How to Handle Tax Rules Affecting Prize and Award Earnings

Tips for handling Tax Rules That Affect Prize and Award Income

There’s nothing like getting a bit of free money, but in reality, nothing really comes free. Even winners of game shows and reward recipients usually have to put some effort into the prizes they receive. Still after this, however, the money isn’t free since taxes will usually be owed on the winnings.

The most obvious example of this is the winning of a Nobel Prize. Winning this award comes along with a substantial monetary award. When President Barack Obama won the award in 2009, for instance, he received a prize of around $1.4 million to go along with the honor. In most cases this would have resulted in a large tax bill, but the president was able to avoid this.

Avoiding Taxes

Avoiding Taxes

Avoiding Taxes through Donations

In most instances, an award such as the one President Obama received would require taxes to be paid, but IRC Section 74 of the tax code provides exceptions for this. By using the exceptions, President Obama was able to avoid any taxes on his winnings. Those who know what’s necessary to get this exception, though, fully understand why.

–    The prize must be awarded without the recipient having taken any action, such as entering into a contest, in order to win the award.
–    Receiving the award must not subject the winner to the responsibility of performing “substantial future services” in order to receive it. These services even include writing, teaching and other work that a person may already be engaged in.
–    The recipient must designate that the award be given to certain types of charities or governmental organizations at any level.

Malala Yousafzai donation

Malala Yousafzai donation

President Obama met all three of these criteria after donating the full award to charities, and this resulted in no taxes owed. Similarly, Malala Yousafzai donated her $50,000 World’s Children’s Prize towards rebuilding a school that had been destroyed during an armed conflict. While she isn’t an American citizen and thus wouldn’t have owed American taxes, her story is another good example.

Don’t File as Self-Employment Income

Of course, there are other instances when a person may receive these awards and be unable to meet the three aforementioned criteria. After all, someone who isn’t rich may not be in the best situation to just give a cash award away. Similarly, an individual may receive an award based on future services or after entering a contest. Fortunately, there are still methods to avoid huge tax bills.

Self-Employment Income

Self-Employment Income

The mistake some make after winning substantial prizes lies in how they file their taxes. In some cases, they’ll mark their winnings at self-employment taxes. This is an understandable, if not costly, mistake since most individuals aren’t accustomed to the many nuances of the tax code.

The self-employment section, which people run into at Section C of Form 1040, is meant to report continuous income. Those who work on their own as a freelance writer, for instance, would need to report their income here. This is because they write solely to earn some form of income, and even though taxes are often not taken out before payment, the writer must report their earnings.

Someone who wins a monetary award, though, obviously doesn’t make a habit of earning their living through cash prizes. Even Ken Jennings, the longest reigning ‘Jeopardy!’ champ in history, didn’t earn a living through winning prizes from the game show. Sure, he’s won nearly $3.2 million by playing on the game show, but this doesn’t make it self-employment income.

Prize and Award Earnings

Prize and Award Earnings

How to Correctly File Taxes for Prizes and Awards

Since awards and prizes obviously aren’t typical income accrued through self-employment, many are left wondering how they should file their taxes. Some even wonder if they owe taxes on their winnings at all. The answer is yes, but their tax burden will be nowhere near as substantial as someone who has to report on Schedule C.

Looking at the front of Form 1040, there is a space focused on ‘other income.’ It is here, on Line 21 of Form 1040, that those who receive financial benefits from prizes or awards should report their earnings. It’s normal to hear about lottery winners having to pay taxes on their prize, but even individuals who win prizes on game shows aren’t exempt from this necessity.

Cash prizes are treated much like gambling winnings, and the IRS has a page devoted strictly to these winnings. They of course give instructions on filing on Line 21, but they also explain how it’s possible to write off gambling losses for the year.

Monetary Losses

Monetary Losses

Monetary Losses Related to Prizes

For those who receive monetary prizes through events such as lotteries, casinos, raffles and even dog races, there’s an additional way to relieve some of the tax burden they’ll face at the end of the year. In Schedule A of Form 1040, Line 28 allows a person to write off losses related to gambling.

These losses can include money spent on non-winning raffles, lotteries and even bingo games. Keep in mind, though, that these deductions cannot exceed the amount of winnings that a person received in prizes for that year.

In a perfectly happy world, a person would be able to keep all of the money received from prizes and awards granted to them. In reality, though, the taxman will always get what is coming to him. Fortunately, by knowing a few simple rules related to the tax code and awards, a person can avoid an overwhelming tax bill and potentially owe nothing at all.

File tax forms

File tax forms

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