Tax Court: Beauty Pageant Winner Loses Tax Contest

Sep 14th 2017
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Beauty is in the eye of the beholder, but the tax law isn’t as subjective, as evidenced by a new case, Lopez, TC Memo. 2017-171, 8/30/17, involving a beauty pageant winner from Indiana.

If a child earns income from a competition, he or she is responsible for paying tax on that income, as well as being able to deduct offsetting expenses – even if the parents are the ones pulling the financial strings.   

The couple in the new case began entering their daughter in beauty pageants when she was about 9 years old with an eye toward her having a performing career.

At each pageant, she participated in various segments, such as the “Red Carpet,” “Photogenic,” and “Interview”. In order for her to participate in the pageants at a competitive level, the parents incurred expenses for travel, outfits and other similar items.

In 2011 and 2012, the daughter won several of these events and cash prizes totaled $1,325 and $1,850, respectively. These prizes were paid by checks written out to her and were then deposited into her college savings account.

The pageant expenses for 2011 totaled $21,732 and $15,445 for 2012. The parents reported the winnings as taxable income and deducted the expenses on their own tax returns. Their tax preparer believed that the daughter’s winning and expenses should be allocated to the parents and not her, based on the preparer’s understanding of Indiana’s child labor laws. The daughter was born in 1999.

Generally, prize winnings are included in a taxpayer’s gross income. In particular, prize winnings from satisfying a contest’s terms or requirements are counted as income because they are considered “payment in return for services rendered,” regardless of whether the donor derives an economic benefit from these services.  

In the past, the Tax Court has consistently treated pageant-related remunerations — even those named as scholarships — as compensation for services.

The Tax Court saw no reason to deviate in the case at hand. As a result, it determined that the beauty pageant winnings were taxable to the daughter, not the parents. By the same token, the pageant expenses could only be deducted by the daughter, although the parents laid out the funds.

Presumably, the parents in the new case wanted to use the deductions to offset their own income, likely taxable at a much higher tax rate than their daughter’s. The deductions in this instance were roughly ten times the amount of the income.

The key is to stay focused on another tax aspect involving income of minors in a family. If a dependent child under age 24 receives unearned income above a specified annual threshold, the excess is taxed at the top tax rate of the child’s parents, regardless of the source of the income.

This “kiddie tax” rule could catch some clients by surprise, so tax professionals should plan accordingly.

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