Grace Lang was employed as a waitress at the Pancake House in Grand Bay, Alabama. While working the morning shift on March 7, 1999, one of Graces customers left her a Florida lottery ticket as a tip. When Grace discovered that she had won part of the Florida Lotto jackpot, the following steps were taken.

Upon advice of her father and legal counsel, the Lang Corporation was formed and immediately made an S election.

Grace received 49% of the stock in Lang, and the 51% balance was distributed to family members.

Grace had the Florida gaming authorities designate the Lang Corporation as the recipient of the prize moneyapproximately $10 million payable over 30 years.

Graces coworkers at the Pancake House filed suit against Grace based on an agreement they had to share any lottery winnings equally. The Alabama courts eventually decided that such an agreement did exist but that it was not enforceable. (Alabama law does not permit enforcement of contracts involving illegal activitiesgambling is illegal in Alabama.) In 2007, the IRS determined that Grace had made taxable gifts in 1999 when she shifted some of the lottery winnings to family members. She made the gifts by having 51% of the Lang Corporation stock issued to them. (As Lang is an S corporation, the lottery income passes through to the shareholders.)

Grace disputed the gift tax assessment by contending that her actions were required by the Lang family agreement. Under this agreement, it was understood that each member would take care of the others in the event he or she came into a substantial amount of money. Because Grace was bound by the Lang family agreement, she was compelled to relinquish any right to 51% of the Lang stock. Thus, the satisfaction of an obligation is not a gift. As no gift occurred, the imposition of the gift tax is not appropriate.

Who should prevail?