Taxes on marked down items
March 1, 2005 12:46 PM Subscribe
Oprah recently gave away cars to everyone in her studio audience, and some of the winners complained about the income tax burden represented by the car. Could she have avoided the problem by selling the cars to the audience for a nominal fee?
This occurred to me when American Express ran a promotion a few months ago in which AmEx cardholders who went to a website at a certain time could purchase items at wildly deflated values; e.g. a new BMW Z4 for $5,000. What are the tax implications if you won that "contest"? Would you have to pay income tax on the difference from the MSRP? Or just sales tax on the $5K? If it's the latter, why don't all sweepstakes work this way? If it's the former, why don't I have to pay income tax whenever I buy a loss-leader at Walmart? If I did such things, of course.
This occurred to me when American Express ran a promotion a few months ago in which AmEx cardholders who went to a website at a certain time could purchase items at wildly deflated values; e.g. a new BMW Z4 for $5,000. What are the tax implications if you won that "contest"? Would you have to pay income tax on the difference from the MSRP? Or just sales tax on the $5K? If it's the latter, why don't all sweepstakes work this way? If it's the former, why don't I have to pay income tax whenever I buy a loss-leader at Walmart? If I did such things, of course.
Some states have minimum taxes and hefty registration fees. I just "bought" a car from a relative, and wound up paying $300 to the state.
posted by grateful at 12:52 PM on March 1, 2005
posted by grateful at 12:52 PM on March 1, 2005
I know that here (in PA), when I sold my old VW to my girlfriend for much less than book value, she still had to pay sales tax based on the book value when she went to register it. So, I could have given it to her for a dollar, and she still would have paid the taxes for an $8,000 car.
posted by qwip at 12:52 PM on March 1, 2005
posted by qwip at 12:52 PM on March 1, 2005
It also seems like it could be treated as bartering income.
posted by smackfu at 12:58 PM on March 1, 2005
posted by smackfu at 12:58 PM on March 1, 2005
In Vermont you pay taxes based on the car's value unless you fill out paperwork explaining why the car is not worth what the bluebook [or Nada guide, I forget] says it is worth. I went through this process when I bought a car that needed some serious work and I had to have a dealer verify that the car was worth what I paid for it, not what the bluebook value of it was. It's a serious hassle and not something you can do with a new car.
posted by jessamyn at 1:58 PM on March 1, 2005
posted by jessamyn at 1:58 PM on March 1, 2005
We're talking about two different taxes: income tax and sales tax.
Of course the recipients were hit with federal and state income tax. They received tangible goods worth, what, $16-18K or so in value. That's the same as income. Pontiac or her production company was negligent in not warning them that the gift would be treated as simple income. In fact, I'd bet anything they did. And a $16K new car for $5000 +/- in taxes seems like a pretty good deal, *if* you can come up with the 5 large come April.
I doubt the gift exclusion applies. I'm guessing it was Pontiac that actually gave the cars away, and I doubt , no, I'm sure that corporate entities don't get the gift exclusion.
As for sales tax, you're almost always going to pay the fair market value in sales tax when you register a vehicle, unless (at least in my state) it's a gift between immediate family members.
posted by mojohand at 2:07 PM on March 1, 2005
Of course the recipients were hit with federal and state income tax. They received tangible goods worth, what, $16-18K or so in value. That's the same as income. Pontiac or her production company was negligent in not warning them that the gift would be treated as simple income. In fact, I'd bet anything they did. And a $16K new car for $5000 +/- in taxes seems like a pretty good deal, *if* you can come up with the 5 large come April.
I doubt the gift exclusion applies. I'm guessing it was Pontiac that actually gave the cars away, and I doubt , no, I'm sure that corporate entities don't get the gift exclusion.
As for sales tax, you're almost always going to pay the fair market value in sales tax when you register a vehicle, unless (at least in my state) it's a gift between immediate family members.
posted by mojohand at 2:07 PM on March 1, 2005
Don't forget the taxes and fees associated with titling and registering the vehicle.
