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Sudden Money: The Prize Winners Who Find Themselves in a Bind

If you landed on this page after a search on the search-engine-of-your-choice, welcome! This article was written by Glory Borgeson, an executive coach, author, and speaker. Schedule her to speak at your organization's next event:
Personal Branding Speaker; Emerging Leadership Speaker; Entrepreneurial Speaker

What happens to people when they win big-ticket prizes? Would you be surprised to find out that all prizes are considered by the U.S. federal government to be "income" in the year in which you win the prize? What happens if the prize did not involve cash winnings? How do you pay the extra income tax on your prize? Read on to find out how you can keep yourself from getting too stressed out if you ever win a big prize.

I've previously written about sudden money and what typically happens when people suddenly have a lot more money than usual. This often involves an inheritance or a lottery win. Per a 2008 Oprah show, it can also involve a business person earning a lot of money in their business in a short period of time.

While having sudden money sounds like a great thing on the surface, it can cause a lot of problems for people who are not prepared for it, such as family members and friends who leach onto you for loans and handouts, the inability to manage the money well over time, and the loss of friends, the money, or both.

There is another group of people who are in a subset of the sudden money people. That is, people who win prizes. Did you know that if you win a prize, the retail value of that prize is considered income to you in that year? Even more so, the value is considered by the U.S. federal government to be income to you in that particular quarter.

In other words, come tax time, you have to pay up. For the particular quarter in which you win the prize, you may need to make an estimated tax payment by that quarter's tax deadline date.

The Chicago Tribune reported on August 6, 2008 about people who have won prizes who could not, or barely could, afford the taxes on the winnings. One woman won a car valued at $24,000, and was taxed for one-third of the value, or $8,000 of federal income tax. Now, as a former accountant, I don't know why she would owe one-third of the value in income taxes. From the story, it appeared that she was not in the 33% tax bracket. But certainly, an extra $24,000 in income for the winnings was going to place her in at least the 25% bracket, meaning she would have to pay $6,000 on the winnings.

Now, what would have happened if this woman had just waited until the first quarter of the following year when she was filing her annual taxes and, netting the refund she would have received had she not won the car with the extra income tax owed because of the car, just paid the smaller amount that she owed? Let's say she would have owed about $1,000. The problem is that she probably would have been penalized for not paying the tax for the quarter in which she won the car.

So, this woman was very stressed out. She did not have $8,000 cash to pay the income tax.

At least if she had won cash instead of a car she could easily set some aside to pay the income taxes! (Or, if she had won the car and enough cash to pay the income taxes on both, the prize would not have caused her such stress.)

Another man won a dream home from HGTV valued at $2.2 million in 2005. The income tax owed to the IRS for the house was $680,000 (which, of course, he didn t have). At the same time, this man's wife needed to have brain surgery, which would have some hefty out-of-pocket costs. In order to pay the income tax and the medical bills, he used the house as collateral to take out a $1 million loan. Later, he had to auction off the house and he got $1.3 million, which means he barely broke even.

The man stated that after winning the house they really didn't think about income taxes until they heard from the IRS.

Most people have seen, or at least heard of, the television show, Extreme Makeover: Home Edition. For a few recipients of those updated homes, the reassessment of the home for real estate taxes placed the value of the house at a level for which the owners could not afford to pay the increased real estate taxes. Or, at least one family used their home as collateral for a loan to start a business, and when the business failed and they were unable to repay the loan, the holder of the loan foreclosed on the house.

A cousin of mine won big a few years ago on the television show, The Price is Right. She and her family were vacationing in California with their adult kids who wanted to go to the show. So who gets called up? Carol, come on down! Carol goes to the front, plays the game well, and wins just about everything. I asked her how the income was handled for her winnings.

She said she went home with a list of her prizes, and she had about a week or two to decide if there was anything she didn't want. Also included on the list was the retail value of each item she won, which was the amount that would be considered income to her if she chose to accept the prize.

They decided that the only item they didn't really want was the trampoline, but her son and daughter-in-law said they would take it.

So they knew the value of everything she won was about $46,000, and that she would have to pay an estimated tax amount for that quarter for the bump in income. Her husband reminded her (when I asked) that CBS also sent her a 1099 form for the value of the prizes. They made a plan to gather the money needed to make the extra income tax payment.

But not everyone is so lucky. Any time you win a big-ticket prize that does not include cash to cover the income tax, it is up to you to come up with the tax payment on time.

So what should you expect if you ever win a big-ticket prize, and what should you do?

Plan on your extra income tax bill to be about 30% of the value of the winnings. Talk to a tax accountant about when the estimated payment is due.

If you win a dream home or some other huge-ticket item, the best idea may be to sell it right away, while it's still pristine and clean. Then, using the cash from the sale of the house, pay the income tax on the winnings, and for the rest, talk with a competent financial planner who will look at your entire situation (such as current debt, retirement plan, kids going to college, etc.) and help you develop a plan to invest wisely for your future.

Why should a prize stress you out, right?

I appreciate your thoughts in response.

Glory Borgeson, President
2008 Borgeson Consulting, Inc.

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