Spaced Out About Taxes
In an Associated Press story that has been posted on a number of news sites (see, e.g., here), we learn that the lucky winner of a sweepstakes has declined to accept his award because of the tax consequences. Having won a "free trip to outer space," our lucky winner calculated that the award (which has a value of $138,000) would cost him about $25,000 in taxes. He concluded that this was more than he was willing to spend, and he declined the award with the philosophical comment: “I was, however briefly, a potential astronaut." The article reports that he "doesn't blame anyone."
That doesn't stop other people from blaming the IRS, of course. The sub-headline on MSNBC.com's website reads: "IRS brings hype over suborbital ticket giveaways back down to earth." Even TaxProf.com, which is notable for its even-handed treatment of tax issues, couldn't resist this headline: "IRS Grounds Prize Winner from Trip to Outer Space." The article, however, makes clear that the IRS did not get involved in this case at all. The prize-winner, having received news of his award, responsibly inquired into the tax treatment of such awards and learned that they are taxable as regular income. He then computed his potential tax payment and decided that he did not want to accept the free trip. This is not even a case where the IRS issued an advisory about a murky issue (such as celebrity "swag bags" at awards shows--which are taxable, by the way). The most that one can say is that the IRS, being the "tax cops," were known to be in the background if the prize-winner had tried to cheat. The IRS is everyone's favorite villain, even when it does nothing more than stand ready to apply the law even-handedly.
The IRS aside, why does the AP think it is worth saying that the prize-winner's dream "was crushed when he had to cancel his reservation because of Uncle Sam," or that space trips "can get mired in that most earthbound hassle: taxes"? As a legal matter, it's completely settled that free trips are "income" and thus taxable. (For that matter, they are also consumption and would be taxed under a consumption tax regime.) As a policy matter, why (and, for that matter, how) would we create an equitable exception for this? Other people have to earn and save $138,000 if they want to take this trip, after paying taxes on their income. This prize-winner was being told that he could take a $138,000 trip for $25,000. He also "became an instant celebrity, giving media interviews and appearing on stage at Oracle’s trade show."
Anyone who thinks that the poor guy should get an even bigger break is free to pay the taxes for him. Several companies that provide these types of prizes, including Virgin Atlantic and Microsoft, reportedly pay cash to cover the winners' taxes. (As the AP article points out, such payments are also subject to taxation, but there is a simple "grossing up" formula to determine how much the prize-winner would have to receive in cash to be able to pay his tax bill, take the trip to space, and not pay a dime out of pocket.) Installment payments are also potentially available. In the meantime, I'm glad that prize-winners are subject to paying taxes on their income under the same rules that apply to taxing everyone else's income, thus preventing the necessity of raising tax rates or increasing the deficit.
That doesn't stop other people from blaming the IRS, of course. The sub-headline on MSNBC.com's website reads: "IRS brings hype over suborbital ticket giveaways back down to earth." Even TaxProf.com, which is notable for its even-handed treatment of tax issues, couldn't resist this headline: "IRS Grounds Prize Winner from Trip to Outer Space." The article, however, makes clear that the IRS did not get involved in this case at all. The prize-winner, having received news of his award, responsibly inquired into the tax treatment of such awards and learned that they are taxable as regular income. He then computed his potential tax payment and decided that he did not want to accept the free trip. This is not even a case where the IRS issued an advisory about a murky issue (such as celebrity "swag bags" at awards shows--which are taxable, by the way). The most that one can say is that the IRS, being the "tax cops," were known to be in the background if the prize-winner had tried to cheat. The IRS is everyone's favorite villain, even when it does nothing more than stand ready to apply the law even-handedly.
The IRS aside, why does the AP think it is worth saying that the prize-winner's dream "was crushed when he had to cancel his reservation because of Uncle Sam," or that space trips "can get mired in that most earthbound hassle: taxes"? As a legal matter, it's completely settled that free trips are "income" and thus taxable. (For that matter, they are also consumption and would be taxed under a consumption tax regime.) As a policy matter, why (and, for that matter, how) would we create an equitable exception for this? Other people have to earn and save $138,000 if they want to take this trip, after paying taxes on their income. This prize-winner was being told that he could take a $138,000 trip for $25,000. He also "became an instant celebrity, giving media interviews and appearing on stage at Oracle’s trade show."
