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Surprise! You won the prize and now you owe the IRS

An Ohio man recently sported a big smile after winning a free computer through a magazine contest. But his smile quickly turned into a scowl after his accountant told him the bad news -- he owed taxes on his prized electronic helper.

For many people, this news of winning something and then owing money because of it comes as a shock.

But there are dozens of items that Uncle Sam slaps a tax on that many people are simply unaware of, including:

  • Trips or prizes won
  • Stock options for employees
  • Gambling winnings
  • Unemployment compensation
  • Some holiday gifts
  • Jury fees
  • Hobby income

Free trips still cost money
"At work, my wife won a $2,000 trip to Hawaii. We had to pay taxes on that $2,000," says Ken Pikor, a certified financial planner and enrolled agent (someone who can represent taxpayers before all administrative levels of the IRS) in Westerville, Ohio. This came as no surprise to Pikor, with his knowledge of taxes, but that didn't make him happy about it.

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One of Pikor's clients, the guy who won the computer, wasn't happy about his bill either. But Pikor was able to take a little bit of the sting out of the IRS' tax bite: the computer had a manufacturer's suggested retail price of $1,995, but it was selling locally for $1,499. Pikor helped his client prove this to the IRS by writing a letter of explanation, and including newspaper advertisements.

Prove it and pay less
After winning some type of prize, make sure you receive Form 1099-MISC, Miscellaneous Income, from the person or organization that's sponsoring the event. Form 1099-MISC states the manufacturer's suggested retail value of the gift and you're required to pay the tax on that item.

Tax Tip: If you can prove within 30 days of receiving the form that the same item could have been purchased at a lower price, you have a good shot at owing less taxes. Pikor recommends that you clip an advertisement that shows the lower price and keep it with your tax records.

Stock options
In addition to wages, sometimes organizations compensate their employees with the company's stock. The stock is either vested or restricted when you receive it.

If you receive vested stock, which means that the waiting period for a stock option to be exercised has been eliminated, you must report compensation income equal to the value of the stock on the date of the grant or award, even if you don't sell the stock.

Example: In August 1999, your employer awards you 100 shares of stock worth $50 each. On your 1999 income tax return, you must report $5,000 of compensation income because of this award.

If you receive restricted stock, you don't have to pay tax at the time you receive the stock. However, the amount of tax you pay later when it vests can be significantly higher.

Tax Tip: If you think you would be better off under the rules for vested stock, you can elect to use those rules, but you have to file the election within 30 days after receiving the stock.

When you end up selling the stock, you'll report either a capital gain or loss. The gain or loss will be short-term if you held the stock one year or less at the time of the sale. You need to hold it at least a year and a day to have a long-term capital gain.

Gambling winnings
You owe income tax if you win more than $5,000 from:

  1. Any sweepstakes, wagering pool or lottery, or
  2. Any other wager if the proceeds are at least 300 times the amount of the bet.

If Lady Luck is on your side and you make that major win, you'll receive Form W-2G from the lottery commission. Attach it to your Form 1040 and report your winnings on line 21 of Form 1040.

Unemployment compensation
To many people's dismay, taxpayers owe income tax on unemployment benefits they receive. It stinks, but at least taxpayers have a choice of having the income tax withheld now or paying it later. Form W-4V must be completed. The amount withheld will be 15 percent of each payment.

Holiday gifts
When it comes to holiday gifts, if your employer gives you an item, such as a ham or a turkey or other merchandise of nominal value, it's not taxable. However, if your employer gives you cash, gift certificates or similar items of readily convertible cash value, the value of the gift is considered to be additional wages or salary. The gift amount would be included in your Form W-2 and would therefore be taxable.

Jury fees
Believe it or not, fees you receive for serving on jury duty constitute income, according to our friends at the IRS. Include the amount on Line 21 of Form 1040.

Hobby income
If you enjoy tie-dying T-shirts and bed sheets at home, and selling the goods to teenagers at rock concerts, technically, the income made is taxable. You should report the amount on Line 21 of Form 1040. Expenses are deductible on Schedule A.

Some of the more obscure items that are deemed taxable include:

  • Beauty contest winnings
  • Buried treasure
  • Embezzlement proceeds

So if you happen to dig up a pot of gold while doing your weekly gardening, and you don't want to get in trouble with Uncle Sam, report it. Otherwise you could end up like gangster Al Capone -- it was income tax evasion that finally locked him away.

 

-- Posted Jan. 26, 2000

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