Everybody would love to win the lottery but just a lucky few actually get to experience the feeling associated with such a great win. Upon winning the lottery one would usually think they will not have any money issues to deal with anymore. You will have won a hefty sum of money for sure, but do you know what are the taxes on lottery winnings? We will get to that in a bit. There are a lot of things you will need to consider when you gain your big win. This is because risks are always present when anyone suddenly receives a huge amount of wealth.
What You Are Advised To Do With Your Lottery Winnings
Before you lead to the discovery of what are the taxes on lottery winnings, there are certain precautionary measures you can take to ensure you manage your winnings wisely. They are as follows:
Protect Your Ticket
Before claiming your winnings, the first thing you need to do is protect your lottery ticket because it is a bearer instrument. What this means is that whoever signs and presents the ticket with a photo ID is able to claim the winnings.
So, if by accident you somehow lose your ticket without putting your signature down on it, it could fall into someone else’s hands and they could end up taking your prize money just because you failed to protect your ticket. You should make a few copies of it and store away some digital copies as well.
Get Some Professional Assistance
When you receive such a huge amount of money, you will need to hire a team of professionals consisting of legal and financial advisors to help you in your decision making process. You will need an accountant, tax professional, an investment advisor and a lawyer but before paying a visit to each one of them, make sure you check their records, complaints and reputation. They will be of great assistance in providing answers to questions like what are the taxes on lottery winnings?, how can I preserve my winnings?, what are my investment options? Etc.
Consider the Option of Remaining Anonymous
The disadvantage of going public is that you may be constantly bothered by financial firms and people will try to get hold of your money any which way they can.
State rules vary on the publicity of winners and if you reside in a state that allows you to remain anonymous for instance in South Carolina, you can claim your prize anonymously. Another thing you can do to avoid going public is to set up a trust so that it can claim your winnings on their behalf. You can also have a limited liability receive your winnings on your behalf in an attempt to avoid going public.
Get Rid Of All Your Debts
Paying off your debts should be your first priority before you start considering investment and purchase options. You may be burdened with mortgage or credit card debt, or even student or automobile loans. It’s always best to first pay off all of your high interest debt so that you can then proceed to making some beneficial investments without any worry of debt holding you back.
Donate a Portion of Your Winnings to Charity
Since you will be the owner of a great deal of wealth after claiming your lottery winnings, you can consider donating a portion of it to a certain charity you support or admire. You can also donate to a Church or help out a family member who is undergoing a financial crisis. When you donate a sum of money to a qualified charity, you can have the donation deducted on your taxes.
You can also offset some additional income from your prize amount with an annual charitable deduction. When you plan charitable gifts, you will become a donor and will be entitled to receiving for your cash contributions, an income tax deduction for up till 50% of the adjusted gross income. You will also be entitled to income tax deductions of up till 30% if you donate other appreciated assets that are held for a period of more than a year.
Invest Your Money
You can meet with your financial advisors to know what are the taxes on lottery winnings and create an investment portfolio which you can divide into fixed income in the form of bonds and equities in the form of stocks. Also, for the first six to eight months, or before you meet with advisors, you can protect your winnings by putting them into short term investments.
Preserve Your Wealth
When you suddenly receive such a huge amount of money, you will naturally be very excited for the first few months. But you should avoid making hasty decisions such as quitting your job or spending a fortune on a shopping spree. If you were not previously accustomed to dealing with large sums of money, you may have a sudden impulse to go out and start spending your wealth.
That would be a wrong step for you though. You should be preserving your wealth and the best way to do so is by living within a set budget. Allocate a budget for yourself on a weekly or monthly basis and try to stick to it. This will aid you in the management of your wealth for future gains.
Now that you are aware of the precautionary measures you can take upon winning the lottery, you can protect your wealth and investments should you ever be lucky enough to win it. Before you get information on what are the taxes on lottery winnings, you should know your choices when it comes to claiming your lottery winnings.
Your Choices at the Time of Claiming Your Prize Money
In order to know what are the taxes on lottery winnings, you will need to meet with a tax professional. But you should first be aware of the options you can choose from when the time for claiming your prize money arrives. When you win the lottery, you can claim your winnings by selecting either one of the two options mentioned below:
- A lump sum payment or
- The long term installment payout
Let’s gain a better understanding of your options and then we will move on to the section about what are the taxes on lottery winnings.
The Lump Sum Payment Option
If you claim your winnings in the form of a lump sum payout, you will not be receiving the entire amount of the jackpot. This is because the lottery amount advertised in on the basis of annuities or installments. If you choose this option, you will be paid the current value of the lottery in cash that is much less in comparison with receiving annual payments.
If you opt for the lump sum payment, you will be required to pay tax on the whole amount on an immediate basis. Some drawbacks of choosing this option are as follows:
- You will be losing out on a guaranteed stream of income.
- You will not be receiving the entire amount and after that amount gets taxed, you will be receiving even less.
- If you fail to properly manage your finances with this option, you could end up losing all of it.
Here are some advantages associated with choosing the lump sum option:
- Your winnings are taxed on the basis of current tax rates and there is a possibility of them being higher in the near future.
- If you are prudent with your investments, the lump sum money could turn out to be much more that the initial payment you received.
- The money you receive is guaranteed without any risk of being affected by future variables.
- Older citizens are guaranteed to receive the whole amount of their winnings if they opt for the lump sum.