I know two people who won cars on this show, they picked them up at the beginning of the year and plan on selling them before the end of the year to pay next year's taxes.
posted by internal at 2:12 PM on March 1, 2005
I know two people who won cars on this show, they picked them up at the beginning of the year and plan on selling them before the end of the year to pay next year's taxes.
posted by internal at 2:12 PM on March 1, 2005
Sorry, to actually answer your question, IANAL, but *if* Amex reported to the IRS that you'd received a vehicle worth $30-odd K for $5K, which they'd have to in order to deduct the marketing expenses from their corporate income tax, yes, the IRS would treat the delta as simple income and come after you for the taxes on $25K.
There's no free lunch.
posted by mojohand at 2:14 PM on March 1, 2005
There's no free lunch.
posted by mojohand at 2:14 PM on March 1, 2005
This is a good question, as I cram for tax class tonight. Here's IRS's rule on prizes and awards, 26 C.F.R. ยง 1.74-1:
The Walmart loss leader isn't a prize or award, it's a contractual sale. Any gain from the result of the discount would be taxed when you liquidate. If you later sold your $3 Walmart widget for $5, you realize $2 in income and must declare accordingly.
As my prof explains, in practice the tax law is a question not of if you get taxed (you will), but when you get taxed. The Oprah winners have to declare income in the same year they received the car. But if I inherit stock, I don't have to declare income until I sell it. The inherent policy issues are (1) how long can you hold off paying the tax (thus decreasing the present value of your tax liability), and (2) will you be able to declare income when your tax liability is lowest (i.e. when you are accumulating tax liability at a lower marginal rate).
posted by Saucy Intruder at 2:18 PM on March 1, 2005
(a) Inclusion in gross income. (1) Section 74(a) requires the inclusion in gross income of all amounts received as prizes and awards, unless [exceptions that don't apply to this situation]. Prizes and awards which are includible in gross income include (but are not limited to) amounts received from radio and television giveaway shows, door prizes, and awards in contests of all types, as well as any prizes and awards from an employer to an employee in recognition of some achievement in connection with his employment.Oprah's happy winners got nailed under subsection (2) of this rule. I think, though, that if you "win" a car for, say, $100, you are still taxed on the fair market value of the award. Your income would then be reduced by your $100 basis in the prize. If your car was free, your basis in the car is $0, and you are taxed on the full resale value.
(2) If the prize or award is not made in money but is made in goods or services, the fair market value of the goods or services is the amount to be included in income.
The Walmart loss leader isn't a prize or award, it's a contractual sale. Any gain from the result of the discount would be taxed when you liquidate. If you later sold your $3 Walmart widget for $5, you realize $2 in income and must declare accordingly.
As my prof explains, in practice the tax law is a question not of if you get taxed (you will), but when you get taxed. The Oprah winners have to declare income in the same year they received the car. But if I inherit stock, I don't have to declare income until I sell it. The inherent policy issues are (1) how long can you hold off paying the tax (thus decreasing the present value of your tax liability), and (2) will you be able to declare income when your tax liability is lowest (i.e. when you are accumulating tax liability at a lower marginal rate).
posted by Saucy Intruder at 2:18 PM on March 1, 2005
Response by poster: The car situation is a bit of a special case, since many states have registration laws to prevent people from avoiding sales tax by, say, buying their cars in New Hampshire and then importing them into Vermont. But the idea is not to avoid sales tax, but to pay sales tax in lieu of income tax.
Bartering income seems different (at least according to smackfu's link), in that it involves transactions without any exchange of money. That would apply to what Oprah did; she gave someone a $29,000 car in exchange for nothing. The question is: what if she had consented to selling the car for $1 to the audience member? Would the member have merely needed to pay the sales tax on $29,000 ($1,450 here in MA), or would they have needed to book $28,999 in income?