Anyone who thinks that the poor guy should get an even bigger break is free to pay the taxes for him. Several companies that provide these types of prizes, including Virgin Atlantic and Microsoft, reportedly pay cash to cover the winners' taxes. (As the AP article points out, such payments are also subject to taxation, but there is a simple "grossing up" formula to determine how much the prize-winner would have to receive in cash to be able to pay his tax bill, take the trip to space, and not pay a dime out of pocket.) Installment payments are also potentially available. In the meantime, I'm glad that prize-winners are subject to paying taxes on their income under the same rules that apply to taxing everyone else's income, thus preventing the necessity of raising tax rates or increasing the deficit.
posted by Neil H. Buchanan @ 12:12 PM
10 Comments:
At 1:09 PM,
dsc25 said…
Why the fuss? It's simple - because everyone likes to complain about taxes, even when there's no reason to. As the saying goes, "People who complain about taxes can be divided into two classes: men and women."
At 2:43 PM,
Neil H. Buchanan said…
I'm sure that dsc25 is right, which makes it all the more interesting that the person directly affected by this was so mature about it.
It is not, however, merely an amusing quirk of human nature that people like to complain about taxes. Pervasive anti-tax and anti-IRS sentiments lead to bad tax policies and under-funding of enforcement efforts.
At 6:54 PM,
Adam S. said…
I disagree with the entirety of the post. There is a false parallel and false symmetry to the seeming justification of "why should he be upset to pay $25,000" for a trip with a VALUE of "$138,000" and the added point that "others would have to pay x amount" blah blah. The trouble is that with respect to certain non divisible or non liquid goods, it is not always justifiable to make parallels and analogies to liquid goods or liquid transactions. Where you receive cash in a casino or from a gameshow you simply convey a part of that cash to Uncle Sam, while you retain the remainder. But with respect to a trip to the moon or some antique or other indivisible good, to tax the award is to make such award unavailable entirely to all but those who would be so fabulously wealthy as to be able to purchase such a good or service outright. The whole FUN and POINT of these awards, though, is to allow the ordinary rather than the exhorbitantly wealthy person a chance to enjoy something unique. Of course, that service has a value, and that value is probably captured reasonably well by using market proxies, but I wonder if in situations such as these the tax might be applied only where the person transfers the good or service to someone else in exchange for cash. That is, the government steps in where there is a realized pecuniary gain, rather than simply an experiential utility dervied from flying to Titan.
At 7:09 PM,
Caleb said…
This is a slightly orthagonal comment, but (sorry for the jingoism) in Canada, lottery and sweepstakes prizes are not taxed (neither are gains from gambling).
While this means that you can feel free to enter contests and sweepstakes with impunity, it has some potential side effects that might be detrimental.
During undergrad, I worked for a while in a meat-packing plant in order to pay for school. My co-workers (unionized long-term workers for the most part) loved to gamble. There were multiple groups who pooled their money to purchase lottery tickets, and regular trips to the closest casino on weekends. Whenever I was asked to participate (which was frequently), I was assured that my winnings would be tax free.
It seems to me that to the extent leaving lottery and gambling (and sweepstakes) winnings untaxed contributes (on the margin at least) to an increase in gambling or lottery purchases, taxing them is certainly justified in the public interest. This might be an oblique way to attack the problem, but it's a pretty simple way, and doesn't involve walking down the path towards the "nanny-state".
(Of course, if you don't agree that lotteries and gambling are detrimental as a "tax" on poorer segments of society, then this argument falls apart).
At 8:08 PM,
Adam S. said…
Caleb,I would distinguish taxation of lottery from other forms of gift or gambling taxation. Lottery itself is a form of revenue raising by the government. That is, your expected value is quite low, because other people put money in, but also because the government takes out a chunk before it awards anything to the winner. To then tax again the individual winner always seemed "unfair" to me, whatever that means, anyway. Analyzing Gambling in Pigouvian terms is also a bit odd to the extent that the default rule tends to be illegality, and all licesnses are presumably granted precisely because the government wants to ENCOURAGE the activity because it spreads money through the community by creating jobs from the attendant shows, lodging etc. Of course, as I say this I recall a guy on NPR this very morning asserting that gambling is a terrible way to try to raise money because you create addicts and simply shift money from many to the casino builders while creating crime and corruption in the process. I guess he assumed that the shows, lodging, building, and other activities don't create enough value to outweigh the costs, but this is all ancillary to the point that the government is presumably trying to encourage high volume in the case of licensed gaming.
At 9:14 PM,
Michael Yuri said…
This is an old issue in tax law and it comes down to the difference between subjective and objective value.
