When Prizes Are Not Tax-Deductible

While most small business-related prizes are deductible, there are scenarios where they may not qualify:

1. Personal or Non-Business Use
   • If the prize is given away for personal reasons and not directly tied to business promotion, it doesn’t qualify
   • Example: A small business owner gifts a vacation package to a friend but claims it as a marketing expense
2. Lack of a Clear Business Purpose
   • If the giveaway is not connected to lead generation, sales, or branding, it may not be deductible
   • Example: A retail store gives away a luxury watch but doesn’t advertise or market it
3. Excessive or Unreasonable Prizes
   • The IRS may challenge deductions for extravagant prizes that seem unreasonable for the small business size
   • Example: A small bakery giving away a $100,000 car
4. Failure to Report Prizes Over $600
   • If a Contestant receives prizes totaling $600 or more, small businesses must issue them a Form 1099-MISC
   • Failing to do so could lead to IRS scrutiny
5. Prizes Given to Employees
   • If an employee wins, the IRS may classify the prize as taxable compensation rather than a marketing expense
   • Example: A company awards an employee a $5,000 vacation but tries to deduct it as marketing

When considering tax implications for prizes in giveaways and contests, there are additional state-specific tax differences to be aware of. While federal tax rules are standard across the U.S., state tax laws vary significantly in terms of how prizes are treated. Some states impose their own specific rules, and small business owners should ensure they are compliant with local regulations.

State Tax Differences in Prize Deductions

1. State-Specific Tax Deductions:
   • Not all states allow small businesses to deduct the full cost of prizes as a marketing expense. While many states align with federal tax rules, others may have restrictions or limitations. For example, certain states may require that prizes be directly tied to a business promotion in order to qualify for deductions.
   • Example*: California and New York typically follow federal guidelines, but some states may have more stringent requirements for claiming prizes as a business expense or may limit deductions for "luxury" items.*
2. State Sales Tax:
   • States may impose sales tax on prizes given in contests or promotions, particularly for tangible goods like electronics, merchandise, or other physical products. If your prize is taxable, the small business may be responsible for collecting sales tax from the winner at the time of distribution
   • Example*: In states like Texas and Florida, physical prizes may require the sponsor to pay sales tax on the value of the prize or collect it from the winner*
3. State-Level Withholding Requirements:
   • Some states require withholding on prize winnings, even if the federal government does not. For example, winners in states like California and Pennsylvania may be subject to state income tax withholding on prizes that exceed certain thresholds, such as $600 or more
   • Example*: If a winner in California wins a $1,000 prize, the sponsor might be required to withhold a percentage of that prize for state taxes in addition to federal withholding. CliquePrize® does not permit prizes with a cash value over $1000*
4. State Reporting Requirements:
   • States like New York, California, and Michigan may have additional reporting requirements for prizes over a certain value. These reports typically go to the state tax authority, and failure to comply can lead to penalties.
   • Example*: A sponsor in New York must report prizes totaling over $600 to the state tax department in addition to the IRS*
5. Gift Certificates and Coupons:
   • Some states treat gift certificates, gift cards, and coupons as taxable income immediately upon issuance, while others may treat them differently, depending on whether they are redeemable for tangible goods or services.
   • Example*: States like Georgia may have different rules on how gift certificates or digital gift cards are taxed compared to cash-equivalent prizes*

While the federal government allows small businesses to deduct prize expenses as part of their marketing budget, some states may impose their own rules or limits on such deductions.

In short:

• Federal taxes: Yes, the deduction for prizes can be deducted as a marketing expense and this rule applies at the federal level
• State taxes: States may have their own specific tax rules that could impact deductions, sales tax on prizes, and withholding requirements for contest winnings

Tax Filing Requirements

• $400: If you're a sole proprietor or single-member LLC, you must file if your net earnings are $400 or more
• Any income: Partnerships and multi-member LLCs must file Form 1065 if they have any income
• Corporations: C-corps and S-corps must file an annual return regardless of income

Recommendations for State Compliance

• Consult a State Tax Professional: Since state tax rules can vary significantly, it is crucial to consult with a tax professional familiar with local regulations to ensure full compliance.
• Track Prize Values: Carefully track the value of prizes given away and be mindful of both federal and state thresholds for reporting and withholding.
• Verify Sales Tax Obligations: In states that impose sales tax on prizes, ensure you are collecting and remitting tax accordingly.

By keeping state tax differences in mind, business owners can better navigate the complexities of prize deductions and avoid potential penalties.

How a CliquePrize® Plan B Monthly Subscription Can Lower Taxable Income

Suppose a Sponsor gives away $100 worth of prizes each month as a CliquePrize® monthly Plan B subscriber. By year’s end, they will have spent $1,200 on prizes. If these prizes qualify as marketing expenses, the small business can deduct the full $1,200, effectively lowering taxable income.

For example:

• If a small business has $50,000 in taxable income before deductions, deducting the $1,200 prize expense reduces the taxable income to $48,800
• This means the small business is not truly spending the full $1,200, as it offsets taxable earnings and lowers the tax burden

Tax Implications for Digital Gift Certificate Prizes

If a digital gift certificate is given as a prize, the Sponsor may be required to report it to the IRS and withhold taxes in certain cases.

Reporting and Withholding Rules:

✅ If the prize value is $600 or more, the Sponsor must issue a 1099-MISC to the winner and report it to the IRS
✅ The IRS treats gift certificates, gift cards, and cash-equivalent prizes as taxable income for the recipient
✅ The Sponsor does not have to withhold taxes unless the recipient is flagged for backup withholding by the IRS
✅ It’s the winner’s responsibility to report and pay taxes on the prize amount

When Would Withholding Be Required?

The Sponsor must withhold 24% for federal taxes if the winner is subject to backup withholding, which happens when:

• The winner does not provide a valid TIN (Social Security Number or Employer Identification Number).
• The IRS has notified the payer (Sponsor) that backup withholding is required.

Best Practices for CliquePrize® Sponsors:

🔹 Have winners complete a W-9 form before receiving prizes of $600+.
🔹 Issue a 1099-MISC if required.
🔹 Inform winners that they are responsible for reporting the prize as income.

For most digital gift certificate prizes under $600, there is no requirement to report or withhold taxes. However, tax laws can change, so consulting a tax professional is always a smart move.

Key Takeaways for CliquePrize® Sponsors

✅ Prizes used for marketing purposes are deductible business expenses
✅ A monthly giveaway strategy using CliquePrize® can provide consistent tax deductions
✅ Proper documentation is essential to ensure compliance with IRS rules
✅ If a single winner receives $600+ in prizes, a 1099-MISC must be issued
✅ Employee prize winnings may be treated as compensation, not marketing expenses

Using CliquePrize® for giveaways and video contests isn’t just a smart marketing move—it’s also a strategic financial decision. By ensuring proper tax compliance and leveraging the deductibility of prize expenses, businesses can reduce taxable income while driving customer engagement. Always consult with a tax professional to maximize these benefits and ensure compliance with IRS regulations.

Start running tax-smart promotions today with CliquePrize®!

🚀 Ready to take your marketing to the next level? Download the CliquePrize® app and create a FREE Sponsor Account today!

CliquePrize®*** is the iPhone Giveaways mobile app that helps Small Businesses grow by reaching, nurturing and converting local, high value prospects. If you have any questions or feedback, please let us know!***