Saturday, February 12, 2011

If Watson loses, Uncle Sam and New York State win!



If Federal and New York State officials worried about ballooning deficits tune in to Jeopardy this coming week, they should be cheering for the humans! The US and New York State Treasury will collect four to five times as much income tax revenue if the computer comes in last.

The grand prize for this competition will be $1 million with second place earning $300,000 and third place $200,000. Rutter and Jennings will donate 50 percent of their winnings to charity and IBM will donate 100 percent of its winnings to charity.


Source: IBM Press release

IBM can easily afford to be generous if it wins the big million dollar prize. The favorable publicity associated with winning first place is worth far more than a million dollars. Donating the money will give its corporate image an additional boost. Moreover, it's likely that IBM will be able to deduct the full million dollars from its taxable income. IBM had almost $15 Billion in taxable income last year, and although it has a track record as a generous corporate giver, it is very unlikely that an additional million dollars of corporate giving will put IBM over the 10% limit on deductible corporate contributions.

On the other hand, human beings like Ken Jennings and Brad Rutter, would be far more likely to hit the limit on deductible donations if they were to donate the full amount of their winnings to charity. Those rules are complicated and depend on the type of charity, so Ken Jennings and Brad Rutter should definitely read those IRS rules in Pub 526 carefully before deciding which charities should get their donations. (Ken Jennings may also want to make use of his free lifetime tax advice from H&R Block by asking their opinion as well.)

Here are some back-of-the envelope calculations, using 2010 federal and NY tax rates. (As usual, we will make some simplifying assumptions. We'll ignore other income and deductions aside from charitable donations and state tax that Mr. Jennings and Mr. Rutter might have, assuming their other deductions will wipe those out. To make life simple, we will also assume they both use married filing joint tax status. I believe that Mr. Jennings is married. I am not sure if Mr. Rutter is married, but--if not--he still has until December 31 to get married to a spouse with no taxable income of her own if he'd like to minimize his taxes. These assumptions are reasonable first approximation assumptions. Refining those assumptions would most likely strenghthen the argument even further.)


Million dollar winner:


If Watson wins:
million dollars goes to charity of IBM's choice
zero tax revenue to US and NYS


If human wins:
$500K goes to charity of winner's choice
approximately $140K goes to US Treasury
approximately $70K goes to New York State Treasury
human takes home about $290K after donation and tax


Second place prize: $300K

If Watson takes second:
$300K goes to charity of IBM's choice
zero tax revenue to US and NYS

If human takes second:
$150K goes to charity of 2nd place winner's choice
approximately $25K goes to US Treasury
approximately $10K goes to New York State Treasury
human takes home about $115K after donation and tax


Third place prize: $200K

If Watson takes third:
$200K goes to charity of IBM's choice
zero tax revenue to US and NYS

If human takes third:
$100K goes to charity of 3rd place winner's choice
approximately $14K goes to US Treasury
approximately $6K goes to New York State Treasury
human takes home about $70K after donation and tax


Bottom line:


If Watson comes in first, US government gains about $40K in revenue while New York State gets about $16K in revenue.

If Watson comes in last, US government gains about $165K in revenue while New York State gets about $80K in revenue.

So Watson losing will generate four to five times as much tax revenue as Watson winning.

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