A lot of taxpayers are still unaware that awards and prizes may be potentially subject to U.S. federal income taxation.
In general, prizes and awards (other than certain types of fellowship grants and scholarships) should be included in gross income and subject to federal taxation.
Awards for religious, charitable, scientific, educational, artistic, literary or civic achievement are excluded from gross income only if the award is transferred unused by the payor to a governmental unit or a tax-exempt organization (charitable, religious, or educational) designed by the recipient.
The recipient of the award must be selected for the contest or proceeding without any of his action (or any action on his behalf). Moreover, the recipient cannot be required to render substantial future services as a condition to receiving the prize or award.
Employee achievement awards are excludable from gross income only to the extent that the cost of the award is deductible by the employer. It is important the awards do not represent disguised compensation. The amounts subject to exclusion from gross income cannot be more than $400 for non-qualified awards and $1,600 for qualified awards (see IRC Sections 74 and 274(j) for further details).