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Prize Winnings Tax

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Gold BarsAre prizes, lottery, and sweepstakes winnings taxed at some especially high rate by the IRS? For the longest time, I’ve had friend tell me that winning prizes and contests, while great, are often a mixed bag because of the taxes you have to pay – around 50% of the value of the prize. I’ve always believed them because I’ve never won anything, so I never had any reason to question it. Well as luck would have it, I won the lottery the other day! The surprising part about winning the lottery was that I had no idea I had even entered but the Emperor of Nigeria, or rather an emissary of the Emperor, notified me via email (look at the picture they sent of part of my loot!) that I had won some ridiculous sum. So I thought I’d dig a little deeper to see how I should make plans for my taxes next year.

Prize winnings are taxed at your regular marginal tax rate (the IRS tax bracket you are in). They’re not taxed at some special sweepstakes rate or anything like that, they’re taxed as income and reported on Line 21 (Other Income) of your Form 1040. Other sources of income that get reported there are gambling winnings, jury duty fees, etc.

So why do people believe you’re taxed at 50%? The winnings are considered income and if you win something substantial, chances are you’ll be put into a much higher tax bracket. As of 2008, the highest tax bracket starts at $357,700 and is 35%. When you start adding in state and local taxes, you could very well get close to 50%. If the prize is smaller, you probably won’t be taxed at 50%.

Another wrinkle is that the organization or company doing the giving will have to report the prize on a 1099 form that is filed with the IRS. If you think back to any contests or giveaways, the prizes often have a valuation listed (X prize is valued at ‘$5,000′). One problem that people run into is that the valuation is wildly inaccurate, this is very common in the case of vacations or big-ticket items (it’s as if every television is purchased from the most expensive place possible!).

There are a few solutions to this:

  • Keep the prize and then argue with the IRS about it (which means filing a form to amend an incorrect 1099),
  • Sell the prize so you have some cash to pay the taxes,
  • Request cash instead (again, so you can have cash to pay the taxes),
  • Get lucky and have the giving organization pay your taxes for you (a lot of places are savvy to this now and give enough money to cover taxes as if you were in the 15% tax bracket).

So, if you win the lottery, you’re OK; if you win a prize, you might have some work ahead of you. Now, if you’ll excuse me, I have to send that Emperor of Nigeria about five thousand bucks to cover the shipping fees on my lottery winnings!

(Photo: bullionvault)

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27 Responses to “Prize Winnings Tax”

  1. Greg says:

    This probably stems from the lotteries that give you the option of a lump sum or an annual payment over 20 years. The lump sum is significantly less.

  2. Traciatim says:

    Another simple answer to this is to move to Canada, no tax on winnings here. Plus if you have a heart attack from the shock of winning, no bill for that either.

  3. jim says:

    @Greg: The lump sum is less because it’s discounted, they’re taking a cash flow over 20 years and accelerating it. You get the same “value” assuming the interest rate they use matches reality.

  4. Eric N. says:

    lol get in line Jim!

    I got that same email yesterday ;)

  5. Ah, yes! I used to win the British lottery every day the lucky person that I am. I don’t win much in the way of real contests, but I have gotten a couple meager prizes.

    I once one $50 via Paypal from a company’s newsletter content, some CDs, and a $250 gift card from Hot Topic as well.

    Traciatim – Seems like Canada has all the fun.. just too darn cold for us Floridians to move there!

  6. Patrick says:

    It really sucks that you win a huge prize and you have to pay so much tax on it. I would rather just get cash instead of a prize because then I could buy whatever I want. My company gives out bonuses of money, but they give them in $100 gift checks instead of the full amount. Sucks to have to cash all of them, but they do cover the taxes for us :)

  7. Believe it or not, my State lottery – a legitimate gambling endeavor for which you must “play to win” – has a little tax page with a link kinda hidden but kinda not on the Maryland Lottery home page. They break it down as follows:

    “For prize payments over $5,000 taxes will be withheld as follows:
    25.0% Federal Tax
    8.5% State tax (Maryland residents)
    6.75% State Tax (non-Maryland residents)”

    …and then provide links to all kinds of informative sites. The bottom line is that while it would be nice to grab it all I would gladly pay the 33.5% to get my hands on the remaining 66.5% of the money. Especially if my initial outlay is only a buck or two. :-)

    • lol says:

      “The bottom line is that while it would be nice to grab it all I would gladly pay the 33.5% to get my hands on the remaining 66.5% of the money. Especially if my initial outlay is only a buck or two. ”
      In that case, everyone send me $1, the 80th millionth person to do it will receiver 70% of the money and I will keep the rest. If this was a smart decision, it would be a dumb decision to take the other side of it. Enjoy your 66.5% of zero, which effectively are your odds

  8. poo boomer says:

    Prize valuations are based on list price, which is grossly inflated far above street price which is what people actually pay to buy the stuff.

  9. Keith says:

    Taxes asside, you are still coming into a wind fall. Why quibble over peanuts when you win the farm!

    • lol says:

      If everyone in the world can send me $1, I will gladly payout 80% of that same money and keep the remaining 1.2 BILLION. Enjoy winning nothing, you aren’t going to win anythig playing the lotto because your expected payout is worse than zero and over 80% of all lotto winners regret ever winning and end up bankrupt within 2 years.

  10. jim says:

    Keith – true, but sometimes you win something you can buy for $50 but the contest says it’s valued at $250… you get taxed at $250 on something that isn’t worth the tax!

