Q:

Subject:  Taxable Prizes

Hi Mr. Kerstetter,
 
I won a prize during July 2009.  The official rules posted in June stated the value of the prize to be $5,084.  I received part of the prize in October 2009 and on that day I priced that model at a nearby store to be $3,010.  About a month later I received the final part of the prize and I again valued it at the same store, $599.  A total fair market value of $3,609.  I contacted both the sponsor and the fullfillment company regarding the 1099 they will send me later this month.  Both stated it would be for the amount posted in the rules and that if I disagreed I could dispute it with the IRS. I requested a copy of the invoices to see the actual fair market value of what the spent and they declined. The 1099 instructions state the FMV of any prizes should be used.  So I am not sure how they are getting away with the fraud using average retail value when they had to actually order these items.  Is my only recourse to wait to have the 1099 in hand and call the IRS to issue them a 4589?
 
Thank you

A:

You must either be trying to prepare your own tax returns or are working with a new inexperienced professional tax advisor because this is a very easy situation to deal with.  I have had several similar cases over the years exactly like this.

There is no need to get into a fight with the company that awarded you the prizes over the 1099.  It is standard practice for them to use as high a value on the prizes as they can justify for their own publicity purposes.  They couldn’t care any less about any tax problems this may cause you.

Only fools accept the figures on 1099s as gospel and use them unchanged on tax returns if there is good reason to suspect that they are incorrect.

As you should know, the legal burden of proving the accuracy of the figures on your tax return is on you.  If you have done your homework and properly documented the true fair market value of the items you won as of the same dates, you can use those figures as your actual prize income.  In fact, I would even attach copies of the documentation to your 1040 to avoid any IRS need to ask for it later on.

The way you avoid any problems with IRS not matching up their 1099 figures to your tax return is to use a backup schedule for Line 21 (Other Income) of your 1040.  On it, your professional tax preparer should enter the full amount shown on the 1099 you received as a positive number.  Below that, enter “Adjustments to reflect real world retail values per attached documentation” and enter negative numbers that will bring the net value into line with what you have determined to be reality.

I have done this literally dozens and dozens of times on client tax returns over the years, and IRS has never once disputed our adjusted values.

What you didn’t mention or ask about are the deductions that you can claim due to your reporting this prize income.  Prizes of the kind you received are in the same category as Gambling income.  When you report gambling and prize income on Line 21, you are eligible to deduct gambling losses on Schedule A of up to the amount of the reported net winnings.  Of course, these have to be legitimate and reasonable.

You can count all different types of gambling losses, including office pools, lottery tickets, raffle tickets, casinos, race tracks, as well as any entry fees for the drawing you won and other similar ones during the year.  If you do a thorough enough job of documenting your losses, you may well be able to completely offset the income you are reporting on Line 21.

Again, you should be working with an experienced professional tax advisor who can ensure that these items are all properly shown on your tax returns.

Good luck.  I hope this helps.

Kerry Kerstetter

Follow-Up:

Thanks Kerry – this is a great big help!

 

Sincerely,