Winning the lottery can be an exciting and life-changing event. With a big cash prize comes some important tax considerations. Do you have to report lottery winnings on your tax return? Are lottery winnings taxable? Here is a comprehensive look at how lottery winnings are taxed and reported.
Do you have to report lottery winnings?
Yes, all lottery winnings, whether from Powerball, Mega Millions, state lotteries, or other lottery games, must be reported as income on your federal tax return. The IRS requires you to report the full amount of your winnings for the year on your Form 1040. This includes any lump sum payment as well as any annual installments you may receive over multiple years. Failure to report lottery winnings can lead to tax evasion charges and penalties from the IRS.
Lottery winnings are considered taxable income
The reason lottery winners have to report their winnings is that the IRS considers lottery winnings to be taxable income. Just like your wages from your job or a bonus you receive, lottery winnings are subject to income tax because they increase your total income for the year.
It does not matter whether the winnings are paid out in a lump sum or as an annuity over many years. Any lottery prizes that you receive in a given tax year must be reported on that year’s tax return.
You may have taxes withheld already
When you collect your lottery prize, there may already be taxes withheld from your winnings. State lotteries are required to withhold federal taxes at a rate of 24% for winnings over $5,000. Some states also withhold state income tax. However, the amount withheld often does not cover your full tax liability on the winnings.
If no taxes were withheld
For very large lottery prizes, you may have to pay estimated taxes to the IRS during the year to cover your tax liability if you did not have taxes withheld already. You want to avoid an underpayment penalty from the IRS when you go to file your return. Speak to a tax professional to determine the right amount to pay in estimated taxes if needed.
Are all lottery winnings taxable?
With just a few exceptions, all lottery winnings you receive during the year are taxable. Here are some of the main rules on the taxability of different types of lottery winnings:
Cash prizes
Cash prizes from lottery games such as Powerball and Mega Millions are fully taxable as ordinary income. This includes lump sum payments as well as any annuity installment payments over many years. Any cash lottery prize must be reported.
Smaller prizes
Even relatively small lottery prizes are taxable. If you win a few hundred or few thousand dollars on a scratch-off ticket, state lottery drawing, or other game, it still must be reported as income. There is no minimum threshold for reporting lottery winnings.
Local prizes
Prizes from informal lottery games, raffles, or drawings at local fundraisers or events can also be taxable above a certain amount. If you did not pay anything to enter and your winnings are over $600, they typically must be reported.
Non-cash prizes
If you win a non-cash prize like a car or vacation from a lottery drawing, that item is taxable at its fair market value. You would report the value of the item just like cash lottery winnings.
Gift cards or tickets
Lottery prizes paid out as gift cards or tickets are taxable based on the face value. So a $500 gift card would be reported just like $500 in cash.
State tax refunds
Refunds from your state tax return are generally not taxable. However, in rare cases where you deducted state taxes in a previous year and get a refund, that amount may be partly taxable.
Foreign lotteries
U.S. residents are taxed on lottery winnings from other countries in the same way as domestic winnings. So be sure to report any lottery prizes won while traveling abroad.
Are lottery winnings taxed at ordinary income or capital gains rates?
Lottery winnings are taxed as ordinary income, not at the lower capital gains rate that applies to investments. This means your winnings will be taxed at your top marginal tax rate, up to 37% federally, plus any applicable state taxes.
Ordinary tax rates vs. capital gains rates
Capital gains tax rates on long-term investments currently range from 0% to 20% federally, which is lower than ordinary income tax rates. However, lottery winnings do not qualify for these lower capital gains rates.
Why lottery winnings are ordinary income
The reason lottery winnings cannot be taxed as capital gains is that you did not make any investment or hold an asset that appreciated. Lottery winnings simply represent an increase in your income for the year. Therefore, they are taxed as ordinary income at your top marginal tax rate.
State income tax on winnings
In addition to owing federal tax on lottery winnings, you typically also owe state income tax in the state where you won, unless that state has no income tax. Your prize will be taxable income on your state return in most cases.
Are jackpots split with other winners taxed differently?
If you split a large lottery jackpot with other winners, how you are taxed does not change. No matter how many winners split the prize, your share is taxable income.
Each winner reports their share
When the advertised jackpot has multiple winners, each winner only reports their percentage share as income. For example, if the jackpot is $500 million and you split it 50/50 with one other person, you each report $250 million as taxable income.
Withholding on split jackpots
For large shared jackpots, taxes are usually withheld at a flat 24% rate. But each winner may owe more or less than that when they file their actual return, based on their personal tax situation.
No difference in tax rates
There is no difference in the tax rates applied, regardless of how many people win a particular lottery drawing. Each winner pays ordinary income tax rates on their share, up to the top 37% rate federally if their income is high enough.
