And the winner is . . . you (and the IRS)

By Jeff Schnepper

Not long ago, a friend sent me a news article about someone of modest means who had won a trip to Africa valued at more than $20,000.

I was of two minds about the winner's luck. If the winner makes $30,000 a year, a trip to Africa is a once-in-a-lifetime experience, and he should enjoy it. But what about the tax bill he'll get stuck with?

Taxes? Yes, the taxes. The safari winner may, in fact, owe the federal government as much as $5,000.

Yes, sometimes, even when you win, you can still lose. Everyone knows that income is taxable, but there's lots of stuff you really didn't know that counts as income and could add to your tax bill. Here's a rundown.

If you win, you pay

If you enter a contest and win, your winnings are taxable income. It doesn't make any difference how you win the prize. You can win a drawing at the county fair. Ditto for a beauty pageant. You may get $1 million because your cure for cancer won the Nobel Prize for medicine. You may invent the next new hot bit of software and get a huge bonus.

How you get the prize -- whether it's cash or a new Mercedes -- makes no difference to the Internal Revenue Service; it is all taxable.

Cash prizes have one big advantage over noncash prizes. They give you the liquidity to pay your fiscal fine.

Bartering

If you get audited, one of the first questions you'll be asked is whether you did any bartering. Bartering is the exchange of goods or services directly for other goods and services.

If I do my neighbor's taxes in exchange for his mowing my lawn all summer, we both have income. He should be taxed on the value of my preparing his taxes, and I should be taxed on the value of his mowing my lawn.

It's done all the time -- you can use my sailboat if I can use your cottage in the mountains for the weekend. Again, we both have taxable income equal to the value of what we receive.

Most people don't report this informal income because they don't even realize it's income, and it would be just about impossible for the IRS to trace all of those informal exchanges. But the IRS can and does track bartering clubs, which are now required to issue 1099 forms for exchange transactions.

Can you beat the IRS?

There aren't many ways to keep your good fortune from the tax man. Probably the best way is to have the prize or award directly given to the charity of your choice. But you don't get the charitable-donation deduction. You simply exclude it from income. It's as if you never got the award.

There is another, more subtle way to limit your tax exposure. You include prizes and award winnings as income on your return at their fair market value to you. This is very important. It's not the general fair market value but rather the fair market value to you.

• Video: Are you a victim of the alternative minimum tax?

Let's say you already have two new attaché cases and, on a quiz show, win a third that normally retails for $200. The value of that third attaché case to you may be negligible. It clearly wouldn't be its full retail selling price.

So you could try to run a new, lower price by the IRS. The burden, however, is on you to prove the reduced value.

If you sell the item, the amount received is normally deemed to be its fair market value. If, for example, you're awarded a car that retails for $30,000 and you immediately sell that car to someone else in town for $20,000, the amount you would include in your income should be the lower amount, or $20,000.

Be careful here, though. If you sell the car to a relative, the IRS will argue that you received $30,000 in income and made a nondeductible gift of $10,000 to your relative. Sorry.

Continued: Sticky questions

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