When Prizes and Awards Are Not Taxable

I won a prize. Not from the Publisher’s Clearinghouse Sweepstakes, although I expect to hear from them any day, but the kind of prize one can only dream about: a tax-free prize. Or at least that was my recollection of the tax code.

Ordinarily, winnings and awards and prizes are taxable. Win $1,000 as “employee of the month?” Taxable. Win the lottery? Taxable. The A.S.P.C.A. raffle? Taxable. You especially don’t want to win that lavish $20,000 Mediterranean cruise, because if you do, and you accept it, you owe maybe $7,000 in taxes (not to mention what you’ll blow on all those needless trinkets you find yourself buying while ashore).

But a “civic” or “literary” prize — a Pulitzer or the Nobel, for example — is different. I did recall that Congress made an exception for those.

And sure enough, they did.

For your prize winnings to be tax-free, you simply have to meet these tests:

It must have been won for outstanding educational, civic or literary achievement. (I had written a magazine article.)

It must have been won without your trying to win it. I mean, it’s OK to have devoted your life to peace … but if you actually applied for a Nobel Peace Prize or had to have done something specific to win it, like 10,000 push-ups, your winnings would be taxable. (Not only had I not made any active attempt to win this prize, I had never heard of it.)

It must require no service on your part; i.e., you don’t have to go around for a year with a crown on your head as a spokesman for something. (My prize — $1,000 — requires nothing of me. It fell into my lap as if dropped by a bird I did not even know was passing overhead.)

Now, as I say, it was only $1,000. And yet the notion of tax-free money … well, to a poet who had won a poetry prize, it might not mean much. Poets’ hearts sing to loftier notes — and they tend not to be in high tax brackets to begin with. But to a financial writer. Ah, the music, the harmony, the peace. Bliss.

Except that there is one other requirement:

For it to be tax-free, the money must be assigned to a government agency or charity before you even touch it — and you can’t take a charitable deduction for it. In other words, it is tax-free so long as you never get a penny of it.

Hello? So why did anyone write all these regulations in the first place? I can trim that section of the tax code down to 20 simple words:

“All cash prizes and awards, and the fair market value of all noncash prizes and awards, are taxable as ordinary income.”

I am told that the U.S. is the only country in the world that taxes Nobel prizes. This is not to say you shouldn’t keep trying to win one or that if you do win one, you should be anything but grateful. I wouldn’t even mind the tax bite at all except that the tax writers have teased us so. It takes your average mass-market tax guide hundreds of words to explain (in lay terms) “When Prize Winnings Are Not Taxable.” But really the answer is: never.

Incidentally, you quarterly estimated tax filers: Today’s the day your fourth estimated 1998 tax payment is due. Have a nice weekend.

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