Are 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 )