Identification

• There is no standard income tax rate on cash prizes. The tax rate on any income depends on which tax bracket you fall. In 2011, for example, the IRS taxes the first $8,500 in income at 10 percent and earnings between $8,500 and $34,500 at 15 percent. If you won a cash prize of $1,000 in 2011 and had no other income, you would have a tentative tax rate of 10 percent, or $100.
  
  

Withholding

• If you win at least $5,000 in a sweepstakes or lottery, the payer must withhold federal taxes at a rate of 28 percent of the prize's value, according to the IRS. If you do furnish a taxpayer identification number, such as a Social Security number, the withholding rate goes up to 31 percent as long the winnings do not exceed $5,000. Not withhold enough tax may result in late payment interest charges, which might add an extra 25 percent to any tax you owe on the winnings.
  
  

Deductions

• You can reduce the tax rate on your cash prize by deducting losses, such as entry fees, against the losses. The IRS allows you to deduct losses up to your winnings. For example, if you won $3,000 in a lottery, but lost $4,000 playing, you can deduct up to $3,000 in losses. The gambling deduction is a miscellaneous deduction — unless you are a professional gambler then it is always deductible as a business expense — but not subject to the 2 percent adjusted gross income limit like most other Schedule A deductions.
  
  

Recordkeeping

• Always keep record of entry fees you pay for any gambling event, such as receipts. In case the IRS audits your return, you must substantiate your gambling deduction or else the agency will negate it and hit you with penalties. You can also keep a handwritten log book of gambling wins and losses, but add details like where you made the wager, how much you paid in entry fees and the location of the gambling hall.