Is good luck taxable?

Easy Money

There seem to be plenty of opportunities to win--big and small--in our lives, from lotteries to radio contests to a friendly wager with a friend. Whether it's $10 on who wins the golf game, or $10 million from the lottery, does the tax man share in our good fortune?

In Canada, the answer is generally "no"--receipts derived by luck are normally classified as non-taxable "windfalls". The Income Tax Act specifies that no capital gain or loss results from the chance to win a prize, and that the cost of such a prize is equal to its fair market value at the time of acquisition.

The Canada Revenue Agency (CRA) notes, in Interpretation Bulletin IT-213R (Prizes from lottery schemes, pool system betting and giveaway contest), that prizes are not taxable as capital gains or as ordinary income, unless they can be found to be income from employment, a business or property, or a prize for achievement in "a field of endeavour ordinarily carried on" by the recipient.

Eyes on the Prize

While the prize itself is tax-free, any income generated from the prize remains taxable. It's probably unsurprising that the income from investing prize money would be taxable. However, consider a "million dollar prize" which is not paid out in one lump sum, but over time. For example, the winner receives payments of $50,000 annually for 20 years. Assuming a rate of return of 2.5% (the Government of Canada 10 year bond rate), the right to receive $50,000 a year for 20 years is worth about $769,000, and that, not $1 million, is the prize won. The remaining $231,000 is interest earned on that initial investment, taxable as received over the 20-year period. The issuer of the annuity should issue T5 slips reflecting this interest income annually. This could come as a nasty shock if the winner was not expecting to pay tax on over $19,000 of interest which would be part of the first year payment (gradually declining in future years).

As the cost is equal to the value of the prize, sale of the prize shortly after winning is unlikely to result in a gain, so the proceeds should be received free of tax. If the value of the prize appreciates over time, then any gains would be subject to taxation in the ordinary course. This might be the case for the winner of a "dream home lottery" who sells the property ten years later. In that case, the owner may have resided in the property and possibly be able to realize any gains free of tax due to the Principal Residence Exemption (See...