My friend Wesley sends the following story:

Bob Choate has sold restaurant equipment for years, so he already knew there was no such thing as a free lunch.

Now, much to his chagrin, Choate has found there’s no such thing as a free doughnut, either.

Choate, 56, of Houston last fall won a year’s supply of coupons from Shipley’s Do-Nuts as one of the lucky prize-winners during Astros Fan Appreciation Day at Minute Maid Park.

“I went up to the customer service window, fat, dumb and happy, and signed a form and picked up a fistful of certificates, each good for a free doughnut or a dozen doughnut holes and one free cup of coffee,” he said.

But last month, much like the Grim Reaper, the punch line to his prize landed in Choate’s mailbox: an Internal Revenue Service Form 1099, informing him that he owed taxes on $927.61 in “free” coffee and doughnuts.

Raise your hand if you saw that coming. In fact, I knew what it was about when I saw the title, even though it didn’t mention taxes or the IRS. Many are aware of Oprah Winfrey giving away cars and the lucky studio audience getting stuck with the tax bill on them. There’s actually a raffle going on in Arapaho that involves a free $40k pickup. When I saw it, I didn’t think “free truck!” so much as “truck for 30% of its value!” Given that I am not in the market for a pickup, much less a $40k one, it would be wasted on me. But at least you can sell a vehicle! This guy is paying taxes on donuts that he may never actually get to eat:

Two months into the new year, Choate said he thus far has used eight coupons. He gave about 30 to his son, who gave them as a birthday present to one of his teachers.

That means he still has more than 300 coupons to go – or 72,600 calories, presuming 242 calories per doughnut, and 1,800 ounces of coffee if he’s to get full value for his prize from the Astros.

He can donate the coupons to charity or he can simply hold on to them and use them over the next eight years or so.

I wonder what the ones that won Superbowl tickets for the rest of their life have to pay annually. Even though it’s free, it’s probably kind of expensive.

I’m not sure that there is a really good answer to this. Payments in donuts are income, after all. Perhaps it’s up to the baseball club to pony up the taxes on it, too. Maybe when it comes to non-cash payments, that sort of thing should be required? I’m sure that’s a bad idea for one reason or another.

Category: Newsroom

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8 Responses to Free Is Expensive

  1. Nanani says:

    Taxing a prize or gift seems a bit illogical.
    If I’m not taxed for an expensive computer or for furniture received as a gift, then why should winners of trucks and donuts be taxed on those things?

    With vehicles there is also the cost of insurance needed for the winner to actually drive it, too. That part makes sense.

    Do winners of cash prizes (lotteries, games shows) also have to pay taxes on it?
    Maybe anyone giving out such a prize should be required to disclose the post-tax winnings to all participants beforehand.

  2. trumwill says:

    Except where there are exceptions (and there are a lot of those), gifts are also taxed. You have to, or else people give away their estates to avoid the estate tax.

    Winnings are taxed more directly, though. Lottery winners always pay taxes. Sometimes more taxes than they would pay if it were money earned on the job.

  3. Abel says:

    “Payments in donuts are income, after all.”

    Only because the IRS defines income as just about anything.

  4. Brandon Berg says:

    The reason they tax prizes and not gifts is that the person who gives the gift doesn’t get to deduct the value of the gift, whereas a prize can be deducted as a business expense by the firm awarding it. With a gift, the government has already taken its bite, but with a prize, if it doesn’t tax the recipient it doesn’t get anything at all.

    A donut shop awarding a prize in the firm of coupons is an interesting case, and I’m not how it is (or should be) taxed. A donut shop has high fixed costs and low marginal costs. Once you’re paying the rent and utilities and your workers’ wages, it hardly costs anything to make a few extra donuts. It might even be free—don’t they sell or give away unsold donuts at the end of the day anyway?

    So if the shop can deduct the face value of all the coupons (say, $10 per dozen) right now, but it only costs $2 to make an extra dozen donut, then they come out ahead, since they’re only spending $2 to get $3 in tax savings (at a 30% tax rate). And that’s assuming that the customer actually uses all the coupons, and ignoring the value of the free loan he’s giving them until they do.

    If that’s actually how this works, then the donut shop is practically stealing money from this fellow by tricking him into paying their taxes. Note that they awarded it through a drawing at a baseball game rather than by having people enter the drawings at their shops, thus making it unlikely that they would cannibalize sales by awarding it to someone who was already a regular customer.

    That seems wrong to be, but I can’t think of an alternative tax rule that wouldn’t involve the IRS double-dipping, given that we already know that they taxed them at face value for the winner.

  5. Brandon Berg says:

    Only because the IRS defines income as just about anything.

    I hate to stick up for the IRS, but there’s a good reason for this: If only cash counted as income, then barter would replace cash in many transactions. For example, your employer might give you an option to live in company-owned housing in exchange for a reduction in wages less than what it would cost you (including income tax) to rent comparable housing yourself. You might also have an option to take a company-owned car for personal use, again in exchange for lower wages.

    To compensate for lost revenues, the government would likely raise taxes on the remaining cash transactions in the economy to unworkably high rates, which would be damaging to the economy. There would also likely be some deadweight loss due to you having to stick with the options the company gave you rather than the wider array of options available on the market.

    To avoid the market distortions and deadweight loss that would be caused by people using barter to avoid taxes, the government just treats any non-gift (see my prior comment) receipt of valuable goods or services as income. It occasionally leads to silliness like this, but on balance it’s a better system than the alternative.

  6. Abel says:

    @Brandon — Actually a better system would be to get rid of the IRS.

  7. Maria says:

    Amen to that, Abel.

  8. Brandon Berg says:

    Well, yes. But as long as it’s there, it should tax all income, not just cash income.

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