On preview: If Walmart sells me a DVD as a loss-leader, say for $11 when it cost them $12, they probably report that as a loss to the IRS (or marketing expense?). Wouldn't I be obligated to report that as $1 as income?
posted by Bezbozhnik at 2:19 PM on March 1, 2005
Bartering income seems different (at least according to smackfu's link), in that it involves transactions without any exchange of money. That would apply to what Oprah did; she gave someone a $29,000 car in exchange for nothing. The question is: what if she had consented to selling the car for $1 to the audience member? Would the member have merely needed to pay the sales tax on $29,000 ($1,450 here in MA), or would they have needed to book $28,999 in income?
On preview: If Walmart sells me a DVD as a loss-leader, say for $11 when it cost them $12, they probably report that as a loss to the IRS (or marketing expense?). Wouldn't I be obligated to report that as $1 as income?
posted by Bezbozhnik at 2:19 PM on March 1, 2005
There are two moving parts here.
First, the IRS has always treated anything that smells like contest winnings as taxable income. Any attempt to recharacterize it as something non-taxable -- like a gift -- will fail. Oprah could have paid the taxes, but the amount she paid would also have to include taxes on the additional amount, since paying someone's taxes is taxable income, too.
Second, any price offered by Wal-Mart is presumably the fair market price at that moment, even if happens to be less than Wal-Mart's cost. If you had to win a raffle or something to be able to pay that price, while others paid a higher price, than the discount would probably be taxable.
posted by MattD at 2:24 PM on March 1, 2005
First, the IRS has always treated anything that smells like contest winnings as taxable income. Any attempt to recharacterize it as something non-taxable -- like a gift -- will fail. Oprah could have paid the taxes, but the amount she paid would also have to include taxes on the additional amount, since paying someone's taxes is taxable income, too.
Second, any price offered by Wal-Mart is presumably the fair market price at that moment, even if happens to be less than Wal-Mart's cost. If you had to win a raffle or something to be able to pay that price, while others paid a higher price, than the discount would probably be taxable.
posted by MattD at 2:24 PM on March 1, 2005
MattD nailed it. Fair market value means what I would pay in the marketplace. If the $12 DVD now costs $11, it's no longer a $12 DVD.
Walmart deducts all its expenses, marketing and otherwise.
posted by Saucy Intruder at 2:29 PM on March 1, 2005
Walmart deducts all its expenses, marketing and otherwise.
posted by Saucy Intruder at 2:29 PM on March 1, 2005
Response by poster: That would seem to indicate a loophole, then. If Walmart can sell stuff for whatever it chooses, then so could American Express, in which case one shouldn't have to pay income tax on that Z4. So why don't all sweepstakes work this way? Perhaps there's just no real desire to make things even easier on the winners.
posted by Bezbozhnik at 2:36 PM on March 1, 2005
posted by Bezbozhnik at 2:36 PM on March 1, 2005
Not a loophole at all. I can't go buy a BMW for $5000 whenever I want. That's a bonus that I have to "win" by luck and as a prize. But Walmart's price is open to everyone.
posted by Saucy Intruder at 2:41 PM on March 1, 2005
posted by Saucy Intruder at 2:41 PM on March 1, 2005
Response by poster: Well, to remove that part: KMart has "blue light specials", and if you're lucky enough to be in the store at the time, you can take advantage. Would they be subject to the same rules if they used a blue light special to sell something for less than they paid for it?
posted by Bezbozhnik at 2:46 PM on March 1, 2005
posted by Bezbozhnik at 2:46 PM on March 1, 2005
Saucy Intruder:
Oprah's happy winners got nailed under subsection (2) of this rule. I think, though, that if you "win" a car for, say, $100, you are still taxed on the fair market value of the award. Your income would then be reduced by your $100 basis in the prize. If your car was free, your basis in the car is $0, and you are taxed on the full resale value.
Careful there, SI, that's not what basis is. You're right that whatever you pay will be offset against the FMV of the car, but that's not because of basis.
