Prize taxes and offsets
December 20, 2011 12:08 PM Subscribe
I sometimes hear about someone winning a prize where somehow the taxes due are somehow offset by the giver of the prize. How is that offset calculated?
Do they just add money to the prize until the post tax amount would be the same as the intended prize (so say 10% tax on $5,000 prize they end up giving $5,555.56. This involves the additional being taxed iteratively since it is all income to you.
Or do they somehow just pay the government the money you would owe on the intended prize amount and the offset doesn't count as income. So for 10% on $5,000 they'd just pay $500.
Or a mystery third option?
Response by poster: That's what I thought, but I have an accountant acquaintance claiming otherwise. Though he also didn't have a cite handy.
My attempt to find a cite either way wasn't useful (though I did get to read the stuff requiring that you report bribes, kickbacks, and income from illegal activities which was kind of fun.)
posted by obfusciatrist at 12:23 PM on December 20, 2011
My attempt to find a cite either way wasn't useful (though I did get to read the stuff requiring that you report bribes, kickbacks, and income from illegal activities which was kind of fun.)
posted by obfusciatrist at 12:23 PM on December 20, 2011
Iteratively is exactly how it is done. For example, U.S. citizens who work for an international organization like the IMF do not have income taxes withheld with the understanding that they will pay the taxes themselves. They are given additional salary to compensate for taxes that would normally be withheld. The way their salary is determined is by using an iterative process starting with their base salary, adding additional income to cover taxes, then repeating the tax calculation iteratively until the final difference is less than one dollar (or one hundred dollars as the case may be). The result converges pretty quickly for general tax rates.
posted by JackFlash at 12:32 PM on December 20, 2011 [1 favorite]
posted by JackFlash at 12:32 PM on December 20, 2011 [1 favorite]
Your winnings are calculated on the gross winnings. In the case of Oprah giving away a car to each of her audience members, the amount on the 1099 would equal the car+tax on car. So in your example the 1099 would have $5555.56 on it, 555.56 goes to the IRS, the remainder (the car) goes to the winner. Depending on where the winner lives, they might have state taxes due as well. These types of giveaways are rare since there's a huge desire to promote the gross value as opposed to what the customer actually receives after taxes. I think in the Oprah case, the show got the cars free from the manufacturers so the only out of pocket costs for them was the tax portion.
I managed campaign where we had a contest once where one lucky winner won a new car worth $35000 every day for a month. We pondered whether or not to "gross it up" to be able to let the winner keep the car w/o having to have that tax liability on it but it would mean we'd have to give away a cheaper car to fit into the prize budget. So instead, we offered winners a choice of the car or $25,000 cash. But the taxes were withheld on the actual check so it would be less than the $25K. I think 25 of the 30 went with the cash because they couldn't or wouldn't come up with the cash on a car that would lose a bunch of its value the second they drove it off the lot. The winner was also responsible for registration and local taxes on top of that. Although the car was pretty sweet, I'd probably take the cash too.
posted by birdherder at 12:35 PM on December 20, 2011
I managed campaign where we had a contest once where one lucky winner won a new car worth $35000 every day for a month. We pondered whether or not to "gross it up" to be able to let the winner keep the car w/o having to have that tax liability on it but it would mean we'd have to give away a cheaper car to fit into the prize budget. So instead, we offered winners a choice of the car or $25,000 cash. But the taxes were withheld on the actual check so it would be less than the $25K. I think 25 of the 30 went with the cash because they couldn't or wouldn't come up with the cash on a car that would lose a bunch of its value the second they drove it off the lot. The winner was also responsible for registration and local taxes on top of that. Although the car was pretty sweet, I'd probably take the cash too.
posted by birdherder at 12:35 PM on December 20, 2011
Best answer: You're looking for the phrase 'tax gross up'. This IRS publication gives you the calculation for an organization paying the tax on the prize for you.
"Organization Pays Withholding Tax: If the organization, as p art of the prize, pays the t axes required to be withheld, it must pay tax not only on the fair market value of the prize less the wager, but also on the taxes it p ays on behalf of the winner. This results in a grossed up prize requiring the use of an algebraic formula. Under this formula, the organization must pay withholding tax of 33.33% of the prize’s fair market value. The organization reports the grossed up amount of the prize (fair market value of prize
plus amount of taxes p aid on behalf of winner) in box 1 of Form W-2G , and the withholding t ax in box 2 of Form W -2G.
Example 4: If in Example 3, X pays the withholding tax on Jason’ s behalf, the withholding tax is $3,332.67 [($10,000 fair market value of prize minus $1 ticket cost) x 33.33%]. X must report $13,333 as the gross winnings in box 1 of Form W-2G , and $3,334.67 withholding t ax in box 2. "
posted by jacalata at 12:37 PM on December 20, 2011 [2 favorites]
"Organization Pays Withholding Tax: If the organization, as p art of the prize, pays the t axes required to be withheld, it must pay tax not only on the fair market value of the prize less the wager, but also on the taxes it p ays on behalf of the winner. This results in a grossed up prize requiring the use of an algebraic formula. Under this formula, the organization must pay withholding tax of 33.33% of the prize’s fair market value. The organization reports the grossed up amount of the prize (fair market value of prize
plus amount of taxes p aid on behalf of winner) in box 1 of Form W-2G , and the withholding t ax in box 2 of Form W -2G.
Example 4: If in Example 3, X pays the withholding tax on Jason’ s behalf, the withholding tax is $3,332.67 [($10,000 fair market value of prize minus $1 ticket cost) x 33.33%]. X must report $13,333 as the gross winnings in box 1 of Form W-2G , and $3,334.67 withholding t ax in box 2. "
posted by jacalata at 12:37 PM on December 20, 2011 [2 favorites]
Response by poster: Thanks jacalata, that looks like the cite I was looking for.
posted by obfusciatrist at 12:46 PM on December 20, 2011
posted by obfusciatrist at 12:46 PM on December 20, 2011
Is should be noted that the "tax gross up" method is only an approximation of the actual taxes due. Actual taxes may be more or less depending on the individual's tax circumstances and because it is only a single iteration. The gross up method works if all you are interested in doing is giving the recipient an approximate tax allowance.
If one wanted to do a more accurate calculation, you would have to do it iteratively. An example came up during the Timothy Geithner nomination hearings because he failed to pay taxes on his IMF salary. In this PDF you can see on page 17 in the attachments exactly how the IMF computes the tax allowance with an iterative example.
Iterations do make a difference. In the IMF example they start with a base pay of $50,000. After the first iteration the pay is $64,790, after the second $68,863, after the third $69,873 and after the fourth $70,171.
posted by JackFlash at 1:03 PM on December 20, 2011
If one wanted to do a more accurate calculation, you would have to do it iteratively. An example came up during the Timothy Geithner nomination hearings because he failed to pay taxes on his IMF salary. In this PDF you can see on page 17 in the attachments exactly how the IMF computes the tax allowance with an iterative example.
Iterations do make a difference. In the IMF example they start with a base pay of $50,000. After the first iteration the pay is $64,790, after the second $68,863, after the third $69,873 and after the fourth $70,171.
posted by JackFlash at 1:03 PM on December 20, 2011
Response by poster: 33.33% is a fully iterated form of 25% isn't it? If it stopped after one iteration it would be 31.25%. Or is my math bad.
Recognizing that the formula is just for withholding, all kinds of things will effect how much tax the person actually owes in the end
posted by obfusciatrist at 1:06 PM on December 20, 2011
Recognizing that the formula is just for withholding, all kinds of things will effect how much tax the person actually owes in the end
posted by obfusciatrist at 1:06 PM on December 20, 2011
Yes, 33.33% would work if the person's marginal tax rate is 25%, but not if the person's marginal tax rate were different to start with, or else changed as a result of the tax allocation. You could have a case near a boundary in which part of the prize is taxed at 25% and part at 28% or in which certain deductions or credits are phased out when you reach a certain threshold which changes the effective tax rate part way through the iterations. That is why the IMF uses an iterative process. 33.3% would be the simple iterative result for the majority of middle class people in the 25% bracket.
posted by JackFlash at 1:59 PM on December 20, 2011
posted by JackFlash at 1:59 PM on December 20, 2011
Interesting!
A number of large companies are now providing both health insurance to same-sex partners, and money to pay the taxes on that health insurance. Which has exactly the same problem of course.
posted by miyabo at 3:24 PM on December 20, 2011
A number of large companies are now providing both health insurance to same-sex partners, and money to pay the taxes on that health insurance. Which has exactly the same problem of course.
posted by miyabo at 3:24 PM on December 20, 2011
I think it's a pretty different scenario when a company is paying an employee, and when an organisation is giving a random prize to someone they have no other relationship with. My company paid for my relocation costs, and did an iterated tax gross up on this, but they already know all the other relevant information such as my tax bracket, and can do a much more individual calculation. In the prize winner scenario, the company probably has no access to any other financial details about the winner, and is probably not interested in varying the final value of the prize based on the eventual winner's current tax bracket anyway. Given these differences, I assume that there is a quite different set of best practices and conventions in the two scenarios.
posted by jacalata at 3:53 PM on December 20, 2011
posted by jacalata at 3:53 PM on December 20, 2011
Response by poster: According to the item jacalata linked to, anybody giving prizes over $5,000 should withhold 25% for taxes to the IRS. So that is what the iteration is based on.
If you're in a higher or lower tax bracket than that, I would imagine that is an issue between you, the IRS, and your tax return.
posted by obfusciatrist at 4:47 PM on December 20, 2011
If you're in a higher or lower tax bracket than that, I would imagine that is an issue between you, the IRS, and your tax return.
posted by obfusciatrist at 4:47 PM on December 20, 2011
This thread is closed to new comments.
There were a number of corporations in the late twentieth century who tried this dodge as a way of padding executive compensation. The IRS isn't stupid, and it issued a ruling--the citation for which escapes me at the moment--that this counts as taxable income.
posted by valkyryn at 12:18 PM on December 20, 2011