Yes, winning a prize, no matter how small, is a moment of joy! We understand your elation on winning a sweepstake. But don’t let your excitement cloud your sensibilities. You still have to pay attention to details, which includes taxes.
Now you might feel that it’s a bit unfair to pay tax on a sweepstake prize. However, rules are rules, and one of the rules of the US government is to treat prize money as ordinary income subject to taxation. You cannot escape taxes on sweepstake winnings, whether it’s HGTV or PCH sweepstakes- tax rules are applicable on all wins without exception.
Regardless of the amount, the US federal government imposes a tax on raffle and lottery wins, sweepstakes, and other kinds of prizes and awards. The amount of tax that you would be asked to pay depends on multiple factors, including the state of your residence. Taxpayers have to report prizes and winnings (cash, trips, or merchandise) on a Form 1099-MISC for the prizes worth over $600.
Most people want to know how to avoid paying taxes on prize winnings. It’s not possible to escape taxes and keep the prize too, but if you are well-informed you might be able to manage the process better.
The Rules of Paying Taxes on Sweepstake Win
If you are a sweepstake enthusiast or winner, here are some tax rules that you should know about.
1. The $600 mark
You have to pay taxes on prizes under $600, as well as for prizes of greater value. However, when the value is greater than $600, the sweepstake company has to inform you and the Internal Revenue Service about it on a Form 1099-MISC. Additionally, you may also have to pay state taxes on your win that varies according to the legislation in different American states.
Whether the prize value is more or less than $600, you are obligated to show the win in your tax form. You don’t have to think of when and how the sponsor reports the win; you have to do your part. Failure to do so would land you in trouble with the Internal Revenue Services.
Also, taxes are applicable to both cash and merchandise prizes. Yes, you have to declare the fair market value of the merchandise win in your cash form, and pay a tax on it!
If you are wondering what kind of taxes are you expected to cough up on a sweepstake win, then let us tell you the IRS treats contest prizes just the way it treats ordinary income. The same tax rates would be applicable to it. Just like the taxes deducted on your paycheck, the taxes drawn on sweepstakes would add to any social security benefits that you receive.
Since sweepstake adds to taxable income, an unexpected prize win could push you into a higher tax bracket, which is a real downside. In such cases, you should evaluate your gains and losses before accepting the prize.
2. Non-taxable states
If you happen to live in Alaska, Tennessee, Wyoming, Texas, Washington, Florida, Nevada, South Dakota, California, New Hampshire, Delaware, or Pennsylvania, you would be exempt from paying state taxes on sweepstakes winning or any other prize. You can enjoy this privilege if the competition was based in any of these states; if it’s based elsewhere the state tax laws would be applicable.
You would still have to pay federal taxes, though.
3. Withholding Taxes Vs Paying Taxes
Whether the taxes will be withheld by the sponsor, or you would have to pay for it, varies according to the situation. In the case of cash prizes, if the amount is more than $5000, the sponsor will withhold 25 percent of it for federal taxes. It is optional to withhold state taxes.
However, if you win a non-cash prize that has a value of more than $5000, you would have to pay the equivalent amount of the applicable federal taxes to the sponsors for taking possession of the prize. You may also have to settle the state taxes in advance. So be prepared to pay a big amount as taxes on sweepstakes winnings for that HGTV house.
If you get a win alert and the sponsors ask you to pay them, please cross-check what the payment is meant for. Calculate the amount that should go for taxes, and ensure that the tax will go to the IRS. These steps are necessary to save you from potential scams.
Big Wins Come With Big Taxes
Now let us discuss some scenarios that sound very promising, but they come with a hidden surprise called taxes!
Tax on winning a car Prize
You would have to pay taxes to both the federal and state government. If you have won a budget car, you might as well pay one-third of its value as taxes, and keep the car for yourself. It’s a profitable situation. If it’s a $100,000 luxury car, you may not be pleased with the idea of paying a prized tax on winning a car. Also, you would have to pay a high insurance premium if you want to keep this fancy car. So carefully assess all these factors and decide if you can afford to keep this car.
