How Are Prize Money and Winnings Taxed?

Receiving a prize or award brings tax responsibilities, as the federal government and most state governments view winnings as income. To comply with tax laws, winners must understand what constitutes a taxable prize, how to calculate the potential tax liability, and how to correctly report the income to the appropriate tax authorities.

What Constitutes a Taxable Prize

The Internal Revenue Service (IRS) considers all prizes and awards to be taxable income. Whether you win cash or a physical item, its value must be included in your gross income for the year. This rule applies even if you did not actively enter a contest to win the prize, as the tax code does not distinguish between winnings from luck and those earned through effort.

Prizes fall into two main categories: cash and non-cash. For cash prizes like lottery payouts or raffle proceeds, the amount of cash received is the amount you must report as income. For example, a $10,000 prize from a local radio contest is considered $10,000 of taxable income.

Non-cash prizes, such as cars or vacations, are valued at their Fair Market Value (FMV), which is the price an item would sell for on the open market. The prize provider is responsible for determining the FMV and reporting it to you and the IRS. If you win a car with an FMV of $40,000, you have $40,000 in taxable income, which can create a tax liability without providing the cash to pay it.

Determining Your Federal Tax Obligation

Prize money is taxed as ordinary income, meaning it is taxed at the same rates as your wages or salary, not as a capital gain. A large prize can increase your total income for the year, potentially pushing you into a higher marginal tax bracket. This means the portion of your income that falls into this new, higher bracket will be taxed at a higher rate.

For certain winnings, tax withholding is automatic. If you win more than $5,000 from sources like lotteries or sweepstakes, the payer is required to withhold 24% of the net winnings for federal income tax. This 24% is an initial payment toward your total tax liability. Depending on your final income and tax bracket, you may owe more than what was withheld, so if your winnings push you into the 37% tax bracket, you will be responsible for the difference when you file your taxes.

Winners of large prizes, such as a major lottery jackpot, face a choice between a lump-sum payment or an annuity. A lump-sum payment means you receive the entire prize at once, and the full amount is taxed in that year, which can place you in the highest federal income tax bracket. An annuity provides annual payments over a set period, allowing you to pay taxes only on the amount you receive each year, which can help manage your annual tax burden.

State and Local Tax Considerations

Beyond federal taxes, most states also tax prize winnings as income. The rules and rates for state and local taxation vary across the country. Some states have no income tax at all, meaning you would not owe any state tax on your prize if you are a resident.

Other states tax winnings according to their standard income tax brackets, similar to any other form of income. A few states have a specific, flat withholding rate for lottery or gambling winnings that is separate from their regular income tax system. This rate is applied directly to the prize amount, regardless of the winner’s other income.

You must also consider non-resident tax rules. If you purchase a winning lottery ticket in a state where you do not live, you will likely owe taxes to that state on your winnings, in addition to any taxes owed to your home state. Some states have reciprocity agreements that can simplify this situation, but it often means filing tax returns in multiple states.

Tax Reporting Requirements

When you receive certain winnings, the payer is required to provide you with Form W-2G, “Certain Gambling Winnings.” The payer must issue this form if your winnings meet certain thresholds. For example, a W-2G is required for winnings of $600 or more from lotteries or sweepstakes if the prize is at least 300 times the wager, $1,200 or more from bingo or slot machines, and $1,500 or more from keno.

The information from Form W-2G is reported on your annual tax return. You will transfer the amount of your winnings to Schedule 1 (Form 1040) on the line for “Other income.” This amount is then included in your total income calculation on your main Form 1040. You must report these winnings even if you do not receive a Form W-2G.

If you have gambling losses, you may be able to deduct them by itemizing your deductions on Schedule A (Form 1040). However, you can only deduct losses up to the amount of your winnings. You cannot deduct more in losses than you won during the year or use them to reduce other types of income.