This section contains the nature of the case and procedural background.

Watkins (D) won $12,358,688 from the Colorado State Lottery with a ticket he purchased for one dollar. D was married to Tammy. The prize winnings were to be distributed to him in twenty-five annual installments through an annuity purchased by the Colorado State Lottery. D reported the receipt of his first six prize payments as ordinary income. In 1997, D and his wife were divorced. The court awarded each party a one-half interest in the future payments. D entered into a contract with Stone Street to assign his one-half interest in the remaining lottery payments. In consideration for the assignment, D received $2,614,744, which represented the discounted present value of his remaining share of the lottery winnings. D gave $200,000 to a third party who provided consulting services in connection with the sale to Stone Street. D reported that the lump sum from Stone Street was the result of a sale of a capital asset worth $2,414,744 with a cost basis of zero. The I.R.S. issued a notice of deficiency claiming the money received from Stone Street was ordinary income. The tax court agreed with the IRS.

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