Tax on winning a new House or Makeover
While winning a house in a contest sounds like the stuff of a dream, the reality could be a bit harsh, and that’s because once again you will be paying prize tax on winning a house. In addition to the income tax that you would pay to the federal and the state government, you also have to think of the property taxes, utility bills, etc. that would come with a new house. In case you actually win a house, you would be notified about it well in advance so that you can assess these factors for yourself.
Of course, if you can afford to pay the tax, and you had been thinking of buying a house, this situation favors you as it would be akin to buying a new house with a very lenient down payment.
Tax on winning a Trip
You might get thrilled at the prospect of winning a free vacation. But free vacations too, are not completely free. Once again, you would be required to include their fair market value in your gross income and pay taxes on it. On top of it, the free holiday might not cover the cost of your transportation from your home to the destination.
In such cases, it’s better to take out a notepad and calculator and figure out the taxes on prize-winning. Include the overhead costs too, and see if you find the ‘free vacation’ a good bargain or not.
How to avoid paying taxes on prize winnings?
1. Sell the Prize
If you win expensive merchandise, and you find the taxes unaffordable, then you can sell the merchandise and use the proceeds to pay the taxes. The merchandise may sell a bit below its market value, but you would still make an overall profit.
Of course, for this idea to work, the merchandise should be easy to sell. For instance, if you win a car you could sell it off before it's time to pay taxes. In case you win a house in a contest, it might be difficult to find buyers for it and sell it off within the same financial year.
2. Donate the prize
If you don’t want to keep the prize for yourself, you could choose a government agency or a tax-exempt charitable organization. In this way, you would be able to contribute to a good cause, and also avoid paying taxes on prizes and awards. The organization should be qualified under Section 501(c)(3) of the Internal Revenue Code, and you would be exempt from paying gift tax or income tax on your win. Usually, charitable hospitals and not-for-profit schools, public charities, churches, etc. are qualified for the same.
You could avail of this exclusion for annual donations of up to 50 percent of your gross annual income. Remember that you have to provide a clear written account of the donation, which should include the description of the prize and the details of the charitable organization to whom you are giving a donation.
If you are wondering how to avoid paying taxes on sweepstake winnings, please remember that donating the prize to a friend or family is not going to help you. In fact, if you give away your prize to a person other than your spouse, you would also have to pay gift tax if the amount exceeds the gift tax exclusion -- $13,000 per beneficiary per year in 2012.
3. Opt For Cash Award
You would have to pay taxes on sweepstakes winnings, whether the prize is in cash or kind. In case, you don’t want the new merchandise and the competition has an option to avail a cash prize of the same value, you could always go for the cash option. You would be able to comfortably pay the applicable taxes from the cash amount, and utilize the rest of it according to your wishes.
But remember that all contests don’t offer this option. You can’t insist on a cash prize if the contest rules don’t have the provision for the same.
4. Forfeit the prize
Well, it’s very easy to do if you don’t like what you have won. You are only taxed for the prizes or amount that you accept. Simply forfeit the prize if you don’t like what you won.
Keep the Prize (Recommended)
There may not be an escape from taxes, but look at the bright side! You have won a prize, so if it’s useful and you can afford the taxes, accept the prize and enjoy it.
For Sweepstakes enthusiast
If you won a million dollars how much would you get after taxes?
For folks who participate in sweepstakes quite frequently, it’s advisable to find answers to such questions in advance. You should also create a separate fund for taxes on prizes and awards. Visit a professional to make an assessment regarding taxes for prize-winning applicable in your state, and keep aside a few dollars every week for the purpose. The accumulated savings could also act as an emergency fund, should the need arises.
Assuming that you keep track of the sweepstakes that you have entered in a diary or excel sheet, you can also make a taxes on prize-winning calculator column and write the applicable tax rates in it. This will help you in quick calculations before responding to a win alert.
Remember that on winning a prize, you pay taxes directly to the IRS. If a company asks you to pay an amount to them to cover taxes, processing fees, or custom handling in order to claim your prize, treat it as a potential scam alert, and respond cautiously.