Is the Nobel Prize Award Subject to Income Taxation?

October 14, 2008

In the wake of Paul Krugman's awarding of the Nobel in economics, a rumor has circulated the internet saying that the cash award of around $1.4 million is not subject to income taxation by the IRS. Here is one such claim (on a website that says Krugman should have a special tax imposed on him). Let's see what the IRS says about this:

Pulitzer, Nobel, and similar prizes.   If you were awarded a prize in recognition of accomplishments in religious, charitable, scientific, artistic, educational, literary, or civic fields, you generally must include the value of the prize in your income. However, you do not include this prize in your income if you meet all of the following requirements.

  1. You were selected without any action on your part to enter the contest or proceeding.

  2. You are not required to perform substantial future services as a condition for receiving the prize or award.

  3. The prize or award is transferred by the payer directly to a governmental unit or tax-exempt charitable organization as designated by you. The following conditions apply to the transfer.

    1. You cannot use the prize or award before it is transferred.

    2. You should provide the designation before the prize or award is presented to prevent a disqualifying use. The designation should contain:

      1. The purpose of the designation by making a reference to section 74(b)(3) of the Internal Revenue Code,

      2. A description of the prize or award,

      3. The name and address of the organization to receive the prize or award,

      4. Your name, address, and taxpayer identification number, and

      5. Your signature and the date signed.

    3. In the case of an unexpected presentation, you must return the prize or award before using it (or spending, depositing, investing it, etc., in the case of money) and then prepare the statement as described in (b).

    4. After the transfer, you should receive from the payer a written response stating when and to whom the designated amounts were transferred.

These rules do not apply to scholarship or fellowship awards. See Scholarships and fellowships, later.

Basically, unless Krugman donates the money to an eligible charity, he must pay tax on it. And that's correct given that such an award is indeed Haig-Simons income.

In terms of the economics, one could possibly justify a special one-time tax on Krugman given that it would be lump-sum. This is similar to a windfall tax on past capital or labor income. And depending upon the elasticity of the cash award to work effort (which is probably pretty small) going forward, optimal tax theory could argue that such awards should be subjected to a higher tax rate than other labor income. From a sound tax policy perspective, however, this would be pretty unfair as it is rather arbitrary.

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