Under an ideal income tax, people would be taxed on the subjective value of non-monetary income (the same is true of an ideal consumption tax.) However, since subjective value is usually impossible to determine, the tax code uses fair market value instead.
In most cases, this is perfectly reasonable. If I receive something for free, and I would have been willing to buy it myself anyway, then obviously its subjective value to me is at least fair market value. However, in the case of prizes that the individual wouldn't have purchased on his own, the subjective value is lower.
If the subjective value is only slightly lower, this isn't a big deal. For example, suppose I win a prize worth $10, but I subjectively value it at only $5. If I only pay $3 in taxes (on the $10 fair market value), then I still come out ahead. However, this is a major issue in the taxation of employment benefits, where the difference between subjective and fair market value can seriously distort incentives to bargain for benefits rather than money, or vice versa.
The bigger problem arises when the subjective value is so low that it is smaller than the tax that will be assessed, as in this case. In those circumstances, the "prize" actually has negative economic value (unless it is transferable, which I take it this space flight is not).
I believe (though I may be confusing this with a different issue) that there are a few provisions in the tax code that specifically tax some non-cash income at less than 100% value specifically to mitigate this problem. There is also an old tax case in which the court held that a man who won a free trip (to Hawaii, I think), would not be taxed on the income, because of precisely these issues.
So, this is a real, non-trivial flaw in the tax code. In an ideal income tax, a taxpayer should be indifferent between receiving non-monetary income and receiving the taxable value in cash. The current system may be the best practical solution to the problem, balancing concerns about over and under taxation, but this story illustrates a way in which it is imperfect.
At 10:17 PM,
Barry said…
I found the posting interesting from the media vantage (I won't comment on the pros and cons of taxing winnings, although settled law is settled law). This headline seems like trying to out fox Fox News. Because it is settled law, it really isn't even news (other than someone giving away trips to outer space, which may be challenging to easily collect on), but I can see the tax angle being picked up by Fox or even Stephen Colbert. He'd talk about how having to pay thousands for a free trip to space is bad for the economy and how "the tax-istas" would even try to impose a death tax on you after you die!
At 2:05 PM,
Tam said…
Treating the prize as taxable income limits the prize to those able to afford the tax bill -- but only in those situations where the prize creators have chosen not include footing the tax bill as part of the prize. In such a case, I see no reason why the blame for the inequity (if it even is inequitable), should lie with the creators of the tax code rather than the creators of the prize. By extension, I see no reason why the tax burden should shifted from the prizewinner onto the rest of society.
And even taking as a baseline assumption that prize creators will not foot the bill, I have no qualms with the result - intended or not - of limiting these prizes to those who can afford to pay the tax bill. It's akin to a luxury tax, with which I have no problem. After all, we are talking about trips to outer space here, not foodstamps.
At 4:26 PM,
Neil H. Buchanan said…
I'm pleased to know that my post has a certain truthiness to it.
At 10:20 PM,
Michael Yuri said…
The original post said:
"As a policy matter, why [. . .] would we create an equitable exception for this? Other people have to earn and save $138,000 if they want to take this trip, after paying taxes on their income. This prize-winner was being told that he could take a $138,000 trip for $25,000.
Anyone who thinks that the poor guy should get an even bigger break is free to pay the taxes for him. ... I'm glad that prize-winners are subject to paying taxes on their income under the same rules that apply to taxing everyone else's income, thus preventing the necessity of raising tax rates or increasing the deficit."
Another poster agreed with this reasoning, saying: "the tax burden [would be] shifted from the prizewinner onto the rest of society".
But I think this is a strange way to think about taxes. It seems to assume that the amount of tax to be collected on this transaction is somehow fixed and that collecting anything less would be inherently cheating the public. But in reality, taxes create incentives that affect people's behavior, and sometimes this change in behavior results in less tax revenue being realized. Look what happened in this case -- he declined the prize due to the tax burden, and as a result the government will collect nothing. But no one would argue that he somehow cheated the government (or other taxpayers) out of $25,000 by declining the prize.
The theory behind an income tax is that people pay based on the amount of value that they actually receive. But the amount of value this guy would have received was not $138,000, but instead something less than $25,000.
Again, I'm not suggesting that there's a better solution -- in fact, I highly doubt there is one. I just claim that in this particular case the end result is neither economically efficient, beneficial to society, nor inherently fair to the prizewinner.
This isn't an indictment of the tax code -- just a recognition that it isn't perfect.
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