The Philosophy of U.S. Tax Law

[The idea]

Perhaps I am wrong, but my understanding is that lottery winnings are taxable in the US.

Now, suppose that there is a "Lunch with a Celebrity" lottery. There are some particular celebrities who have contracts with the lottery organization. The winner of the lottery gets to choose any one of them to have lunch with.

Let's make three important assumptions.

1) The celebrity is paid to have a meal with the winner. The amount of money is agreed upon in advance between the lottery organization and the celebrity. Let's suppose it is some amount between $4,000 and $12,000, depending on the celebrity.

2) The lottery rules specify that the winner gets nothing but lunch with the celebrity (among the available celebrities) of the winner's choice. The winner cannot opt to skip the lunch and take the cash that the lottery would have paid to the celebrity.

3) Although this might be unrealistic regarding business pragmatics, let's assume that each of the two diners pays for his or her own meal. This is just to avoid relatively trivial complications. The cost of the food is assumed to be trivial compared to the lottery organization's cost of getting the celebrity to have lunch with the winner.

Question 1: Would the winner be taxed on the "cash value" of the prize?

Question 2: If the prize has a cash value, then does it follow that, whenever people have lunch with celebrities, they should be paying tax on the cash value of such experiences? For example, if a celebrity has a poor friend, then the celebrity might offer to pay the taxes associated with the lunch experience. Otherwise, the celebrity's friend might not be able to afford the lunch, even if the cost of the food is not a problem.

[AmateurScientist]

Originally posted by The idea
Perhaps I am wrong, but my understanding is that lottery winnings are taxable in the US.

Now, suppose that there is a "Lunch with a Celebrity" lottery. There are some particular celebrities who have contracts with the lottery organization. The winner of the lottery gets to choose any one of them to have lunch with.

Let's make three important assumptions.

1) The celebrity is paid to have a meal with the winner. The amount of money is agreed upon in advance between the lottery organization and the celebrity. Let's suppose it is some amount between $4,000 and $12,000, depending on the celebrity.

2) The lottery rules specify that the winner gets nothing but lunch with the celebrity (among the available celebrities) of the winner's choice. The winner cannot opt to skip the lunch and take the cash that the lottery would have paid to the celebrity.

3) Although this might be unrealistic regarding business pragmatics, let's assume that each of the two diners pays for his or her own meal. This is just to avoid relatively trivial complications. The cost of the food is assumed to be trivial compared to the lottery organization's cost of getting the celebrity to have lunch with the winner.

Question 1: Would the winner be taxed on the "cash value" of the prize?

Question 2: If the prize has a cash value, then does it follow that, whenever people have lunch with celebrities, they should be paying tax on the cash value of such experiences? For example, if a celebrity has a poor friend, then the celebrity might offer to pay the taxes associated with the lunch experience. Otherwise, the celebrity's friend might not be able to afford the lunch, even if the cost of the food is not a problem.

Taxable income is generally that derived from any source. The only person I believe who has income in this situation is the celebrity who is being paid to have lunch. The celebrity's fee is taxable income to him or her.

I presume the value of the lunch itself is de minimus, so it's probably not income to anyone.

Your question about the cash value is really one about imputed income. Dining with a celebrity itself has no intrinsic value. I suppose it might have a fair market value (I presume that is what you mean by "cash value"), but that may be difficult to determine. Under the tax code and IRS Regulations and letter rulings, is the fair market value of the experience of dining with a celebrity imputed income to the recipient?

I have no idea. My guess--and it's a pure guess--is no. I think the impracticability of determing the FMV and being able to substantiate or document it would render it worthless. I probably wouldn't declare it as income, although I might want to research it first. A good start would be with a tax accountant.

AS

[balrog666]

1. Yes

2. No, the "prize" is taxable, the activity is not.

[AmateurScientist]

Originally posted by balrog666
1. Yes

2. No, the "prize" is taxable, the activity is not.

1. On what do you base your response? Can you cite a reg or letter ruling on the precise issue?

2. Doesn't your answer beg the question in 1?

AS

[Lee]

The answer to question 1 is "Yes". The IRS considers prizes to be taxable income (with a few exceptions). The taxable value is determined by the market value of the prize, less expenses. Therefore, if the winner paid for the meal, that amount could be deducted from the market value of the prize.

The answer to question 2 is "No". The IRS doesn't consider the privilege of having lunch with a celebrity to be a taxable event.

[AmateurScientist]

Originally posted by Lee
The answer to question 1 is "Yes". The IRS considers prizes to be taxable income (with a few exceptions). The taxable value is determined by the market value of the prize, less expenses. Therefore, if the winner paid for the meal, that amount could be deducted from the market value of the prize.

The answer to question 2 is "No". The IRS doesn't consider the privilege of having lunch with a celebrity to be a taxable event.

I think your response to 2 contradicts your response to 1 under the facts given.

I realize the OP threw the celebrity's friends dining into the question, but your answer begs the question of what is the FMV of dining with that celebrity. If it's $0, as you postulate, then it's non-taxable to the "prize" winner too. See? Labeling it a "prize" doesn't give it value.

If the "prize" includes travel and lodging to a place other than the winner's home, then sure, the FMV of the travel and lodging is taxable. That's not given under the facts, however.

The dining experience with the celebrity has no intrinsic monetary value. It may have some FMV, but I doubt it, and I doubt the IRS would require a taxpayer to determine a value for it and declare it as income.

If someone has some authority to the contrary, I'd be happy to see it.

AS

[The idea]

Originally posted by Lee
[...] if the winner paid for the meal, that amount could be deducted from the market value of the prize.

The winner pays for the winner's meal and the celebrity pays for the celebrity's meal. The purpose of assumption #3 was to focus attention on the main issue.

Originally posted by Lee
The IRS considers prizes to be taxable income (with a few exceptions).
What's the justification for this? The questions aren't really intended to be about the IRS's specific decisions, but about the philosophy that is the basis for those decisions.

If you are having a meal with a celebrity and you are paying for your own meal, then you aren't receiving anything that increases your ability to pay taxes.

[The idea]

Originally posted by AmateurScientist
If the "prize" includes travel and lodging to a place other than the winner's home, then sure, the FMV of the travel and lodging is taxable. That's not given under the facts, however.

You are right, it's not given under the facts. To make it completely clear, I should have specified that the meal takes place in a restaurant chosen by the winner and that the winner takes care of the winner's own transportation to and from the restaurant.

Lodging shouldn't arise as an issue. It's just lunch, not a pyjama party. ;)

[AmateurScientist]

It's too late for me to edit it to correct my mistake, but ignore my second paragraph in my first post in this thread. I misread the OP and thought that the meal would be paid by the lottery organizers. The facts in the hypothetical state that each diner pays for his or her own meal, so the value of it is immaterial.

It's not income and not a deductible expense to the prize winner.

It may be a deductible business expense for the celebrity, depending on the facts, and subject to the limitations on deducting meals and entertainment expenses.

AS

[Lee]

The idea,

What evidence do you have that the IRS operates under a particular "philosophy"? The IRS is a government organization that implements laws. It is my understanding that the definition of "philosophy" excludes the law.

[The idea]

Originally posted by Lee
The IRS is a government organization that implements laws. It is my understanding that the definition of "philosophy" excludes the law.
Just take question 2 literally as it is written:

If the prize has a cash value, then does it follow that, whenever people have lunch with celebrities, they should be paying tax on the cash value of such experiences?
The word "should" was used, making it a question about the philosophy of law rather than just a question about the actual law.

[AmateurScientist]

Originally posted by The idea

What's the justification for this? The questions aren't really intended to be about the IRS's specific decisions, but about the philosophy that is the basis for those decisions.


Fair enough.


If you are having a meal with a celebrity and you are paying for your own meal, then you aren't receiving anything that increases your ability to pay taxes.

If you're examining the reasoning behind income tax law, then you've misstated something vital here.

Under the US Tax Code, income isn't "anything that increases your ability to pay taxes." It's defined circularly. "Income" is income derived from any source. It can be "earned" (e.g., your salary and bonuses) or "passive" (e.g., interest or dividends from investments). Generally speaking, if you get something of value that is not a gift or bequest (and prizes are deemed not to be gifts), then that something's value is taxable income to you.

Imputed income is income that is imputed (assigned) to you by means of a fiction. Even if you do not earn it in the form of cash, if it is something of value given to you for services, or won as a prize, its fair market value will be imputed to you as income. You will be taxed on the FMV of the item or service. For instance, employee benefits or perqs such as a free membership at a country club, are taxable income and their FMV is imputed to you, just as if you had been paid it with your paycheck.

Back to your example. The reason I don't think the "prize" is taxable income to the winner is not because it doesn't increase the winner's ability to pay taxes. It's because it has no intrinsic value and its fair market value is probably impracticable for the taxpayer to determine.

The cars Oprah Winfrey (and GM) gave to her audience members were prizes they won. The cars themselves did not increase the audience members' ability to pay taxes, but the fair market value of their new cars were certainly taxable income to them. The next time Oprah gave away valuable prizes to her studio audiences, she included cash in the prize to defray the increased income tax burden upon the winners.

AS

[Lee]

The idea,

Perhaps I'm incapable of shedding my corporate persona for this discussion. I don't appear to be adding anything of value.

One more try... I would say that a prize is assumed to have value. In your assumptions, the celebrity was paid a certain amount. Obviously, the time of a celebrity has some value. The prize, lunch included or not, has value because the winner is allowed to partake of a "paid for" commodity.

One would assume that "the celebrity" has lunch with people without the benefit of payment.

[The idea]

Originally posted by AmateurScientist
I suppose it might have a fair market value (I presume that is what you mean by "cash value"), but that may be difficult to determine.
I have no problem accepting that the term "cash value" was inappropriate, but I'm wondering about how the concept of fair market value could be applied. For example, suppose one succeeds in buying, for a low price, an antique that has a high fair market value. Calculate the amount by which the fair market value exceeds the price paid. Should one's official income number be increased by that amount?

Maybe an actual cash lottery prize should be treated as a capital gain?

[ceo_esq]

AS,

My instinct is the same as yours, although I'm not a tax specialist.

For what it's worth, I informally put this hypothetical to a specialist colleague who's also a former revenue agent, and he (equally informally) expressed doubt that the IRS would go after a prizewinner in that situation, for broadly the same reasons you've raised.

By the way, with regard to the definition of income, let's not forget the not-too-helpful phrase sometimes kicked around by the Supreme Court: "any accession of wealth."

[AmateurScientist]

Originally posted by Lee


One more try... I would say that a prize is assumed to have value. In your assumptions, the celebrity was paid a certain amount. Obviously, the time of a celebrity has some value. The prize, lunch included or not, has value because the winner is allowed to partake of a "paid for" commodity.


If that were the case, then what is the value of the "prize" that the taxpayer winner declares as income?

(It's not the fee paid to the celebrity)



One would assume that "the celebrity" has lunch with people without the benefit of payment.

Of course. Inasmuch as this relates to Question 2, the celebrity's dining with his or her friends has no monetary value. Suggesting otherwise would be akin to assigning a monetary value to a friendship.

If dining with the celebrity has no value to the friend, then why does it have value to the winner of the "prize?"

(I see this set of facts as different from another I'll offer. If the prize were a pre-paid attendance at a $25,000 a plate dinner attended by A-list celebrities or politicians, then the value would be easy to determine--it's $25,000.00. Our facts are different. The lunch has no value assigned to it. Just because the celebrity is paid a fee to attend doesn't mean that's the value of the event to the "prize" winner).

AS

[The idea]

Originally posted by Lee
Perhaps I'm incapable of shedding my corporate persona for this discussion.

Shedding your persona is optional here.

Originally posted by Lee
I don't appear to be adding anything of value.

That's a good thing because otherwise we might have to levy a value added tax. ;)

Originally posted by Lee
I would say that a prize is assumed to have value. In your assumptions, the celebrity was paid a certain amount. Obviously, the time of a celebrity has some value. The prize, lunch included or not, has value because the winner is allowed to partake of a "paid for" commodity.

Yes, you can certainly argue for that point of view.

Originally posted by Lee
One would assume that "the celebrity" has lunch with people without the benefit of payment.
Suppose you thought that the celebrity was your friend, but it turns out that someone was actually paying the celebrity to have lunch with you. Would you then be ready, willing, and able to pay a big tax bill to cover the taxes payable on, say, eight months of weekly lunches with the celebrity?

[AmateurScientist]

Originally posted by ceo_esq
AS,

My instinct is the same as yours, although I'm not a tax specialist.

For what it's worth, I informally put this hypothetical to a specialist colleague who's also former revenue agent, and he (equally informally) expressed doubt that the IRS would go after a prizewinner in that situation, for broadly the same reasons you've raised.

By the way, with regard to the definition of income, let's not forget the not-too-helpful phrase sometimes kicked around by the Supreme Court: "any accession of wealth."

Thanks, ceo_esq. I'm not a tax specialist either, although I do have some experience with some tax issues. I also booked my federal income tax course and did some course work towards an LLM in tax, although that's been years ago. For that reason, I feel I have a pretty good grasp of some basic tax principles, and I think I have a good feel for the practice and application of some of them too. Having said that, I freely admit I'm flying by the seat of my pants here.

(I even tried a case before the U.S. Tax Court for four days. That was fun, and the judge was brilliant.)

Yeah, I almost mentioned the adding to wealth aspect, although I forgot the "any accession" terminology.

I appreciate your colleague's affirmation of my gut instinct and reliance on decades-old memories. Thanks.

AS

[ceo_esq]

Originally posted by The idea
For example, suppose one succeeds in buying, for a low price, an antique that has a high fair market value. Calculate the amount by which the fair market value exceeds the price paid. Should one's official income number be increased by that amount?Ordinarily (there are always some exceptions with tax rules), no. Of course, the antique would likely be a capital asset, and any gain you eventually realize on its sale would take into account your cost basis.
Originally posted by The idea
Maybe an actual cash lottery prize should be treated as a capital gain? Why?

[Lee]

AS,

The IRS puts the burden of determining the fair market value on the organization. Sadly, the IRS does not consider cost to be relevant in determining the fair market value. The celebrity's time may be far more valuable than the organization was willing to pay. As an example, I donate some "professional" time to a humane society in my area. If my "time" as awarded as a prize then the lucky winner will be informed that the prize is worth a certain amount. That amount must be reported to the IRS. The humane society has paid no monies to me and yet it is obvious that my time has a "fair market value" as evidenced by my clients.

I'm not sure I understand the relevance of your example. If a celebrity needed to be paid to endure my(known) company at luncheon I'm absolutely certain I wouldn't consider that to be much of a prize. I would consider it to an insult of the highest order.

[AmateurScientist]

Originally posted by The idea
I have no problem accepting that the term "cash value" was inappropriate, but I'm wondering about how the concept of fair market value could be applied. For example, suppose one succeeds in buying, for a low price, an antique that has a high fair market value. Calculate the amount by which the fair market value exceeds the price paid. Should one's official income number be increased by that amount?

Maybe an actual cash lottery prize should be treated as a capital gain?

Fair market value is simply the price a willing buyer will pay to a willing seller when neither is under a compulsion to buy or sell. One can get a good deal and pay less than what other buyers may have been willing to pay, but usually for tax purposes the actual sales price paid in fact determines the fair market value at that time.

You are actually asking a question about cost basis.

That's a different concept from FMV. It applies to capital assets, whether tangible (like a tractor) or intangible (shares in a mutual fund, for instance). The cost basis is established at the time of your purchase. It's what you paid for it.

You do not realize any income until you dispose of the capital asset, usually by a sale of it. If you sell it in another tax year, then the year of the sale is the year in which you have either a taxable gain or a deductible loss resulting from the sale of the asset.

Your gain or loss is determined by comparing the sales price you got from your selling the asset to the cost basis you paid for it when you acquired it.

It's important to keep in mind the concept of realization. Although on paper you have "made" money by buying something for less than what you believe its FMV to be, you don't realize any income from the transaction until you dispose of the asset.

Your rhetorical question about treating the lottery win as a capital gain makes no sense. What would your cost basis be? It's not a capital gain because you didn't pay anything for it. It's ordinary income to you.

AS

[The idea]

Maybe an actual cash lottery prize should be treated as a capital gain?
Originally posted by ceo_esq
Why?

If the difference between the cost of acquiring household furnishings and the amount they are sold for counts as a capital gain, then the term "capital" apparently applies to nonproductive assets.

It costs money to acquire a lottery ticket and, if the ticket wins, then the value of the ticket (which is an asset) has increased.

Isn't appreciation in the value of highly speculative investments classified as a capital gain, regardless of how speculative the investment is?

[Lee]

The idea,

Mea culpa. I answered your post in my response to AS.

[The idea]

Originally posted by AmateurScientist
Your rhetorical question about treating the lottery win as a capital gain makes no sense. What would your cost basis be?

Whatever you paid for the ticket is the cost.

[The idea]

Originally posted by Lee
If a celebrity needed to be paid to endure my (known) company at luncheon I'm absolutely certain I wouldn't consider that to be much of a prize. I would consider it to an insult of the highest order.
Of course! Nevertheless, you would have to admit that "the celebrity was paid a certain amount" and that you partook of a "paid for" commodity.

