. The Division of Taxation is expected to appeal.