According to the IRS, awards, prizes, contest winnings and gambling proceeds (including lotteries) are taxable income which must be reported on Form 1040.  Which means if I am lucky enough to win the gorgeous HGTV Dream Home in Sonoma California, then I have to come up with the money to pay taxes on the value of the home and other prizes included.  Bummer, huh?

If you win a cash prize, such as gambling winnings or the lottery, sure it’s a bummer to pay the taxes, but at least you have the cash to do so.

When you win a non-cash prize, such as a vacation, a new car, or a house (such as in the case of the HGTV Dream Home Giveaway), then paying the taxes is an even bigger challenge because you have to come up with the cash to do so.

For many people it’s difficult to come up with the cash needed to pay for a non-cash prize and as a result they have to sell the prize just to pay the taxes.  This has been true for every winner of the HGTV Dream Home so far (this is the 11th year they have held this giveaway).  The value of the homes given away are usually in excess of $1 million, so you can see why someone would have difficulty paying the taxes without selling the house.  Unfortunately, I would be in the same boat, but I sure would enjoy vacationing in the house before I sell it!

Bottom line, if you are lucky enough to win a prize or award, whether it’s cash or non-cash, just be aware that you will have to include the value of that award in your taxable income, and you will have to come up with the cash to pay those taxes.  Prizes and awards are reported as Miscellaneous Income on line 21 of Form 1040; the taxes will depend on what tax bracket you fall into.  If the prize or award is substantial it could push you into a higher tax bracket (for example a senior citizen who’s only income is Social Security is usually in the lowest tax bracket, but a $50,000 jackpot at the casino could push her into the 15% tax bracket and cause some of her Social Security to be taxable).

One final note: if you have gambling winnings, you are allowed to deduct losses up to the amount of your winnings as a miscellaneous deduction on Schedule A – Itemized Deductions.

Related Posts:

• Year End Tax Tips
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Most people probably aren’t thinking about taxes yet, but the time to do tax planning is before the year ends.  Once December 31 has passed, there’s very little you can do to help reduce your 2008 taxes.

The first step in tax planning is to determine where you are for the year.  Pull out last year’s tax return for a reference.  You also need your most current profit and loss statement, so if your books aren’t up to date, now’s the time to get caught up.

Compare your income and expenses to last year’s tax return.  Is your income up?  Do you have the same amount of deductions as last year?  If your income is up, or if your expenses were down, you may owe more taxes than you did last year.

If you are a small business owner you should be very familiar with estimated tax payments.  Have you paid in enough taxes to avoid the under-payment penalty?  The general rule of thumb is that if you expect to owe a balance due of $1,000 or more, after all of your payments (from withholding, tax credits, etc.), then you need to make estimated tax payments.

Once you have compared your current year income and deductions to last year’s tax return, where do you stand?  Do you have more taxable income this year?  If you do, then you can defer income or accelerate expenses to reduce your taxable income for the year.  Just remember, these strategies will likely increase your taxable income for the following year; your tax plan should be long-term, not just for the current year only.

Defer Income:  One way to reduce your current year taxes is to defer income.  If you are a small business owner, you have more control over this than wage earners do.  If you have accounts that you expect to bill in the last week or two of December, consider delaying your invoicing until the last few days of December or even the first few days of January.  Cash basis taxpayers report income when it’s received, so if you invoice a customer on December 28, and you don’t receive payment until January 2nd, then the income will be reported on the next year’s tax return instead of the current year.

Accelerate expenses:  Another way to reduce your taxes is to pay expenses ahead of time.  If you can see that your income is higher this year and you want to minimize your taxes, determine which expenses you can pre-pay before the end of the year to reduce your taxable income.  Some examples include your rent, insurance, utilities, or other invoices you receive at the end of the year that aren’t due until after December 31.  Also, consider stocking up on supplies, inventory, or other items you’ll need to purchase soon anyway.  Do you have any plans to upgrade your equipment or computers?  Consider doing those before the end of the year as well.

Another way to minimize your taxes is to fund your retirement account.  As a small business owner, you have a number of options including traditional IRAs, SEP IRAs, Simple IRAs, or 401K plans.  Determine which plan is best for you and fund it before the due date (this is the one strategy that doesn’t have to be done before the end of the year).

This is just a basic guideline for year-end tax planning.  To determine the strategies best for you and your small business, discuss year-end tax planning with your tax professional.  But don’t wait too long… the year will be over before you know it!

Resources:

Tax Planning & Estimates
The New Biz Tax Consultation

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