I Won the Gold Medal in Sochi. Awesome! Do I Owe Taxes on the Value of My Prize?
As a general rule, in accordance with IRC § 61, the value of any prize or award a taxpayer receives is subject to taxation. IRC §§ 74 and 117 provide limited exceptions to this general rule.
IRC § 74 specifically excludes from the income of the recipient certain employee achievement awards and certain prizes or awards transferred to charitable organizations prior to receipt. IRC § 117 specifically excludes from the income of the recipient “qualified scholarship” proceeds. These exceptions are subject to rigid qualifications.
The value of prizes and awards which do not come within the parameters of these limited exceptions are subject to taxation. Consequently, as we know, the winning ticketholder of the lottery is taxed on his or her winnings. The recipient of the Nobel Prize is subject to taxation on the cash prize he or she receives. Likewise, the value of the ring received by each of the members of the Seattle Seahawks this year for winning the Super Bowl is subject to taxation. Also, the value of the rings received by each member of the Miami Heat for winning the NBA championship in 2012 and 2013 is subject to taxation.
Is a full time gambler in the trade or business of gambling? If the answer is yes, two results follow (one result which is good and one result which is not so good): (1) the gambler is able to deduct under Section 162 of the Code all of the ordinary, necessary and reasonable expenses incurred in carrying on the business; and (2) the net income of the gambler, if any, is subject to self-employment tax under Section 1401 of the Code.
In 1987, the United States Supreme Court was presented with the issue of whether a full time gambler was engaged in the trade or business of gambling. Commissioner v. Groetzinger, 480 US 23 (1987). Justice Blackmun issued the court’s opinion. The Supreme Court thoroughly reviewed the history of the phrase “trade or business” in the context of the Internal Revenue Code. The court stated: “[T]o be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income profit. A sporadic activity, a hobby, or an amusement diversion does not qualify.” Whether a taxpayer is engaged in a trade or business is a question of facts and circumstances.
In Groetzinger, evidence revealed the taxpayer spent substantial amounts of time preparing for and actually gambling. He had been gambling for a long period of time; the activity was not sporadic. It was continuous. Mr. Groetzinger had no other “profession or type of employment.” He engaged in gambling with the intent to make a profit. The court ultimately concluded, gambling may constitute a trade or business, and based upon the facts presented, Mr. Groetzinger was engaged in the trade or business of gambling.
Mr. Groetzinger won the battle in that his victory allowed him to deduct is ordinary, necessary and reasonable expenses associated with his gambling activities. He lost the war in part because his net income (if any) would now be subjected to self employment taxes. The result was likely unsuspected by the taxpayer.
Faris Fink, Commissioner of the Small Business/Self-Employed Division of the Internal Revenue Service, announced at the AICPA National Tax Conference on November 5, 2013, that his division is moving its audit focus from corporations to pass-through entities (i.e., S corporations, partnerships and sole proprietorships).
Fink was candid when he said his employees do not currently have the skills and knowledge to conduct these examinations. In anticipation of its new focus, however, the Service is developing pass-through entity examination strategies and is training its audit staff to conduct the exams. Practitioners should expect to see significantly more pass-through entity examinations in 2014. One would suspect these examinations, especially early on, will be challenging for taxpayers and their advisors.
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Larry J. Brant
Editor
Larry J. Brant is a Shareholder and the Chair of the Tax & Benefits practice group at Foster Garvey, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; Washington, D.C.; New York, New York, Spokane, Washington; Tulsa, Oklahoma; and Beijing, China. Mr. Brant is licensed to practice in Oregon and Washington. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long-term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
