When you win a prize, there are really two winners: you and the taxing authorities. Should you be fortunate enough to win that trip of a lifetime to the French Riviera in your new yacht, here is what you need to know.
Prizes and taxes
Prizes are taxable. Almost all prizes are taxable income. You report them on your income tax return as other income. This is the case whether your prize is cash, merchandise, or free services.
The prize may be reported to the IRS. Prizes valued at $600 or more must be reported to the IRS. Prize values below this reporting threshold may also be reported at the discretion of the sponsor of the prize. As the winner, you should look to receive the proper Form 1099-MISC.
Employee awards are different. When you receive a prize or something of value from your employer, different rules apply. These fall under business expense, fringe benefits, and award rules. Things like a holiday turkey or occasional service awards are often (but not always) a non-taxable award. On the other hand, a bonus or prize points for merchandise as a sales award usually needs to be reported as income.
Gifts and prizes have different tax rules. A different part of the tax code applies to gifts. In short, gifts received from someone that are less than the annual gift threshold ($17,000 in 2023 or $34,000 for a married couple) are not deemed prizes.
Other considerations and tips
Should you receive a prize during the year, here are some tips to consider:
Donate to charity. If you wish to avoid paying tax on the prize you can refuse the prize or opt to donate the prize to a charity. It is best to sign appropriate paperwork to assign ownership of the prize to the charity and have the prize sent directly to them as you cannot use the prize before donating it.
Establish fair market value. Should you win property, like a car or vacation trip, establish the fair market value (FMV) of what you won. Hosts of prize contests often over-value the prize to aid in marketing their contest. You do not want to pay tax on an over-inflated value. So if you win merchandise, get copies of advertisements for the item. If it is a trip, document hotel rates, transportation costs and cost of meals to build a case for a lower FMV. If there is a discrepancy with the value received, show your documentation to the provider of the prize and get your Form 1099 value corrected.
Keep good records. When you win a prize, fill out a sheet outlining the details of the event. Record the identity of the sponsor, the date, a detailed description of what was won, copies of documentation, photos of the items won, and the approximate retail value assigned to the prize by the sponsor.
Plan for the tax. Using the value provided to you by the sponsor, determine if you will be able to pay the tax for the prize. You may need to plan to make an estimated tax payment to avoid any surprises when you file your tax return.
Remember should you be lucky enough to win a prize, ask for help to determine what steps need to be taken to manage your tax obligation.