Tag Archives: records keeping

Prizes, winnings and taxes – Part 2

How to figure the fair market value for tax reporting

Calculating tax on prize winnings

Raffle winnings need to be run through a formula to determine the amount of tax owed.

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.

 

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‘Tis the Season for Charitable Contributions

Season of GivingAs this holiday season rapidly approaches, you might want to get your charitable efforts well underway before your schedule spins out of control … again … like it does every year.

So right now, before bad weather sets in and everybody heads south for the season, it’s the perfect time to catch local businesspeople and ask for donations of cash or products for your next raffle or drawing. With Thanksgiving still a couple of weeks away, you’ll be able to find most business owners in their offices. Many of them will be feeling warm, charitable thoughts (and it’s not just because they haven’t yet opened their credit card statements or suffered through the 300th rendition of “I want a hippopotamus for Christmas”.)

At year’s end, many businesses might have unsold inventory they need to clear out to make space for next year’s products. And, let’s not overlook the fact that many of these businesses can be greatly benefited by squeezing in a bit of last-minute tax deductions! Many businesses have their fiscal year’s-end coming up and every little bit makes a difference.

There are a few rules your business friends should be aware of before they start packing your arms full of unsold inventory. I recommend reading a recent article by About.com’s contributor William Perez called ” Tax Deduction for Charity Donations Contributions to churches and non-profits are tax-deductible.”

Perez points out that a gift of cash or property must meet certain criteria in order to be tax-deductible.

Businesses must actually donate cash or property. A pledge or promise to donate is not deductible until they actually pay.

They must contribute to a qualified tax-exempt organization.A qualified charity will be able to provide the business with the proper documentation to prove their 501(c)(3) tax-exempt status. Not all organizations, such as churches and religious organizations are required to obtain 501(c)(3) status from the IRS.

Proper records must be kept. This includes saving canceled checks, acknowledgment letters from the charity, and appraisals for donated property. Contributions of property (other than cash) are also subject to strict record keeping and substantiation rules. The business must be able to substantiate the fair market value of the goods or property donated, plus keep any written acknowledgments you receive from the charity.

There are limitations on the deduction that can be applied. A charitable contribution’s tax deduction may be limited. There are limits specific to charitable contributions, and there are general limits on itemized deductions. A properly certified accountant is the best source for this information.

Not all contributions are tax deductible. Contributions are not tax deductible if given to any of the following:

  • Political parties, political campaigns, or political action committees.
  • Contributions given to individual people.
  • Fees or dues paid to professional associations.
  • Contributions to labor unions, chambers of commerce, or business associations.
  • Contributions to for-profit schools and hospitals.
  • Contributions to foreign governments.
  • Fines or penalties paid to local or state governments.
  • The value of your time for services rendered to a non-profit.

Charities should be ready to provide documentation to businesses regarding their donations in a timely manner. This includes both cash and non-cash contributions. No tax deduction will be allowed if the taxpayer cannot provide any supporting documentation –  and that might make the business owner less likely to contribute next year.

IRS Resources: