Jeopardy! Winner, Tax Loser

Even with H&R Block's free advice, experts say Ken Jennings can't do much to shield his $2.5 million win from a big IRS bite this year

By Amey Stone

Thanks to news-breaking bloggers, Net-savvy executives at tax-prep firm H&R Block (HRB ) learned back in September that a question concerning their outfit would foil the 75-show winning streak of Jeopardy! superstar Ken Jennings. He incorrectly guessed, on a show that aired Nov. 30 but was taped months in advance, that FedEx was a company with 70,000 seasonal white-collar workers. The correct answer was: "What is H&R Block?"

The forewarning gave Block marketers an idea. Why not offer Jennings a lifetime of free tax and financial advice when the show finally aired and the contestant's error became public? Jennings, 30, a software engineer from Salt Lake City who won a record $2.5 million on the long-running game show, readily accepted H&R Block's freebie. "Clearly he's going through a major life change and is going to be in need of financial advice," says Block spokeswoman Denise Sposato. "What better question to have him lose to than 'What is H&R Block?'"


 There's only one problem: At least when it comes to this year's tax bite, there isn't much advice H&R Block, or any other financial professional, can give Jennings that will ease the sting. Tax professionals estimate that he'll owe nearly half of his winnings in taxes. Any savvy sheltering moves, such as setting up a 529 college savings account for his child or an individual retirement account for himself, would only help in future years.

"He may have won on Jeopardy!, but from a tax point of view, he has lost," says Ed Zelinsky, a professor of tax law at the Benjamin N. Cardozo School of Law in New York. That's because one-time, earned income game-show winnings face some of the harshest taxation there is, he says. Twenty years ago, it would have been a different story. Prior to tax-law changes in 1986, prizes and awards were tax-free. But in 2004, the new era of regulatory scrutiny means tax-sheltering schemes are a clear no-no, Zelinsky says.

That leaves Jennings with one option: "Pay your taxes, and be happy with what's left over," advises Richard Upton, a tax attorney at New York firm Patterson, Belknap, Webb & Tyler. He can lessen his tax burden by giving some of his winnings to charity, but his taxable income would only be reduced only by the amount he gave away, which doesn't net him any more in the end.


  "It's a nice thing to do, but not a tax gimmick," says Upton. The way charitable contributions help out on tax bills is when people give away long-term holdings, such as stocks or property, that have appreciated a great deal, reducing their capital-gains tax bite. That doesn't apply to Jennings' windfall.

For now, H&R Block will mainly be helping Jennings with his fourth-quarter estimated taxes. He'll need to prepare a pro-forma income tax return and might need to ante up all the money owed to the IRS on his winnings by Jan. 15, or risk owing a penalty.

After that he'll need to figure out his long-term goals. Jennings says he would like to pursue "new opportunities," such as returning to school and gaining a PhD. At his young age, with less than $1.5 million after taxes, he sure won't have enough to money to retire. "He'd need north of $4 or $5 million for that to happen," says Ron Roge, an independent financial planner in Bohemia, N.Y.


  If he wants to generate current income from his winnings, Roge says Jennings could set up a laddered portfolio of tax-free municipal bonds. Putting some of the money in an individual retirement account (IRA) would allow his investments to grow tax-deferred, although he might not be eligible for deductions since his income could well be too high. "There's not a lot he can do this year, but he'll certainly have funds to do things with next year," says Roge.

Should Jennings stick with H&R Block for his financial adviser? As long as the person he works with has plenty of experience and they work well together, why not? One tip: Roge advises Jennings to ask for full disclosure on any commissions his Block adviser stands to earn from products like mutual funds or life insurance that are sold to him.

H&R Block has found a winning marketing strategy in Jennings and Jeopardy!. But to make the deal work for Jennings, his Block advisers will have to come up with creative tactics for the future -- long after this year's big tax bite has come and gone.

Stone is a senior writer for BusinessWeek Online in New York

Edited by Beth Belton

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