How do you calculate taxes owed on lottery winnings?
Calculating the taxes you owe on lottery winnings involves adding your winnings to your other income for the year and applying your ordinary income tax rates. Here are some key steps in calculating your lottery tax bill:
1. Determine your total taxable income
Add up your lottery winnings for the year plus all your other taxable income, including your wages, self-employment income, taxable interest and dividends, and other income.
2. Look up your tax rates
Consult the tax rate tables to determine your federal ordinary income tax rate based on your total taxable income amount. Also look up your state income tax rate if applicable.
3. Apply your tax rates
Apply your federal and state tax rate percentages to your total taxable income to estimate the total tax you owe. Factor in any withholding or estimated payments already made.
4. Consider itemized deduction effects
If you claim itemized deductions, those can reduce your taxable income amount. Work with a tax professional to calculate optimal deductions.
5. Review withholding
Be sure federal and state taxes are properly withheld from any annuity installment payments you receive over multiple years.
6. Get professional help
Consulting a tax professional or accountant can be very helpful in planning for taxes on large lottery prizes.
How do I calculate estimated taxes on lottery winnings?
For very large lottery prizes, you may need to make estimated federal and state tax payments during the year to avoid penalties. Here are some tips:
Calculate your total expected tax bill
Based on your overall income, determine your estimated total tax liability for the year. Factor in your lottery winnings.
Determine required estimated payments
You typically need to pay in 90% of your total expected tax liability through withholding and/or estimated payments to avoid penalties.
Figure required quarterly amounts
Divide your required estimated payments evenly across each quarterly due date. Payments are due 4/15, 6/15, 9/15 and 1/15 of the following year.
Work with a professional
A tax professional can help you safely determine the right amounts to pay each quarter based on your unique situation.
Stay up to date
Be sure to update your estimated payments as your income situation changes so you do not fall behind.
What if I miss reporting lottery winnings?
If you fail to report lottery winnings on your tax return, you could face penalties, interest, and other ramifications from the IRS for tax evasion:
Tax evasion penalties
Criminal tax evasion charges are possible for intentionally not reporting substantial lottery winnings. Civil tax fraud penalties of up to 75% may also apply.
Interest charges
The IRS will charge interest on any taxes you should have paid but did not because you did not report winnings. Interest is typically 0.5% per month.
Audit risk
Not reporting winnings greatly increases your audit risk, since the IRS receives records of lottery payouts. An audit could uncover other issues as well.
Jeopardized prizes
If the IRS discovers you did not report winnings, your right to future lottery prize payments could be jeopardized.
File amended returns
If you discover you failed to report winnings, file amended returns immediately to correct the omission and minimize penalties.
Do I need professional tax help for large lottery prizes?
It is highly advisable to work with a tax professional or accountant if you win a sizable lottery prize. A tax pro can help you:
Calculate complex estimated payments
Properly calculating estimated tax payments is crucial. A tax preparer can determine the right amounts so you do not face underpayment penalties.
Maximize deductions
There may be steps you can take to lower your taxable income through deductions. An expert can identify legal deduction opportunities.
Navigate state issues
Collecting a prize across state lines can complicate tax obligations. A seasoned tax pro can appropriately handle multi-state taxation.
Plan for the long term
Tax planning is important if you receive an annuity and owe taxes on installment payments each year for decades. A professional can plan ahead to minimize your long-term tax burden.
Avoid rookie mistakes
Making a mistake on your taxes after winning the lottery can be costly. Consulting an expert can help you avoid rookie errors.
Frequently Asked Questions
Do I have to report relatively small lottery prizes?
Yes, even small lottery winnings must be reported on your tax return. There is no minimum threshold for reporting prize income.
What if I split the jackpot but part of the prize is not claimed?
If you are entitled to half the prize but the other winning ticket is never redeemed, you must still only report your percentage share as income. You would not owe taxes on the unused portion.
Can I establish a trust to claim a lottery prize anonymously?
While allowed in some states, anonymous trusts do not exempt you from reporting and paying taxes on lottery winnings. The trust must file a return and report income.
Are lottery winnings reported on my W-2 or 1099 form?
Lottery operators will issue winners a Form W-2G showing the amount won and any taxes withheld. You then report that on your personal 1040 tax return.
Do I have to make estimated tax payments during the year?
You typically need to make estimated payments if you will owe more than $1,000 in taxes above what is withheld from your income. This applies to taxes on large lottery winnings.
Conclusion
Winning the lottery certainly has life-changing financial implications. Make sure you account for the tax implications as well. All lottery prizes are fully taxable income and must be reported accurately to the IRS and your state tax authority. Large jackpots often require estimated tax payments and expert tax planning. Be sure to report all winnings and pay all taxes owed to avoid significant penalties down the road.