Assume a car with $10,000 FMV. As I analyze the transaction, you are considered to have received $9,900 in cash, which you then combined with your $100 to buy the car for $10,000. Section 1012 gives you a cost basis in the car: $10,000. You wind up with $9,900 in taxable ordinary income (see 114 Yale L.J. 195 for a cute case comment on some people's attempts to treat lottery winnings as capital gains).
posted by grimmelm at 2:48 PM on March 1, 2005
Oprah's happy winners got nailed under subsection (2) of this rule. I think, though, that if you "win" a car for, say, $100, you are still taxed on the fair market value of the award. Your income would then be reduced by your $100 basis in the prize. If your car was free, your basis in the car is $0, and you are taxed on the full resale value.
Careful there, SI, that's not what basis is. You're right that whatever you pay will be offset against the FMV of the car, but that's not because of basis.
Assume a car with $10,000 FMV. As I analyze the transaction, you are considered to have received $9,900 in cash, which you then combined with your $100 to buy the car for $10,000. Section 1012 gives you a cost basis in the car: $10,000. You wind up with $9,900 in taxable ordinary income (see 114 Yale L.J. 195 for a cute case comment on some people's attempts to treat lottery winnings as capital gains).
posted by grimmelm at 2:48 PM on March 1, 2005
In the US you are allowed to give a person $11,000 a year w/o either party having to pay tax on it.
So... if a family member wanted to get $50,000 from his pocket into mine in any given year without tax liability on either end, couldn't we draft a contract indicating that the cash is a loan that is ... say ... due 100 years from now at 0% interest?
posted by whatisish at 3:19 PM on March 1, 2005
So... if a family member wanted to get $50,000 from his pocket into mine in any given year without tax liability on either end, couldn't we draft a contract indicating that the cash is a loan that is ... say ... due 100 years from now at 0% interest?
posted by whatisish at 3:19 PM on March 1, 2005
whatisish, H&R Block has a good primer on no interest family loans. In your hypothetical, only if you had less than $1,000 in investment income would it be legit. Otherwise, they would have to pay income tax on the phantom interest the loan didn't produce. Another explanation here.
posted by ..ooOOoo....ooOOoo.. at 3:43 PM on March 1, 2005
posted by ..ooOOoo....ooOOoo.. at 3:43 PM on March 1, 2005
Yeah...one of the sobering realities of the tax code--and a lot of its complexity--comes from the fact most of those "what if" loopholes were exposed long ago by people trying to get away with the very same thing. ("What if I sold it for $1?" "What if I made it a 0% loan?" It's all been tried, caught, and closed off.)
The issue with game show prizes is a long-standing one. There's usually a TV news report or magazine article expose every couple of years on this. I remember the first time I ever heard about it was about prizes on "The Price Is Right", in the 70s, but you if you look around, there've been articles in the past year regarding the tax burdens of the families on "Extreme Makeover: Home Edition", Oprah's cars, and all the rest.
As people have pointed out, you can't just give someone the money for the taxes, because you get into a Zeno's paradox--you'd have to keep helping to pay taxes on the taxes, and then taxes on _those_ taxes. That basically amounts to twice the initial award, and brings you back to the only solution: If you want someone to have $20,000 when all's said and done, you have to give them about $40,000.
On a cash-only show, like Jeopardy, that's easy...they just end up keeping half the money they win. Most game shows and sweepstakes will now let someone either take home the actual prize, with a tax warning, or let them take a cash equivalent. As a result, very few winners actually take the prize--they usually take a cash award that's disappointingly small, and pay taxes on that amount. ("Sure, the car _lists_ for $30,000, but we were only going to have to pay $15,000 for it, so that's your cash award. Enjoy the $7,500 you'll get to keep, instead of really getting that car!")
posted by LairBob at 6:05 PM on March 1, 2005
The issue with game show prizes is a long-standing one. There's usually a TV news report or magazine article expose every couple of years on this. I remember the first time I ever heard about it was about prizes on "The Price Is Right", in the 70s, but you if you look around, there've been articles in the past year regarding the tax burdens of the families on "Extreme Makeover: Home Edition", Oprah's cars, and all the rest.
