What are the tax ramifications of winning a cash award at a dance competition? Many school owners who are faced with this question want to do the right thing when it comes to their tax obligation, so the first thing they do is run to their accountants. But it helps to have a basic understanding of

tax issues before you start asking specific questions. The following questions and answers will help you understand your responsibilities as a taxpayer in regard to prizes, cash awards, and scholarships. Remember, circumstances vary from studio to studio, and you should consult your tax advisor to determine the best tax treatment for your dance studio.

 

Is there a difference between a cash prize and a scholarship?\

Let’s begin with some definitions. According to Internal Revenue Code Section 74(a), all amounts received as prizes and awards, with limited exceptions, are required to be included in gross income. Prizes and awards received in contests of all types, including dance competitions, are includible in gross income, and must be reported by the recipient on Form 1040, Line 21 "Other Income." If a prize or award is received in goods or services instead of money, the fair market value of the goods or services must be included in the gross income.

 

An exception to the general rule of inclusion in gross income is provided for prizes and awards made primarily in recognition of religious, charitable, scientific, educational, or as in this case, artistic, literary, or civic achievement, but only if:

 

1. The recipient is selected without any action on his (her) part to enter the contest;

 

2. The recipient is not required to render substantial future services as a consideration for receiving the prize; and,

 

3. The payor transfers the prize or award to a "qualified charitable organization" at the recipient’s request.

 

This means that if you voluntarily enroll your students in a competition of your choosing, any prizes or awards given would not be exempt from being included as gross income. However, if the prize or award is made to a student, the rules for individual filing requirements must be considered to determine if filing an income-tax return is necessary. In other words, although the prize or award may be taxable, the recipient may not have enough income to require filing an income tax return. In such cases, a tax advisor should be consulted.

 

A scholarship is generally an amount paid for the benefit of a student (undergraduate or graduate) in pursuing studies at a "qualified educational organization." An eligible educational institution is one that maintains a regular faculty and curriculum and has a regularly enrolled body of students at the place where it carries on its educational activities. Scholarships are tax free as long as they meet the IRS’ definition of one. If there’s any doubt, check with your accountant.

 

If the prize or award check is made payable to my school, how should I classify the deposit into my checking account?

 If your dance studio received the cash prize or award, the deposit would be considered prize income to the studio. As discussed above, all amounts received as prizes and awards are considered as the recipient’s (in this case, the dance studio’s) income.

 

Should the studio distribute the funds equally among the dancers, and

should it issue individual checks to them?

If the school is the participant in the contest, the prize or award is taxable to it. However, if the individual students are the participants, the prizes and awards should be made payable to them. A careful review should be made to determine who is the actual participant in the contest.

 

Frequently the prize or award is made payable to the dance studio although the individual participants are actually the recipients of the awards. If this occurs, the deposit should be recorded as an "Exchange" on the studio’s books and records, and the corresponding checks written to the participants should also be recorded as an "Exchange." The transaction results in no income or expense to the studio; instead, it documents taxable income to the

individual participants.

 

Would you recommend that the studio use the funds to benefit all the

dancers, such as by bringing in a master teacher or guest artist?

If the studio’s prize or award is properly reported as income, it makes sense to use the proceeds of these awards in a way that benefits it. Using the funds for a master teacher or to purchase new equipment or sound systems would result in no net taxable income to the studio and would add benefit to its going-concern value. The school and the dancers would benefit from these capital outlays.

 

Could I use the funds to make a donation to a children’s charity?

Making a donation to a children’s charity not only benefits the organization from an income-tax standpoint, it also develops tremendous goodwill toward the school. As mentioned earlier, prizes are exempt from being considered as income when they are given in recognition of artistic achievement, when the awardees were selected without having made any effort on their part, and when the payor transfers the prize to a qualified charitable organization.

 

Could I apply the funds toward the cost of sending the dancers to the

national finals of the competition?

Yes. Under Internal Revenue Code Section 162, all ordinary and necessary business expenses are deductible. The task at hand is determining what is considered an ordinary and necessary business expense. Thousands of

court cases have attempted to answer this seemingly simple question. Having dancers compete at the national level brings both a level of prestige and, purportedly, additional revenue to the studio. Reasonable travel-related expenses and other incidentals should be considered ordinary and necessary if the dance studio maintains proper records regarding the business purpose

of the national dance competitions.

 

Could I use the funds to take a vacation?

There is nothing wrong with using the additional funds to go on a much-deserved vacation. Just remember, these funds must come from the business either as salary, a bonus, or another form of compensation, and they are taxable to the recipient. But paying income taxes is certainly no reason not to take that vacation!

 

 

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