Every so often tax practitioners will encounter a client who has won a noncash prize or vacation trip from a game show, or won a car or even a house from the purchase of a charity raffle ticket. Whatever the noncash prize or the source of the prize, one thing is for certain, the winner must pay taxes on the fair market value (FMV) of the prize (Reg. Sec. 1.74-1(a)(2)).
This is where things get complicated. The definition of FMV that has been adopted by tax courts for general income tax purposes is “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.”
Where the prize value is $600 or more and no services were performed, the FMV of the prize is reported in box 3 of Form 1099-MISC (2017 1099-MISC Instructions, Pg. 5). Since the awarding entity has no way of determining what a willing buyer might pay a willing seller, they quite often use the manufacturer’s suggested retail price of the item or some other means of determining the amount they enter in Box 3, which may not be the true measure of FMV.
Thus the amount in box 3 is disputable if it can be reasonably established and documented that the FMV is different. Tax courts have frequently taken special factors into consideration in determining the fair market value of awards and prizes.
It is understandable that a prizewinner may not be able to resell the prize for as much as the awarding entity valued it. The Tax Court says in this situation, resale value, not cost, determines the amount of income reportable by the taxpayer (McCoy, Lawrence W, (1962) 38 TC 841, acq 1963-2 CB 5).
Where a taxpayer argued a trip prize was not worth the retail price to him, the court agreed (Turner, Reginald (1954) TC Memo 1954-38). In another case the court reduced the retail price to the discounted price the awarding entity paid for the trip (Wade, Nathan, (1988) TC Memo 1988-118). In the latter case, the court wrote: “In valuing taxable prizes and awards for Federal income tax purposes, courts do not always adopt the same methodology. In some situations, the retail value of prizes and awards is used. In other situations, a wholesale or other discounted value is used….Objective factors are emphasized, but subjective factors also are given weight in determining the value of prizes and awards to particular taxpayers.”
For some items a retail advertisement for the item around the time the prize was won could help to determine FMV. If someone is lucky enough to buy the winning ticket for a large ticket item such as a home, it might be appropriate to obtain a certified appraisal.