Before Bob Dylan accepts his Nobel prize for literature or you accept your prize for notarial science, keep in mind that Internal Revenue Code Section 61(a) states that all income from whatever source derived is includible in gross income, unless specifically excluded.
Bob Dylan’s monetary prize won’t be known until later this year (the award ceremony is in December); the 2015 award was 8 million Swedish kroner, close to $1 million—not chopped liver or Swedish meatballs.
Before the Tax Reform Act of 1986 (TRA ’86), prizes and awards for charitable, religious, scientific, educational, artistic, literary or civic achievement could be excluded from gross income if the recipient hadn’t applied for the award and wasn’t required to render substantial services to receive it. But since TRA ‘86, even if a prize meets those requirements, it can be excluded from gross income only if the recipient assigns it to a governmental unit or charity entitled to receive deductible charitable contributions.1 Amounts assigned by the prize recipient aren’t deductible charitable contributions.
The Joint Committee on Taxation’s General Explanation of TRA ‘86 fleshes out the IRC:
The designation must be made by the taxpayer (the award recipient), and must be carried out by the party making the prize or award, before the taxpayer uses the item that is awarded (e.g., in the case of an award of money, before the taxpayer spends, deposits and invests, or otherwise uses the money). [emphasis supplied]
Disqualifying uses by the taxpayer include such uses of the property with the permission of the taxpayer or by one associated with the taxpayer (e.g., a member of the taxpayer’s family). Absent a disqualifying use, however, the taxpayer can make the required designation of the governmental unit or charitable organization (to which the award is to be transferred by the payor) after receipt of the prize or award.
A prize recipient has three choices (not mutually exclusive):
1. Accept the prize and pay the income tax. Use the remaining balance of the prize to buy a Porsche, pay kids’ tuition—you get the idea.
2. Accept the prize and contribute it to charity. Although the prize will be includible in gross income and adjusted gross income (AGI), an itemizer gets an income tax charitable deduction of up to 50 percent of AGI for cash gifts to public charities and up to 30 percent of AGI for those gifts to private foundations. ‘‘Excess’’ 50 percent and 30 percent type gifts are deductible up to the applicable AGI ceiling in each of the five following years.
3. Assign the award to charity before using, depositing, investing, or spending it (if it meets the requirements described at the beginning of this article).
Caution re: choice 2 (above). If your client will have a carryover that lasts for more than five years, she should see a tax professional immediately. He’ll tell you that the 5-year carryover can’t be extended and there may be side effects. The prize increases AGI. Even if it’s fully deductible as a charitable deduction, increased AGI can adversely affect the medical and casualty loss deductions that have a 10 percent AGI floor. Did I mention that the 2 percent floor on miscellaneous itemized deductions will also be raised? As you work your way toward determining taxable income, you’ll no doubt think of other unfavorable tax consequences that arise when gross income and AGI are increased, even though the amount of the gift is fully deductible. Also, for high-income taxpayers, an increase in AGI can make their personal exemptions fade away and subject them to the “3 percent reduction of deductions” rule.
As noted, choices 1, 2, and 3 aren’t mutually exclusive—so your client can keep some of the prize (paying taxes), give some of it to charity (claiming allowable charitable deductions) and assign part of it to charity (keeping it out of gross income and AGI).
Reminder: Also, check any state income tax rules.
Assignment of Prizes or Awards
If your client decides to assign the prize or award to charity (to keep it out of gross income and AGI and, of course, to benefit charity, the IRS tells how to do it.2 The IRS gives language for the recipient-donor to use when requesting that the prize be assigned to a charity and language for the prize payer to use when acknowledging the transfer. This isn’t the only way to do it, but it is good to sail into a safe harbor.
Author’s disclosure: No taxpayers were harmed in the writing of this article. And I hope some charities will benefit.
The Gold Medal
In addition to the cash prize, the Nobel laureate also receives a gold medal. The medal’s fair market value (FMV) is also includible in the recipient’s gross income.
But what’s the medal’s FMV? Is it the value of the precious metal? Some Nobel prize recipients have sold their medals for millions of dollars. Does FMV depend on how much a particular recipient can get for the medal if she were to sell it? Might a Nobel Prize in tax economics be awarded for interpretation of the IRC? Just asking.
The “United States Appreciation for Olympians and Paralympians Act of 2016" (signed by President Obama) on Oct. 7 excludes from gross income the value of any medal awarded in, or any prize money received from the United States Olympic Committee on account of competition in the Olympic Games or Paralympic Games.
Exception. Any taxpayer who in any taxable year has AGI (determined without regard to this new IRC provision) of over $1 million (half of that amount for a married individual filing a separate return) must include the prize in his gross income.
Effective. Prizes and awards received after Dec. 31, 2015.
- Internal Revenue Code Section 74(b)(3).)
- See Revenue Procedure 87-54.
© Conrad Teitell 2016