The Long Term Installment Payout Option
If you claim your winnings in the form of the long term installment payout option, you are entitled to receive the entire amount of the lottery over a 20 to 30 year period. If you opt for this option, you are taxed on the basis of when each installment payment is received by you. Here are some of the drawbacks of choosing this option:
- Since you are unable to grab all of your winnings, you therefore have limited access to them and you will be unable to access more than the annual amount in case of an emergency.
- Because the annual payout isn’t adjusted according to inflation, your earnings will become less valuable with each passing year.
- You are unable to get compound interest that can be attained with a lump sum investment.
- In case of death before the conclusion of the payments, whether or not your winnings will be passed on to your heirs will be dependent upon the state laws and on the lottery.
Some advantages of choosing this option are as follows:
- You can expect to receive long term cash flows on your annual payments.
- The question of what are the taxes on lottery winnings has not been answered yet, but over the period of the payout term, you may end up paying fewer taxes with this option. This is because with annual payments, you can expect to receive an income tax bracket that is marginally lower in comparison with the lump sum payment.
- Since you will not receive all of your payments in one go, you will not run the risk of spending it all in one go.
What Are The Taxes On Lottery Winnings? (Federal Taxes)
Let’s first have a look at the amount of federal taxes that are held from the winnings of a lottery:
The bigger the amount of your winnings, the higher the tax rate you will need to pay. The Internal Revenue Service (IRS) requires about 25% or 28% to be withheld from lottery winnings as far as federal income tax is concerned.
If your lottery winnings amount up to $600 or more, you will have to file the W-2G form, meaning that the IRS will be aware of your winnings and you’ll be required to pay taxes on them. But if your winnings range between $600 and $5,000 no taxes will be withheld.
Tax Withholding Requirements
In accordance with IRS requirements, taxes will be withheld from winnings that amount to more than $5,000. In the event of you giving your social security number to the lottery, it may report your winnings along with your identity and then 25% taxes will be withheld from your winnings. As for those who don’t provide their social security numbers, 28% will be withheld from their winnings.
The Amount You Owe
Your withholding amount is just an estimate but the amount you owe is determined on the basis of your actual tax rate. So the more you win, the more you will have to pay. The brackets change with each year so as an example, the first $9,075 of your income will be taxed at a 10%. A 15% tax rate is applied to an income that amounts up to $36,900 and a tax rate of 25% is applicable to an income of around $89,350.
If you want to know what are the taxes on lottery winnings with the installment option, you don’t have to make a huge tax payment in a single go and your tax payments will be spread out over a 26 year period. If country, city, state or federal income taxes remain unchanged for this 26 year period, they will not impact your winnings. But you would have to pay more than winners who chose the lump sum payment in the event of all these taxes rising over the next 26 years.
If you opt for a single lump sum payment during the purchase of lottery tickets, in case you win the prize, you will have to pay all of the taxes due on the prize money before you collect your winnings. For lottery winnings, the standardized federal percentage is 35% so if your winnings add up to $100 million, you will have to pay $35 million in taxes alone.
Before the local and state governments sweep in to take the share, you will be left with $65 million. So now you know what are the taxes on lottery winnings for single lump sum payments. Also, because winnings from lotteries are taxed as income, current federal rates are applicable to them.
Local and State Taxes
In addition to the federal rate of 35%, local and state taxes are also applied. Some states have income tax rates while others don’t. For example, the state of New York has a local rate of almost 4% and a state rate of nearly 9%.
The total amount of your taxable income, inclusive of the tax on your winnings can be reduced since charitable donations are free of tax. Your donations will be immediately deductable if you make them in the same year you attain your lump sum lottery winnings. In the event of you opting for a payment plan, you can maximize the amount of deductions by making donations that are smaller.
If you would like your wealth to be distributed among certain family members or friends, a tax rate of 35% will be applicable to each gift of over $13,000. If an amount below $13,000 is made to separate individuals only once a year, it will be free of tax. What are the taxes on lottery winnings of gifts between spouses? You can gift your spouse up to $10.24 million over your lifetime. As far as your heirs are concerned, upon inheriting anything over $5 million, they will be charged with a tax rate of 35%.
What Are The Taxes On Lottery Winnings? (Income Tax on Lump Sum Prizes)
Mandatory income tax withholding is applied to winnings of over $5,000 and state lottery agencies are supposed to report to the IRS the wins of over $600. When you win a lottery jackpot, in a total of 34 states, income tax will be withheld by the lottery agency. What are the taxes on lottery winnings? The state withholding rates range from 3.4% till 10.8%. Lottery winnings are not taxed by the remaining 16 states.
Group Lottery Winnings
The manner in which you claim your lottery winnings, whether on behalf of a particular group such as an office lottery pool or as an individual, will impact the income tax payable on your money earned via the lottery. Only one single payee is permitted by most of the states as per each winning ticket.
If your winning ticket belonged to a particular group or pool however, you and the remaining group members should first create a formal legal entity by way of a trust or a partnership and then cash in the ticket by claiming and then distributing the winnings. If you do not do so, as an individual, when you claim your prize, you could be deemed liable for the whole of the income tax bill.
The benefit of first creating a legalized entity is that every single member will owe tax on the basis of their share of the lottery winnings.
If you were pondering on the question of what are the taxes on lottery winnings? You now have the required information to guide you through if you are lucky enough to own the winning ticket.