    Plus, it’s good ot know how things work… it’s not necessarily “quibbling” just because you want to understand.

  11. cautious says:

    uhh…are you sure about this? Not the tax info but the lottery winnings you say you’ve received. There’s been a Nigerian Scam going around for a while now. I received an email of a similar nature about a year ago. It seemed suspicious so I did some research and found a lot of scam information. Like I said, it was about a year ago so I don’t remember all of the sources, but I’ll look for them.

    Anyway, from what I do remember, they randomly choose email addresses, tell you you’ve won the Nigerian Lottery (or some other random way to receive a LOT of money) with a really good explanation as to how, then ask you for you bank info to transfer the funds when in reality they drain you of your funds… I would look into this a lot more before believing anything.

    You should always be aware of what you’re winning. Check the email address that you received the notice from against lists of fraudulent ones that you can find on the internet. You can’t win a prize for a contest you never entered and you should never pay for a prize before you receive it. Like you said, you’ll pay taxes on it, but that’s all you should pay. You should never be asked to pay the distributors of the prize itself. That’s a bad sign.

    I’ll look for that website and post it if I find it soon. Good luck! And sorry, I don’t mean to damper things. I’d be thrilled if this was for real, but it just seems a bit sketh and I want you to be cautious. There are few things worse than getting scammed.

  12. cautious says:

    haha, I was hoping you’d say that. It didn’t quite occur to me at first, obviously lol, but after I posted I realized that I wasn’t familiar with your site so it was likely… Glad to hear it!

    • jim says:

      The fact that some people are still tricked by these scams always surprises me, but sometimes greed outmuscles common sense.

  13. Hmmbug says:

    I’m pretty sure that this is false; you do have to withhold taxes at a higher rate. I don’t know about the tax bracket that you fall into, but you would be in trouble if you didn’t withhold 31% for taxes, if the amount is over $500. And that is for the Feds. It works like the inheritance tax.

  14. Blindsided says:

    What about Social Securtiy and Medicare. Being listed as other income does this come into play?

  15. Swope says:

    What if you have a dependent that won 10,000 and u carry them on your taxes how will this be taxed.

  16. Alethia says:

    Thanks for the info. I won a prize from the McDonalds Monopoly game in 2010, and I got my prize in 2011 so I am researching about the taxes now on it. You explained it alot better than some of the other sites that I have read. Thanks!

  17. MrsFish says:

    Ah the beauty of being in the future…some wonderfully intelligent father and daughter duo went so far as to *fly* themselves to the “money” and were immediately held hostage. Before the state could prosecute them, the two rightfully humiliated persons flew back home. To be fair, I think they were from a country that severely monitored media activity. Where’s snopes.com or wikipedia when you need it??

  18. MrsFish says:

    oops….the criminals were prosecuted, not the unfortunate victims!

  19. Clark says:

    Thank you Mssr. Lee for a very informative article that was also a scream.

  20. Anonymous says:

    if i win a prize through cash like kotyadipathi how much percentage of amount deducted

  21. lol says:

    The dumb thing about this is you only payon your gross winnings. In other words, if you are skillful at poker or fantasy football or something, you pay $10,000 and with $5000 you spend, you lose all $5000, but with 5the other $5,000 you spend you win $5000, even though you broke even, you have to pay taxes on $5000 and don’t get to deduct your slosses (as I understand it). So that means after “breaking even” even after beating the fees and expenses from the casino/racetrack/sportsbook site/whatever, you pay your 40% tax after state and local tax and what not. So “breaking even” cost you $2000 bucks! or 20% of what you put at risk!. Now even if you win more than the $5,000 that is taxed at the 40% including state local and federal taxes or whatever… So you could be a winning player and still lose. Not to mention people’s stupidity in misunderstanding risk and odds and statistics that they think they can somehow beat the lottery or win it and then quit and not play it again or whatever. Taxes and gambling is a reverse intelligent tax and compulsive tax. The more compulsive of a gambler you are and/or the dumber you are, the more you are going to lose. Additionally, the casino or whatever has operating expenses, so they charge you fees, not only that but those operating expenses are taxed, requiring them to take even more in fees that they otherwise could pay out in winnings. So it’s not just the taxes that YOU pay, it’s the taxes that the casino/sportsbook/whatever has to pay that really screws you over. You just can’t win a dang thing playing he lotto. Forget the very rare occasion or story of someone winning once or twice, because that only happened afterso many losses that paying back taxes after the winnings ended up resulting in the person being worse off, just like 80% of all lotto WINNERS. That means that 99.99% lose money in the lotto, and .008% of the fortunate .01% also lose more than they started with. Actually, the percentages are much worse because it’s really 1/80Million that win the lottery. So it’s really 1 millionth of .0125% or .00000000125% which can be rounded down to zero.
    Don’t pay the stupid tax people, save your money or else send it to me and I will send the 80th millionth person that sends me money 60% of the prize pool.

  22. Joey Z says:

    Most people don’t know this, but it is ILLEGAL to win a FOREIGN LOTTERY, SWEEPSTAKES, OR CONTEST OF ANY KIND, in the USA, unless you actually go to the country and enter. Anyone who gets a notice of winnings through the mail from another country, I can guarantee you it is a scam. And if it says you need to pay a small processing fee first, it is also a scam. You can only win if you actually play the game. No one wins what they don’t play. So winners beware!!!


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