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Tax Talk with George Saenz

Ask the tax adviser

When to pay taxes on a prize

Dear Tax Talk:
I recently won a large sum of money on a radio contest. The money was given to me pretax. I am curious about what my best course of action is in paying the tax on the windfall.

Originally, I was going to invest it and pay the taxes by April 15. Then I was told I should pay quarterly estimated taxes this year because I can deduct that from my federal return next year and it may keep me from the higher tax bracket. Any input on this matter is appreciated. Thanks.
Tom

Dear Tom:
You got free money, and now you're getting free advice.

Generally, when you win a prize, the prize giver must withhold income taxes. Apparently in your case, that didn't happen. You now have the luxury of deciding when to pay the taxes. The law requires that you pay estimated taxes to cover the lesser of 100 percent of your 2002 taxes or 90 percent of your current year's taxes. If your 2002 adjusted gross income (AGI) was over $150,000, you have to pay in 110 percent of your 2002 tax bill.

For example, if your 2002 tax bill was $10,000 and you estimate your 2003 tax bill with the winnings will be $25,000, then you need to have paid in only $10,000 during 2003 for your 2003 taxes. The other $15,000 you may owe can be paid with your tax return in April 2004. Assuming your income hasn't changed much, this amount is probably covered by withholding taxes.

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You should estimate your tax bill as accurately as possible. If you pay in less than the required amount, you incur an estimated tax penalty, which is approximately 5 percent of the underpaid amount. Using the example above, if you only pay in $9,000, you would be charged a penalty of about 5 percent of $1,000 or $50.

Federal estimated tax payments are never deductible on your federal income tax return. But if you live in a state that charges income tax, it may make sense to pay an estimate of the state tax bill that you'll owe on the prize, since that can be deducted on your federal return reducing your federal taxes.

Otherwise, for federal taxes, invest the money and pay in the balance in April 2004 as long as you otherwise covered your 2002 tax bill through withholding.

-- Posted: June 19, 2003

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See Also
Estimated tax filings required on some extra income
Reporting gambling wins and losses

How to handle sudden wealth

Tax glossary
More tax adviser stories
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