Winning the lottery is an exhilarating experience. The prospect of having millions of dollars at your disposal is incredibly exciting. However, along with the euphoria of winning the lottery comes the reality of how it will affect your taxes. While a lottery jackpot is not considered income for tax purposes, there are still tax obligations that come with winning.
Do you have to pay taxes on lottery winnings?
Yes, lottery winnings are considered taxable income by the IRS. Any prize over $600 is subject to federal tax withholding. If your total winnings for the year exceed $5,000, the lottery is required to withhold 24% for federal taxes before paying out your prize. The top federal tax rate is 37%, so you may owe additional taxes when you file your return.
You must also pay state taxes on lottery winnings. State tax rates vary widely across the country from 0% to over 11%. Some states like California, Florida, New Hampshire, Tennessee, Texas, Washington, and Wyoming do not tax lottery winnings at all. Other states like New York, Oregon, Idaho, and Minnesota have some of the highest tax rates on lottery winnings.
In addition to federal and state taxes, you may also be required to pay local taxes on lottery winnings if your municipality or county levies an income tax. The rate can be as high as 3.5% in some areas.
How do state taxes apply to lottery winnings?
Lottery winnings are taxed based on the state in which you purchased the winning ticket, not the state in which you reside. For example, if you live in Florida where there is no state income tax, but bought a winning ticket in New York which taxes lottery winnings at 8.82%, you would be on the hook for nearly $900,000 in state taxes on a $10 million jackpot.
The majority of states withhold state taxes from lottery winnings above $5,000. Some states have different withholding thresholds, like Wisconsin at $2,000 and Michigan at $50,000. A few states like Delaware and North Dakota don’t withhold taxes, but you are still responsible for paying state tax on your lottery income.
Is the full prize amount taxed?
If you win the lottery jackpot, the advertised amount is not what ends up in your bank account. You do not pay taxes on the full prize amount. Instead, taxes are due on the payout you receive after withholdings for federal and state taxes. Here is how it works:
- Jackpot amount: $500 million
- Federal withholding (24%): $120 million
- State withholding (8%): $40 million
- Payout before taxes: $340 million
- Taxes owed on $340 million payout (37% federal, 8% state): $149.8 million
- After-tax prize amount: $190.2 million
As you can see, the advertised jackpot is significantly reduced after federal and state taxes are paid. You do not pay tax again on the amount already withheld.
Do lottery winnings put you in a higher tax bracket?
Yes, winning a large lottery prize can easily propel you into a higher federal tax bracket for the year. Federal tax rates are progressive, meaning higher amounts of income are taxed at a higher rate. For 2023, federal tax brackets are:
- 10% on income up to $11,000 for single filers
- 12% on income from $11,001 to $44,725
- 22% on income from $44,726 to $95,375
- 24% on income from $95,376 to $182,100
- 32% on income from $182,101 to $990,150
- 35% on income from $990,151 to $1,130,150
- 37% on income above $1,130,150
As an example, if you were a single tax filer who normally has $60,000 in annual income, winning a $1 million lottery prize would push you into the 24% bracket on the portion of income over $95,375. This means more of your money gets taxed at a higher rate.
Does withholding cover all taxes owed?
Withholding on lottery winnings helps cover a portion of taxes owed, but it rarely covers 100% of your tax liability. The federal withholding rate of 24% is fixed, while your actual tax rate may be higher depending on your total income and deductions for the year. Some things that can lead to underwithholding include:
- You have other sources of income beyond just lottery winnings
- You have large deductions that significantly reduce your taxable income
- Your state does not levy income tax or has a much lower rate than the federal 24%
- Your win pushes you into a higher federal tax bracket
For large jackpot winners, it is advisable to do tax planning with a professional to project your total tax obligation. You may need to make estimated tax payments during the year to avoid penalties for underpayment.
When do you have to pay taxes on lottery winnings?
Taxes on lottery winnings are due by the normal federal and state tax filing deadlines. For most individuals, this is April 15 of the following year for federal returns and a similar state deadline.
For very large jackpots, you may be required to pay quarterly estimated taxes to avoid penalties. Estimated taxes are typically paid in four installments on April 15, June 15, September 15 and January 15 of the following year. The amount due each period is 25% of your projected tax liability.
If you win toward the end of the year, you may be able to make one estimated payment for the year rather than quarterly installments. However, check with a tax professional to determine the right approach based on your situation.
What if you take the lump sum option?
Most lottery jackpots offer the choice between receiving your prize as an annuity paid out over 30 years or taking a reduced lump sum payment up front. The lump sum amount is significantly lower than the advertised jackpot.
For example, the cash value on a $500 million jackpot might be $300 million if taken as a lump sum. This reduces the amount of tax withholding and taxes owed overall. However, you miss out on decades of annual lottery payments that could be invested.
One advantage of the lump sum is flexibility with tax planning. Spreading the tax burden over several years or offsetting the income with deductions can help manage the tax bite. You also have access to the full amount right away for major purchases or investments.
Can you reduce taxes with deductions?
It is possible to reduce your taxable income from lottery winnings through various deductions. However, deductions must be carefully documented and may be subject to limitations.
Some potential deductions include:
- Gambling losses – You can deduct gambling losses up to the amount of gambling winnings reported. However, you must have documentation like losing lottery tickets.
- State taxes paid – State taxes withheld from a lottery prize are deductible on your federal return.
