How are Lottery Winnings Taxed?
Are you dreaming of winning the lottery and hitting the jackpot? We all know the thrill of imagining what we could do with all that cash – from traveling the world to buying a new house or car. But before you start counting your winnings, it’s important to understand the tax implications of hitting the lottery jackpot. That’s right, even lottery winnings are subject to taxes, which can put a dent in your grand plans for spending your newfound wealth. So, before you start planning your shopping spree, let’s take a closer look at what you can expect to pay in taxes on lottery winnings. Don’t worry, we’ll try to make it as painless as possible!
We share the important information below if you’re a lotto player or anyone who wants to know about the lottery and taxes. For example, imagine you’ve won the recent billion-dollar-plus jackpots!
Chances of Winning a Lottery
Winning a lottery jackpot is the dream of many. However, winning is almost virtually impossible. The odds of winning a jackpot are estimated to be around 1 in 200 million. This means that if you play every single day for your entire life, you won’t be able to win a jackpot even once. The chances of you being struck by lightning are even greater than winning the lottery.
Factors That Affect Your Prize’s Taxes
There’s a complex formula that takes into account your total income for the year and how much state income tax you pay. Typically, around 24% to 37% of your jackpot prize will be given to Uncle Sam. However, the tax portion will depend on the following factors:
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Total Winnings: The size of your prize determines your tax rate. Winnings up to $599.99 are tax-free, but anything above this amount will be taxed as income at 24%.
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Which state you bought the winning ticket: The rules governing lottery and winnings vary per state, with rates ranging from 0 (tax-free) to 8.82% (New York).
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Personal Income: Your prize becomes part of your taxable income for that year. It means your total winnings and income will be taxed up to 37% if you reach the top bracket.
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How you claim your winnings: You can receive your prize as a lump sum or an annual installment. Claiming a lump sum may require you to pay higher taxes than annuity payments.
How Do Taxes Work With Lottery Winnings?
US lottery taxes differ from other countries because winnings can consider taxable income for both federal and state taxes. Unfortunately, that means the government gets to claim 24% of your winnings right off the bat.
On top of the federal tax deposit, you may also be required to pay local withholding taxes. Each state has its own tax threshold, and only prizes that exceed this amount will be subject to taxation. For example, New York has a state tax threshold of $5000. So the $1.2B you won from the Mega Millions is subject to 8.82% from the state and another 3.876% to the city. Additionally, 24% is subject to federal state tax. It’s taxable because it goes above the $5000 threshold of that particular state.
Luckily, the states of Florida, Alaska, Tennessee, Texas, South Dakota, Washington, and Wyoming don’t levy an individual income tax. Thus, if you won in these states, you only have a tax liability to the federal government. Meanwhile, California, New Hampshire, and Tennessee exclude lottery winnings from taxes. The other six states don’t allow lotteries at all.
Taking a Lump Sum or Annuity Payments
The way you choose to receive your lottery payout can affect your federal income taxes in the following ways:
Lump Sum
If you receive your lottery winnings as a single lump sum, you could be subject to the highest tax bracket for the current year. Your $1.2B winnings are over the set threshold for the top tax bracket ($539,901+ for single taxpayers and $647,851+ for married couples filing jointly) — so you could be taxed at 37%.
Therefore, if you’re single when you win $1.2B as a lump sum and have a taxable income of $50,000, your total income for the current year is $1,200,050,000. In this case, the part of your income that exceeds $539,90 will be taxed at 37%. Unfortunately, lower tax rates would also apply to portions of your income below that threshold.
For sample computations, here’s how it looks:
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10% of your income up to $10,275 = 1,027.5
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12% on the next $41,775 = $5,013
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22% on the next $89,075 = $19,596.5
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24% on the next $170,050 = $40,812
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32% on the next $215,950 = $69,104
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35% on the next $539,900 = $188,965
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37% on the next $539,901+= $443,998,557
You could pay a whopping amount of $444,322,275 in taxes. However, if you look at the bright side, not the whole amount was taxed at 37% — only the amount that exceeds the set threshold.
Annuity Payments
On the other hand, if you want to avoid a hefty tax bill, consider splitting your winnings into annual payments. For example, let’s say you decided to take your prize annually for 40 years. This means you get $30 million per year plus your $50,000. It’s still a high amount, though. But, you can stretch your tax payment instead of paying at once.
Look at the difference below:
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10% of your income up to $10,275 = $1,027.50
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12% on the next $41,775 = $5,013
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22% on the next $89,075 = $19,596.5
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24% on the next $170,050 = $40,812
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32% on the next $215,950 = $69,104
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35% on the next $539,900 = $188,965
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37% on the next $539,901+= $10,900,237
Instead of paying $444,322,275 at once, you only pay $11,224,754 annually! In this example, the jackpot is huge, so you still pay the top bracket. However, if it’s smaller, your tax bracket could go down.
Minimizing Your Tax Burden
Unfortunately, taxes on lottery winnings are unavoidable. However, it’s possible to structure your lotto earnings to minimize the blow. You can take steps such as:
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Receiving your prize in installments over 30 years keeps you in the lower bracket.
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Donate a portion of your winnings to a charitable institution and deduct the amount from your income.
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Deduct your total gambling losses if the total doesn’t exceed your prize’s value.
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Share your good fortune with your loved ones, such as family and friends.
Conclusion
While winning the lottery is always exciting, it’s essential to know that any US federal and state income taxes will still apply. If you win the lottery and are anxious about tax computation, you can ask for help from a professional accountant to do the job for you. This isn’t financial advice and you can visit https://www.irs.gov/taxtopics/tc419 for information regarding gambling income and losses directly from the IRS.
The reality is that for many, the lottery preys upon their dreams and ultimately does more harm than good for scores of individuals that are in a weak financial position.
