Taxation of a Prize or Reward

Generally speaking, prizes and rewards are included as gross income in a taxpayer's federal return. Taxpayers are taxed on the cash equivalent of items won in contests, pageants, drawings, game shows, and other competitions. However, certain exceptions may apply, and there are a few ways to reduce the tax burden.

Tax Winnings

A taxpayer can exclude a prize or award from gross income if it is:

  • Transferred to a charity before being claimed.
  • Given as an employee achievement award.
  • Given as a gift.
  • Under a certain amount.

Prize Transferred to a Charity Exclusion
To qualify for the transfer to charity exclusion, the transfer must take place before the prize or award is actually presented to the taxpayer. A taxpayer who exercises control over the prize and immediately transfers it to charity must include the prize as taxable gross income. If the taxpayer is unaware of the exclusion when he or she receives the award, the taxpayer must return it then make an appropriate designation. To make a designation, the taxpayer must do so in writing, describing the award and identifying the charitable organization receiving the award.

Employee Achievement Award Exception
Employers use prizes as an incentive for their employees to heighten professional achievement. This is generally considered taxable income. However, an employee who receives a prize or award for past achievement does not have to include the value of the prize or award in gross income if:

  1. The prize or award was made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement
  2. The taxpayer was selected without any action on his or her part to enter the contest or proceeding
  3. The taxpayer is not required to render substantial future services
  4. The prize or award is transferred by the payer as directed by the recipient to a governmental unit or a charitable organization pursuant to the recipient's designation

Gift Exclusion
If the prize or award was the result of a gift meaning that the taxpayer received the item as a result of detached and disinterested generosity, then the taxpayer does not have to include the amount received in gross income.

Cost of Ticket or Entry Fee
The ticket price or entry fee paid is an offset to the amount included in gross income. A purchaser of losing raffle tickets can deduct the cost against gains from wagering transactions.

When taxpayers fail to claim a prize or reward, or make a positive assertion to not exercise any control over the winnings, they can avoid taxation all together. While certain prizes may not be taxable and there are ways to minimize taxes, it is important for all taxpayers to recognize the tax consequence when accepting a prize.

What Counts as Gambling Winnings?

If you're lucky enough to "win it big", you will likely wind up dealing with the issue of taxes at the venue before winnings are paid out. Even if you win a smaller amount, and retain the full amount of your winnings, you still must report them on your tax return. The IRS requires taxpayers to fill out a Form W2-G when their winnings reach or exceed certain thresholds. For example, you're required to fill out this form if:

  • Your horse track winnings are $600 or 300 times the bet.
  • You win $1,200 or more at bingo or slot machine games.
  • You win $1,500 or more from keno games.
  • You win $5,000 or more in a poker tournament.

When you complete the tax form, often the venue will withhold of 25% on site for taxes. Keep in mind that the IRS doesn't require taxpayers to complete a W2-G for certain table games. However, you will still need to report the winnings and pay taxes on them, so it's important to keep good records.

If you have gambling losses, you may be able to claim them to help offset winnings. In addition to federal taxes, you may have to pay state taxes, but this depends on your state of residence. If you gamble regularly, it may be a good idea to familiarize yourself with your state's laws to stay in compliance. You can find more information on individual states here.

Quiz: Is your Gambling income/loss affecting your taxes?

True or False: Your taxes are unaffected if your gambling winnings include non-cash prizes such as vacations or appliances. Answer
False. The market value of non-cash winnings is taxable gambling income.

You spent the weekend in Las Vegas and won $500 at craps but lost $1,000 in the slots. The trip cost you $750. Your only other income is from your job that pays $40,000 a year. What is your gambling loss deduction? Answer

A. $0
B. $500
C. $750
D. $1,000

B. Gambling losses are only deductible to the extent of winnings. The winnings must be included in your income, making it $40,500. Gambling losses can only be deducted if you itemize but are not subject to a threshold using 2% of your adjusted gross income ($40,500.) Your deduction is $500 since your winnings weren’t near $1,000 and the cost of the trip isn’t deductible for casual gamblers.

How much would you need to have won in a poker tournament to receive a Form W-2G for certain gambling winnings? Answer

A. $600
B. $1,200
C. $2,500
D. $5,000

D. Casinos and other issuers must give you a W-2G form if you win $1,200 or more in bingo or slot machines, $1,500 or more from keno which you can reduce by your wagers, $600 from other types of gambling where the payout is at least 300 times the wager, and $5,000 for poker tournaments reduced by the wager or buy-in. Other types of gambling winnings will need to have federal taxes taken out and reported on a W2-G, such as certain lottery winnings.

True or False: You only need to report gambling and lottery winnings on your taxes if you receive a W2-G. Answer
False. Regardless of whether you receive a W2-G or not, you need to report your gambling and lottery winnings. It’s prudent to keep records of receipts, statements, and logs if you gamble frequently so you can tally up your deductible losses for each trip you took or ticket purchased.

True or False: Losing lottery tickets are tax-deductible so long as you won at least once. Answer
True. Just like with placing wagers at the track or casinos, your lottery tickets count as a gambling loss if they didn’t result in any winnings. But just like any other type of gambling, lottery tickets are only deductible to the extent that you have winnings. If you spent $200 on scratch-off tickets throughout the year but only won $10, your deduction is $10 if you itemize.

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