- Charitable contributions – Donations to qualifying charities can be deducted up to 60% of AGI.
- Mortgage interest – If you pay mortgage interest, this may be deductible subject to limits.
- Investment expenses – Costs related to investments like advisor fees may be deductible.
Consult a tax professional to identify allowable deductions and proper documentation given your specific circumstances.
Are lottery winnings taxed after retirement?
Lottery winnings are taxable income regardless of whether you are retired or still working. In some cases, required minimum distributions (RMDs) from retirement accounts could even push your income into a higher tax bracket in years when you receive a large lump sum lottery prize.
One tax advantage in retirement is that if your taxable income is below $34,000 as a single filer or $68,000 married filing jointly, your capital gains rate may be 0%. This means large prizes spread across multiple years could take advantage of the 0% capital gains rate.
In addition, taxpayers 65 and older are allowed an extra standard deduction of $1,400 for singles and $1,750 for married couples. So your taxable income may be lower if you are retired.
Can you create a trust to reduce taxes on lottery winnings?
Setting up a trust is one strategy that may help reduce taxes on lottery winnings. A lawyer can help establish the trust and transfer your lottery prize into it. Types of trusts that are sometimes used include:
- Irrevocable trust – This permanently transfers assets out of your ownership. Income generated by the trust assets is taxable to the trust beneficiaries who may be in lower tax brackets.
- Charitable trust – These trusts pay out a portion of assets to charity. This provides a current tax deduction while spreading payments to beneficiaries over time.
- Grantor retained annuity trust (GRAT) – This pays you an annuity from the assets for a set period of time. Appreciation passes to beneficiaries gift and estate tax-free.
A trust can help shift the annual tax burden on lottery winnings to your beneficiaries. The downside is giving up control over the assets.
What happens if you win the lottery while on public assistance?
Winning a significant lottery prize means you are no longer eligible for most public assistance programs. However, lottery winnings are generally exempt from counting as income for 60 days.
Here are some impacts to be aware of if you win the lottery while receiving government benefits:
- Medicaid – You will lose eligibility and no longer qualify based on income.
- Medicare – No impact unless you also received Medicaid benefits.
- Social Security – No effect on SSDI disability or retirement benefits.
- SSI – Income above $1,176 per month will disqualify you.
- Food stamps – Lottery winnings will make you ineligible for SNAP food benefits.
- Rental assistance – Eligibility for Section 8 or public housing will be lost.
In most cases, it makes sense to opt out of public assistance programs if you win more than a modest lottery prize. Be aware the lottery administrator will likely report your winnings to government agencies like the Social Security Administration that administer benefit programs.
Are lottery winnings taxed for child support?
Child support obligations are based on your income, including lottery winnings and other windfalls. Many states consider your gross income before taxes. However, exact policies vary in terms of how lump sum payments are handled.
In general, a substantial lottery prize means higher income available for child support. State guidelines dictate what percentage of income goes toward child support based on factors like how many children you have.
You should expect an upward adjustment in child support if you win millions in the lottery. Arrears may also be collected from your prize money if you are behind on payments. Consult a lawyer to understand the specific implications in your state.
Can back taxes be taken out of lottery winnings?
Yes, certain debts can be collected from lottery winnings, including back taxes you owe. Under the Treasury Offset Program, if you have outstanding tax debt, the IRS can levy your lottery payments or seize a lump sum jackpot.
Other debts that may be collected from lottery winnings include:
- Past due child support
- Overdue student loans
- Amounts owed for state unemployment benefits
- Uncollected unemployment taxes from employers
- Other unpaid federal debts
It is important to resolve outstanding debts prior to playing the lottery if possible. Otherwise, be prepared for collections from any prizes you win.
Are lottery winnings considered income when applying for a mortgage?
Yes, any lottery prizes you win will be counted as income by mortgage lenders. Income from all sources, including one-time windfalls like prizes and inheritances, must be disclosed on mortgage applications.
Lenders will consider both your regular income, such as wages, as well as any additional income from lottery winnings when qualifying you for a home loan. The additional income can help you qualify for a larger mortgage.
However, lenders may look for you to have a steady source of regular income, beyond just lottery winnings, to repay the long-term debt obligation. Significant prizes may also be held for a period to make sure the funds are still available.
How are lottery winnings taxed in an IRA or 401(k)?
While it is unlikely you will win the lottery in your retirement account, any lottery winnings inside an IRA or 401(k) would be tax-deferred. These accounts provide tax-free growth to retirement.
If you take lottery winnings you earned within an IRA or 401(k) and distribute them, you would then owe ordinary income tax on the amount withdrawn, just like other pre-tax retirement savings.
For large jackpots, keeping the funds in the retirement account to grow on a tax-deferred basis can be quite advantageous. Make sure to consult your financial advisor before distributing any lottery winnings from retirement accounts.
Conclusion
A big lottery win certainly has life-changing financial implications. But it also comes with tax obligations that can take a significant bite out of your prize money. Understanding how winnings will be taxed, both at the federal and state level, is key to maximizing your jackpot.
Planning ahead with a tax professional can help you minimize taxes in an optimal manner through techniques like creating trusts, harvesting deductions, and thoughtful timing of withdrawals from retirement accounts. While the euphoria of a jackpot is powerful, don’t let the tax tail wag the dog when it comes to making the most of your lottery fortune.
