Winning the lottery is an exciting prospect for many people. With millions or even hundreds of millions of dollars on the line, it’s no wonder that lottery jackpots capture the public’s attention. However, before getting carried away with spending plans, it’s important for lottery winners to understand how taxes will impact their prize money. Specifically, lottery winners need to know whether the advertised jackpot is the amount they will receive before or after taxes are taken out.
The Advertised Jackpot is Before Taxes
The cash value or lump sum amount that lotteries advertise for a jackpot is the amount before any taxes are deducted. This represents the total prize money that is available to be won. Lottery organizers advertise the full pretax amount to show the maximum prize up for grabs in order to generate player excitement and ticket sales.
However, the winner does not get to keep the entire advertised jackpot. Federal and possibly state taxes apply that will significantly reduce the amount of money the winner takes home. The tax impact can be quite substantial.
For example, if the jackpot cash value is advertised as $500 million and the winner is subject to a 37% federal tax rate, the federal tax owed would be 37% of $500 million, which is $185 million. This would leave the winner with $315 million after paying federal taxes. Any state taxes would further reduce the take home amount. The winner receives the cash value minus all applicable taxes.
Federal Tax Rates on Lottery Winnings
Lottery prizes are considered “unearned” income for tax purposes, which means they are taxed at a higher rate than typical income. In the United States, the federal tax rate on lottery winnings follows a progressive structure based on income levels:
- 24% for winnings up to $80,800
- 32% for winnings between $80,801 and $171,050
- 35% for winnings between $171,051 and $372,950
- 37% for winnings over $372,951
These tax brackets are applicable for 2022 and 2023. Based on the magnitude of most lottery jackpots, winners often fall into the top 37% tax bracket. However, the exact rate will depend on the winner’s total taxable income for the year.
State Tax Rates on Lottery Winnings
In addition to federal tax, lottery winnings may be subject to state taxes in the state where the winner resides and in the state where the lottery ticket was purchased. Here are some examples of state tax rates on lottery winnings:
| State | Tax Rate on Lottery Winnings |
|---|---|
| California | None |
| New York | 8.82% |
| Texas | None |
| Florida | None |
| Pennsylvania | 3.07% |
Some states like California, Texas, and Florida exempt lottery winnings from state income tax while other states like New York and Pennsylvania apply their highest tax rates. Winners should check their state’s laws to determine the state tax impact.
Withholding on Lottery Winnings
Lottery winnings typically have both federal and state taxes withheld immediately upon payout of the prize money. Federal taxes withheld are 24% of the winnings while state taxes can vary based on applicable rates. So a portion of the taxes are paid upfront before the winner receives any money.
However, withholding amounts may not cover the full tax obligation on large jackpots. Winners are responsible for paying any additional taxes when they file their tax returns for the year. It’s advisable for winners to work with legal and tax experts to ensure proper tax planning and payment.
Lump Sum Cash vs. Annuity Options
For large lottery jackpots, winners usually get to choose between receiving their prize as a lump sum cash payment or as an annuity with yearly installments over 30 years. Both options have important tax considerations.
Lump sum payment: The lump sum cash value, before taxes, is typically 50-60% of the advertised jackpot amount. Taxes are only applied once on the lump sum payment in the year the money is received. Choosing the lump sum allows winners to invest the balance after taxes.
Annuity payment: With the annuity option, winners receive a small portion of each year’s payment upfront after taxes are deducted. So taxes apply every year on the new installment amounts. The after-tax amount received depends on the applicable tax rates in each specific year.
Financially, the lump sum cash value is usually the better option despite the large one-time tax obligation. Proper investing and tax planning can enable winners to grow the lump sum into a larger long-term sum than the annuity after-tax amounts.
Claiming Lottery Prizes Anonymously
Winners concerned about privacy sometimes wish to claim their lottery prizes anonymously. However, only a handful of US states allow lottery winners to remain anonymous. These states are Delaware, Kansas, Maryland, North Dakota, Ohio, and South Carolina. In these states, winners can claim through trusts or other legal entities to shield their identities.
In all other states, lottery winners’ names and cities/towns of residence are made publicly available. This is required under transparency laws applying to lotteries. While anonymity is appealing, coming forward publicly also has benefits, including being able to tell one’s story and potentially motivate others.
Using a Lawyer for Collecting Lottery Winnings
It can be wise for lottery winners to consult with legal counsel experienced in lottery claims. A lawyer can advise on applicable taxes, best options for receiving the money, setting up trusts, maintaining privacy if desired, developing an investment strategy, and other financial planning steps. This can help ensure that winners hold onto as much of their winnings as possible.
Lawyers can also assist with collecting the lottery prize discreetly if the winner wishes to remain anonymous and state laws permit it. Attorneys can create legal entities like limited liability companies or trusts on the winner’s behalf that can be used to claim the lottery prize while keeping the winner’s identity out of the public eye.
Having strong legal advice is highly recommended before and during the lottery claiming process. This helps winners take full advantage of their sudden financial windfall.
Getting Financial Advice
Coming into large sums of money can be overwhelming for the average person. Those who play the lottery often spend and dream about what they would do if they won.
However, without professional financial management advice, lottery winners can struggle with money management. Approximately 70% of lottery winners end up broke within a few years after hitting a jackpot.
