Virtually all official rules for sweepstakes or contests in the United States include the Approximate Retail Value (ARV) of each prize. In fact, many state laws and other regulations require that the ARV be included in the rules.
In most cases, the ARV is determined by the Sponsor, which often uses its cost to purchase the prize, the advertised price, the Manufacturer’s Suggested Retail Price (MSRP,) or other manner of determining the ARV.
To a large extent, the value that is used depends on the circumstances. For example, if the price the Sponsor paid for a prize is less than what the winner would have to pay (e.g. the sponsor incurs a lower price because it manufactures the prize or if the sponsor receives a discount because the number of its purchases, etc.) the Sponsor may use the price that would be paid by individuals like the winner.
Similarly, if the MSRP is higher than the sales price of the prize, the sponsor may reduce the ARV to the actual cost to purchase the prize.
Most sponsors try to set the ARV based on the price that the winner would actually have to pay to purchase the prize.
Winners are sometimes surprised to learn that they must pay Federal and, in some cases, state income taxes on the prize they have won. Prize winners must include the Fair Market Value (FMV) of their prize when they prepare their income tax returns and winning a sweepstakes or contest may increase the amount that the winner pays in taxes. The FMV of the prize is included in the winner’s federal tax return as ordinary income. In addition, more than 35 states also require winners to pay taxes on their prizes. If any of the prizes are valued over $600, the sponsor must notify the IRS who won the prize and send the winner a Form 1099.
If the FMV of the prize is over $5,000, the sponsor is required to withhold 25 percent of the value of the prize in federal income taxes. There also may be state income tax withholding. For example, if someone wins a new boat valued at $8,000, the winner must pay the sponsor $2,000 for the sponsor to withhold federal income taxes, before the winner can receive the boat.
Many people who enter the sweepstakes (as well as some Sponsors) assume that the winner must pay taxes on the amount of the prize’s ARV. However, that is not correct. The IRS determines the amount of taxes owed by the prize winner, based on the FMV of the prize (not the ARV). As a result, winners may dispute that the ARV is in fact the FMV. For example, if the sponsor of the sweepstakes sets the ARV of a motorcycle at the MSRP, the winners could argue that most dealers routinely sell the bike at a lower price, and as such the FMV is actually much lower than the ARV. It is for this reason that Prizes that are based on MSRPs, and those that include trips or vacation packages are the most likely types of promotions in which winners will challenge the ARV.
Determining the ARV for sweepstakes and contest prizes, defending their accuracy and responding to challenges by recipients of those prizes can be complicated and these ARV issues may require securing the advice of tax lawyers as well as attorneys who have experience with sweepstakes and contests.
Dale Joerling is the chair of Thompson Coburn’s Advertising, Marketing and Promotion Law group. He is editorial director of the Sweepstakes Law Blog. You can find Dale on Google+ and Twitter, and reach him at (314) 552-6058 or firstname.lastname@example.org.