How Much State & Federal Tax Is Owed on Sweepstakes Winnings?
If you win a sweepstakes or contest prize, you will owe income taxes to Uncle Sam and perhaps your state. Prizes are considered taxable income regardless of whether the prize is in the form of cash, trips or merchandise. If you win a prize valued over $600, the sweepstakes or contest sponsor must report the value to you and the Internal Revenue Service on a Form 1099-MISC. You’re still supposed to report and pay tax on prizes under $600.
Addition to Income
Prizes and awards will increase your tax bill, but the question of how much depends on the value of the winnings and the amount of your other income. Prizes are taxed as ordinary income. That means you add the prize value to the income you received from your job and other sources during the year. Sometimes, a sponsor will include a cash award to help cover taxes on the prize, but the cash also is taxable income to the winner. The prize value will increase your federal adjusted gross income, which likely will increase your net taxable income after you take your exemptions and deductions. The prize win could push you into a higher tax bracket. Your federal adjusted gross income is the starting point for most state income tax returns so the value of the sweepstakes prize within your federal AGI could increase your state taxable income.
You will have to pay state income tax on your winnings in 39 states. If you live in one of the 11 states that don’t tax sweepstakes prizes, you may be spared state income taxes. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming have no state income taxes. Additionally, California, Delaware, New Hampshire and Pennsylvania don’t tax winnings on sweepstakes or other gambling. But if you live in a non-taxable state and win a sweepstakes based in a taxable state, you may have to file a tax return with the taxable state where the sweepstakes is based. If you are unsure about whether you will owe state tax on your big win, ask your state's tax collection agency.
If the sweepstakes prize is worth more than $5,000, the sponsor must withhold 25 percent of the prize value for federal taxes and may have to withhold state taxes as well. But if the prize is a car or other expensive merchandise, you may be required to give the sponsor the cash to pay the federal tax withholding before the sponsor will release the non-cash prize to you. For instance, if you won a $25,000 car, you may have to give the sponsor $6,250 for the federal tax withholding before the sponsor will give you the car. You may also have to pay state withholding up front. The sweepstakes sponsor could choose to pay the federal tax withholding, but if it does, the sponsor’s withholding rate is one-third of the prize’s fair market value.
If your prize is a non-cash award such as a trip or a car, you will owe tax on the fair market value of the prize. There is no uniform method for determining fair market value. Neither the U.S. tax code nor U.S. Tax Court rulings have specified the proper way to set the fair market value of a non-cash prize. The sweepstakes or contest promoter will report what it considers to be fair market value. That figure may be different from the “approximate retail value” the sponsor cited in sweepstakes advertising. But the sponsor’s fair market value figure may be subject to dispute. For example, parties could dispute whether the fair market value of an automobile is the manufacturer’s suggested retail price or the discounted price the sweepstakes sponsor paid to buy the car.
You can avoid all taxes on a prize if you refuse to accept it. A prize may not be taxable if it meets certain legal tests. To be tax-exempt, the prize must be in recognition of personal achievement in religious, scientific, literary, artistic, charitable, educational or civic affairs. You cannot have nominated yourself for the prize or submitted your own work for review. You can’t be required to perform services as a condition for receiving the prize. You cannot claim the prize for yourself but instead must assign the prize to charity. If you assign away the prize, you don’t get a charitable donation deduction. All these tests must be met to avoid tax on the prize.
Herb Kirchhoff has more than three decades of hands-on experience as an avid garden hobbyist and home handyman. Since retiring from the news business in 2008, Kirchhoff takes care of a 12-acre rural Michigan lakefront property and applies his experience to his vegetable and flower gardens and home repair and renovation projects.