[AmateurScientist]

Originally posted by Lee
AS,

The IRS puts the burden of determining the fair market value on the organization. Sadly, the IRS does not consider cost to be relevant in determining the fair market value. The celebrity's time may be far more valuable than the organization was willing to pay. As an example, I donate some "professional" time to a humane society in my area. If my "time" as awarded as a prize then the lucky winner will be informed that the prize is worth a certain amount. That amount must be reported to the IRS. The humane society has paid no monies to me and yet it is obvious that my time has a "fair market value" as evidenced by my clients.



The burden is on the organization for informational return reporting. It is manifestly the taxpayer's duty, however, to declare the value of the prize on his or her return. I would argue the taxpayer isn't bound by the organization's assessment of the value of the prize. The organization could be arbitrarily assigning a value, or it could be wrong. Under the hypothetical, I simply don't think the "prize" has any fair market value. It's a dutch treat lunch.

The value of your professional time is easy to determine. What do you charge your paying clients (or patients, as you hint that you might be a veterinarian--please forgive me if I'm wrong) for the same services? That's the value to the prize winner. It doesn't matter whether you get paid or not in determining the value to the winning taxpayer.

The fee paid to the celebrity in the hypothetical bears no relationship to the FMV of the lunch. Presumably, the celebrity is being paid an appearance fee. Just as the cost is irrelevant in your example, it's irrelevant in The Idea's hypothetical too.


I'm not sure I understand the relevance of your example. If a celebrity needed to be paid to endure my(known) company at luncheon I'm absolutely certain I wouldn't consider that to be much of a prize. I would consider it to an insult of the highest order.

My point was that receiving a paid invitation to a $25,000 a plate dinner does in fact have an easily determined fair market value. It's $25,000. It's taxable as ordinary income, unless it's a gift, but that's for another thread.

AS

[Lee]

The idea,

No, it is a false analogy. I did not accept a prize. I would merely be having lunch with a friend. There would be no implied contract.

[The idea]

Originally posted by AmateurScientist
Your rhetorical question about treating the lottery win as a capital gain makes no sense. What would your cost basis be?
I don't understand why you asked that question. For example, surely the annual budget proposal to Congress doesn't include an item "cost of funding lottery jackpots." People buy tickets and that money pays for the jackpots, no?

[AmateurScientist]

Originally posted by The idea
Whatever you paid for the ticket is the cost.

Nice try, but your ticket isn't a capital asset. It's a receipt for gambling in a game of chance.

Unless you can convince the IRS that your full-time occupation is playing the lottery, you won't get anywhere trying to convince them that your lottery winnings are capital gains and that your one winning ticket is the capital asset. Good luck with that.

AS

[edited for verb tense]

[The idea]

Originally posted by Lee
No, it is a false analogy. I did not accept a prize.
Aha! So you don't prize the company of your celebrity friend. No wonder the celebrity had to be paid to have lunch with you. ;)

Originally posted by Lee
I would merely be having lunch with a friend. There would be no implied contract.
You would have agreed to have lunch with each other. That's an agreement even if it's not officially a "contract."

[AmateurScientist]

Originally posted by The idea
Of course! Nevertheless, you would have to admit that "the celebrity was paid a certain amount" and that you partook of a "paid for" commodity.

I disagree. The celebrity was paid for participating in the sponsor's promotion. It wasn't a fee to dine. Dining is not an occupation or profession recognized by US tax law.

The winner didn't "part[ake] of a 'paid for' commodity." The winner attended a dutch treat lunch. The winner got to enjoy the company of a celebrity. That company probably has no fair market value for all practical purposes. That's why I don't think the winner has to declare it as income.

You seem to imply that the winner gained something of value equal to the fee paid to the celebrity. I disagree. It's not a zero sum situation.

AS

[The idea]

Originally posted by AmateurScientist
The winner didn't "part[ake] of a 'paid for' commodity." The winner attended a dutch treat lunch. The winner got to enjoy the company of a celebrity. That company probably has no fair market value for all practical purposes. That's why I don't think the winner has to declare it as income.

You seem to imply that the winner gained something of value equal to the fee paid to the celebrity.
I was attempting to respond to Lee using Lee's language. See below.

Originally posted by Lee
One more try... I would say that a prize is assumed to have value. In your assumptions, the celebrity was paid a certain amount. Obviously, the time of a celebrity has some value. The prize, lunch included or not, has value because the winner is allowed to partake of a "paid for" commodity.

[AmateurScientist]

Originally posted by The idea
I was attempting to respond to Lee using Lee's language. See below.

My mistake and my apologies.

I think Lee is mistaken.

AS