Money mentorship from qualified financial planners, wealth managers, and accountants can help lottery winners responsibly invest and plan for their new financial reality. This includes budgeting, banking, asset protection, tax strategy, and controlling spending habits.
Following a sound financial plan greatly increases the likelihood that a lottery winner’s money will last long-term. Learning to live within a budget and getting guidance from experts helps lottery winners thrive instead of squander their windfall.
Pitfalls to Avoid as a Lottery Winner
Coming into large sums of money unexpectedly can be dangerous if winners are not careful. Some common pitfalls that lottery winners face include:
- Spending too freely and extravagantly, burning through the money quickly
- Being overly generous by loaning money to friends and family that is not repaid
- Investing or giving money to sham opportunities without doing proper due diligence
- Not setting aside enough for tax obligations, resulting in penalties or asset seizures
- Going into debt to maintain an unsustainable expensive lifestyle
- Being victimized by scams or lawsuits from people seeking a portion of the winnings
- Developing an overreliance on the money, only to make poor financial decisions when the funds run out
Winners can avoid these negative consequences by living modestly, budgeting carefully, keeping a low profile, getting professional advice, maintaining a diversified investment portfolio, and keeping debts low.
Impact on Eligibility for Government Assistance
For low-income individuals who receive certain government benefits, winning the lottery can impact eligibility for those programs going forward due to increased income and assets.
Benefits that may be reduced or eliminated entirely include Medicare Savings Programs, Medicaid, Supplementary Nutrition Assistance Program (SNAP or food stamps), Supplemental Security Income (SSI), subsidized public housing, and Temporary Assistance for Needy Families (TANF).
Lottery winners who are currently receiving such benefits should consult a legal aid advisor to understand the potential effect a financial windfall may have on ongoing eligibility and make any needed adjustments in advance.
Costs Associated with Claiming a Jackpot
Beyond just taxes, there are some other costs and fees that come with claiming lottery prizes:
- Lawyer fees – For advice on claiming prizes, setting up trusts, maintaining anonymity, etc. Typical fees may be 1-5% of winnings.
- Financial advisor fees – For long-term management of winnings and investment planning. May charge hourly, per project, or an ongoing % of assets under management.
- State fee – Some states charge a fee for winning, such as California’s $0.5 million fee on prizes over $500 million.
- Insurance – Winners may incur various insurance costs like liability coverage to protect from lawsuits.
Winners need to factor in these assorted fees and costs from their lottery proceeds. Proper planning is key to maximize the net gains.
The Possibility of Shared Winnings
For major jackpots, it’s common for multiple winning tickets to be sold. Winnings are split evenly amongst all winners. This means each winner collects less than the advertised jackpot amount if there are multiple winners.
For example, if four people hold winning tickets for a $1 billion jackpot, each person would receive $250 million before taxes. This reduces both the cash value and annual payment for winners who have to divide the pot.
Income Tax Implications of Winning
In addition to taxes directly on the lottery winnings, the increased income can also push winners into higher tax brackets for their other earnings.
If a winner’s total annual income surpasses certain thresholds due to lottery winnings, their other income earned during the year is taxed at higher marginal rates.
For example, a single taxpayer with $50,000 in annual salary would fall in the 22% marginal tax bracket for 2022. But if they win $100 million in the lottery, their overall income increases to over $100 million, putting them in the top 37% bracket. So the taxes on their $50,000 salary will increase as well.
Estate Planning Considerations
Without proper estate planning, a lottery fortune can be depleted through estate taxes imposed when the winner passes away. Estate taxes apply on estates valued over $12.06 million per individual for 2022.
Estate planning strategies like creating trusts and gifting assets during one’s lifetime can help minimize estate taxes and ensure more money passes onto heirs rather than being lost to taxes. This protects a winner’s financial legacy.
The Benefits of Setting Up a Trust
Setting up a trust can provide valuable benefits to lottery winners such as:
- Privacy – Assets and identity can be shielded from the public.
- Control – Terms around asset distribution and use can be defined.
- Tax savings – Trusts may enable tax savings not available to individuals.
- Asset protection – Trust assets can have enhanced protection from creditors and lawsuits.
- Charitable giving – Trusts allow structured approaches for philanthropy.
Different types of trusts (revocable, irrevocable, living, etc.) offer different advantages that can be tailored to a winner’s situation. Consulting an experienced lawyer on trust options is recommended.
Being Smart with Newfound Wealth
Coming into a windfall of cash can be life-changing. But winning the lottery or getting a big cash infusion is just the starting point. Managing the money smartly over the long-term is critical.
Resisting the urge to indulge lavishly, being discreet about the winnings, living within reasonable means, getting professional financial guidance, and planning carefully for taxes and the future are wise moves for any lottery winner to make. With prudence and patience, a lottery fortune can turn into lasting financial stability.
The Takeaway on Taxes
While winning the lottery may seem like a dream come true, the advertised jackpot is not what winners take home. Taxes at the federal and possibly state level apply that immediately shave off a significant portion before the winner sees a dime.
But with proper tax planning assistance from advisors, wise investment of the net proceeds, and reasonable spending habits, lottery winners can still make their newfound wealth last and change their lives substantially for the better.
