Posted by Karen Munoz, EA

Are Merit Awards and Prizes Taxable?

Are Merit Awards and Prizes Taxable?

What if you had the chance to win an award of excellence for your outstanding contributions to art, community service, or science? Do you have to pay income tax on this amount? The short answer is yes. Unsolicited prizes or merit prizes are fully taxable except for the United States Olympic Committee's cash prizes due to competing at the Olympic or Paralympic Games.

It may not seem right, but the IRS and state tax agencies don't care if you didn't apply for the award or only received it after years of hard work for society's benefit. For the IRS, money is money, and they want their share.

If you are in the United States, the issuing entity will have to report the amount paid to the IRS, so you cannot claim that you never received it. If you don't report it for income tax, the IRS will detect it and send you an invoice. However, whether or not you pay the award fee depends on how you use the money.

If all the money is in your pocket, you will have to pay all of the income tax. The tax will be due for the year you receive the money. The amount you will need to pay depends on the higher tax category.

You can avoid paying tax on an award by donating the money. You can't give money to just anyone, for example, a family member. The money must be donated in good faith to a tax-free charity. This includes any nonprofit organization that operates exclusively for scientific, educational, religious, or charitable purposes, such as helping the poor. 

How to claim a charitable deduction

One strategy is to cash the check, return the funds to selected charities or institutions, and deduct the amount as a charitable contribution. If you do this, you must first report your income on your tax return. However, if you are eligible for the tax deduction, the deduction will offset the additional income you report.

Example: John receives a $10,000 scholarship from the American Medical Society to contribute to medicine. He redeems the check and donates the full amount to a 501 (c) (3) charity. John also includes the $ 10,000 of his annual income on his tax return for that year. John will be able to itemize his deductions by deducting $10,000 in taxes as a charitable contribution. This offsets the $ 10,000 income from the award he reported.

However, under the TCJA, it is much more difficult for many taxpayers to deduct their charitable contributions. This is because, to do this, you must itemize your deductions in IRS Schedule A instead of taking the standard deduction. Personal deductions include charitable contributions, interest on home loans, up to $ 10,000 in state and local taxes, and a few other items. TCJA nearly doubled the standard deduction from the previous law to $ 12,000 for single taxpayers and $ 24,000 for couples filing jointly. As a result, far fewer taxpayers will discriminate and be able to claim charitable deductions because the limit for exceeding the standard deduction amount is too high.

Example: Suppose John, in the previous example, is married. He and his wife are entitled to a standard deduction of $ 24,000. Including the charitable contribution of $10,000, their total personal deductions add up to $ 20,000, so they do not have to itemize their deductions. Therefore, Charles cannot deduct his contribution of $ 10,000.

If the award is very high, you may have little difficulty itemizing your deductions. However, please note that the annual charitable donation deduction is limited to 60% of your adjusted gross income. Therefore, it may be necessary to deduct a very large award over several years.

Exclude the award from your income

Fortunately, there is a way to give out an award without having to report it as income on your tax return and then deduct it as a charitable contribution. A special tax rule provides that a person who receives an award in recognition of his scientific, educational, literary, religious, artistic, or civic achievements must not include money in his income if:

  • Before receiving the prize, indicate in writing to the entity that the money will be transferred directly to a charity or a tax-free government unit (which you can select). Money should never be in your hands. 

  • The award was unsolicited. 

  • You are not obligated to provide substantial future services as a condition of receiving the award.

If you do all of this, you won't have to report the prize as income on your tax return, and you won't have to make a charitable deduction. In other words, for tax purposes, as if the prize had never been awarded. If you want to donate money to charities, this is the way to go. 



Karen Munoz, EA
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