As people have pointed out, you can't just give someone the money for the taxes, because you get into a Zeno's paradox--you'd have to keep helping to pay taxes on the taxes, and then taxes on _those_ taxes. That basically amounts to twice the initial award, and brings you back to the only solution: If you want someone to have $20,000 when all's said and done, you have to give them about $40,000.
On a cash-only show, like Jeopardy, that's easy...they just end up keeping half the money they win. Most game shows and sweepstakes will now let someone either take home the actual prize, with a tax warning, or let them take a cash equivalent. As a result, very few winners actually take the prize--they usually take a cash award that's disappointingly small, and pay taxes on that amount. ("Sure, the car _lists_ for $30,000, but we were only going to have to pay $15,000 for it, so that's your cash award. Enjoy the $7,500 you'll get to keep, instead of really getting that car!")
posted by LairBob at 6:05 PM on March 1, 2005
How about immediately giving the brand new car to a charity organisation in exchange for the charity giving you an annuity for the amount of the car's FMV.
I believe the annuity payments going forward are tax-free.
posted by Fupped Duck at 11:05 PM on March 1, 2005
I believe the annuity payments going forward are tax-free.
posted by Fupped Duck at 11:05 PM on March 1, 2005
LairBob, what you said is only true if the tax rate on the winnings is 50%. The formula for calculating the additional amount that needs to be given in cash to cover taxes for a non-cash prize is:
additional amount = fair market value of prize * (tax rate/1 - tax rate)
So if the tax rate was 50%, the additional amount would equal the fair market value of the prize. But if we have a tax rate of 28%, then the additional amount is only 45% of the value of the prize. Still a lot, but nowhere near the full value of the prize.
So I think if Oprah had given everyone about $9,000 more (assuming the cars were worth $20,000 and the rate the people would get taxed on the cars was 28%), then the recipients would not have had any out-of-pocket expenses. Of course, she didn't do that.
posted by EatenByAGrue at 11:06 PM on March 1, 2005
additional amount = fair market value of prize * (tax rate/1 - tax rate)
So if the tax rate was 50%, the additional amount would equal the fair market value of the prize. But if we have a tax rate of 28%, then the additional amount is only 45% of the value of the prize. Still a lot, but nowhere near the full value of the prize.
So I think if Oprah had given everyone about $9,000 more (assuming the cars were worth $20,000 and the rate the people would get taxed on the cars was 28%), then the recipients would not have had any out-of-pocket expenses. Of course, she didn't do that.
posted by EatenByAGrue at 11:06 PM on March 1, 2005
Eaten, yes, you're right--I was just positing an argumentative 50% rate. Nevertheless, the basic issue remains...you've got to give "winners" substantially more than you'd appear to be giving them if you want them to go home with that amount. (And isn't the actual tax on this sort of thing a lot higher than 28% in the US?)
posted by LairBob at 11:13 PM on March 1, 2005
posted by LairBob at 11:13 PM on March 1, 2005
I forget if there's a specific tax rate used for winnings that gets deducted up front. But even if there were, presumably a prize winner could just file taxes and get back the excess tax paid, in which case their marginal rate would be the pertinent one. I think the highest current marginal rate is 28% (though there are hidden additional rates once you exceed a certain level of income). But yes, I agree with you LairBob, you would have to pay out a lot of additional cash, which is why Oprah, for example, didn't do it.
posted by EatenByAGrue at 11:41 PM on March 1, 2005
posted by EatenByAGrue at 11:41 PM on March 1, 2005
This thread is closed to new comments.
One way way she could have avoided the problem would have been to "gift" each audience member who received a car the the amount of money that the tax was. In the US you are allowed to give a person $11,000 a year w/o either party having to pay tax on it.
posted by mlis at 12:51 PM on March 1, 2005