TAX ADVICE from Julian Block

renowned tax advisor and Larchmont neighbor, Julian Block, provides help for Gazette readers

Award-winning Artists, Photographers and Writers Are Losers Under the Tax Laws

As part of its unending quest for tax fairness, Congress keeps overhauling the Internal Revenue Code. One of the sneakier consequences of those efforts was evisceration of a long-standing break for outstanding American writers, photographers and artists who receive prizes and awards that honor their accomplishments.

By way of background, the law authorizes the IRS to exact taxes from individuals who receive prizes from lucky number drawings, television or radio quiz programs, beauty contests and similar events, just as the agency gets to tax employees who are the recipients of bonuses and other awards from employers for outstanding work or suggestions.

Prior law, however, carved out an exception for writers, photographers and artists, among others. They were exempted from paying taxes on awards that are bestowed primarily in recognition of their past achievements in literature, among other cultural endeavors. The best-known example of big-bucks awards that were undiminished by taxes: the Nobel Prizes, which are worth several million dollars.

In governmentalese, this kind of largess is what is known as an “exclusion” from taxable income; writers and others need not list the awards on their 1040 forms. However, the exclusion was available only for recipients who are able to pass a two-step test. The first requirement was that you were named the winner without any action on your part -- that is, you did not specifically apply for the award by, say, entering the contest or proceeding. The second stipulation was that you are not obligated, as a condition of receiving the award, to perform substantial future services, such as teaching or writing.

How does current law blue-pencil the tax break for writers and others? What it does is to retain the not-personally-seeking and no-future-services prerequisites and supplement them with a third one. As a practical matter, the third requirement makes the break meaningless.

The law now grants tax relief for your award only if you assign it away from yourself to a charity. Specifically, you must "designate" – that is, instruct the award-conferring organization to turn the proceeds over to one or more governmental agencies (at federal, state or local levels) or to certain charities, such as schools or churches. Unsurprisingly, the list of qualifying designees includes everyone's favorite, the IRS.

Also predictable is that the law includes some fine print that you ignore at your peril. The key condition is that there is a deadline for the designation. If you fail to meet the deadline, you disqualify yourself for the exclusion and have to count the award as reportable income.

To stay in the good graces of the IRS, your designation and the awarding organization's fulfillment of that designation must occur before any prohibited use by you of the money or other property awarded. In the case of a cash award, the designation/fulfillment has to take place before you spend, deposit, or otherwise invest the funds. Moreover, you run afoul of the prohibited-use rule and become liable for taxes if you allow use of the property by someone else, such as a family member, in advance of the designation/fulfillment.

Ah, but wait: Can you convert what is supposed to be a restriction into a double break by combining tax-free treatment of the award with a charitable deduction for assigning the proceeds to, for example, your Uncle Sam or your alma mater? Not surprisingly, the feds anticipated that maneuver. The law specifically instructs the tax gatherers to disallow a charitable write-off for an assigned award.

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