Dear Tax Talk:
I was recently notified that I have won a tractor mower valued at $10,500. I must claim the prize at their location, which is out of state, and, in order to claim the prize, I must pay the applicable tax, which they said was $2,500. I have no use for a tractor mower, so if I go ahead and accept it, I will have to sell it. That is a lot of tax to pay on the hopes I can sell it. What could be the overall tax liability in proceeding with this venture? I believe my costs are $2,500 for tax, agent commission to sell it from the local site, or transportation cost to my home. Yikes! The hidden pitfalls of winning! What about tax on the selling price? Is it worth it?
Any time you have to hand over your own money to claim a prize you need to be wary. You certainly don't want to be a loser when you think you're a winner.
The rules for withholding tax depend on whether there was a wager. If there was, you have to look at the rules that apply to gambling winnings. If there was no wager, then it is considered a prize or award.
Tax is required to be withheld from
gambling winnings, for example from a raffle.
A sweepstakes that does not involve a wager is
considered a prize and no tax needs to be withheld
-- think game shows.
Assuming your prize comes from some
sort of raffle, and because it is not paid in
cash, the giver needs to collect from you the
appropriate tax to hand it over to the IRS. Noncash
prizes are valued at their fair market value less
the amount of the wager. Tax at 25 percent of
the net value is required to be withheld if the
net value exceeds $5,000. No withholding is required
if the net value is less than $5,000.
In your case, if you wagered $500 and won the $10,500 tractor, you would have to pay $2,500 to the prize giver to claim your prize. You should receive a Form W-2G from the prize giver reflecting the tax withheld.
You would include the value of your prize in your income for 2007 and the amount of tax withheld as a credit on your return. Assuming your tax is not more than 25 percent, all your tax will have been taken care of.
If you sell the tractor for $10,500 you'll be ahead $8,000 and won't have any further tax consequence. It's not so bad.