How to figure the fair market value for tax reporting
Last time, we looked at how to determine whether a raffle prize must be reported to the IRS. Now let’s look at some of the perhaps lesser-known or less-understood aspects of income tax law as it relates to raffles.
Backup withholding applies to raffle prizes, to the tune of 28% of the total proceeds, if the prize is otherwise subject to reporting (that is, the amount of the prize minus the amount wagered is $600 or more and 300 times the amount of the wager) and the winner doesn’t provide a correct taxpayer identification number (TIN) – a Social Security number, an individual taxpayer identification number or an employer identification number (EIN).
The rules are a little different for noncash prizes: the winner must pay the organization 25% of the fair market value of the prize minus the wager cost.
For example, let’s say Emma purchased a $1 ticket for a raffle conducted by an exempt organization called ABC. On March 28, 2012, Emma won a drawing for a car with a fair market value of $20,000. Because the prize exceeds $5,000 and the fair market value of the car is $20,000, the tax on the fair market value of the prize is $4,999.75 [($20,000 minus the $1 ticket cost) x 25%)]. Emma must pay $4,999.75 to ABC, which will in turn remit this amount to the IRS on Emma’s behalf.
To remit this tax, ABC will need to indicate the car’s fair market value ($20,000) in box 1 and the amount of the withholding tax paid ($4,999.75) in box 2 on Form W-2G.
What if the organization pays the withholding tax as part of the prize? In such a circumstance, the organization must pay tax not only on the fair market value of the prize less the wager, but also on the taxes it pays on behalf of the winner. This requires the use of an algebraic formula.
To do this, the organization must pay a withholding tax of 33.33% of the prize’s fair market value and report the grossed-up prize amount – the fair market value of the prize plus the amount of taxes paid on behalf of winner – in box1of Form W-2G and the withholding tax inbox2.
If ABC pays the withholding tax on Emma’s behalf, the withholding tax is $6,665.67 [($20,000 fair market value of prize minus the $1 ticket cost) x 33.33%]. ABC must report $26,666 as the grossed-up prize winnings inbox1of Form W-2G, and $6,665.67 withholding tax inbox2.
To report and send withheld tax to the IRS, the organization must send in Form 945 by Jan. 31 of the year following the year in which taxes were withheld (be sure to mark the Form 945 checkbox on Form 8109, the federal tax deposit coupon!) and list its EIN on Forms W-2G, 1096 and 945. Don’t have one? Use Form SS-4, Application for Employer Identification Number or visit www.irs.gov under the topic Employer ID Numbers on the Businesses Contents page to apply for an EIN.