When someone wins the lottery, they often look forward to claiming their prize and celebrating their newfound wealth. However, winning the lottery also comes with tax obligations that must be addressed. The Internal Revenue Service (IRS) treats lottery winnings like ordinary income, meaning taxes must be paid on the full amount. Here’s a quick look at how lottery winnings are taxed and what the IRS does with the taxes collected from big lottery winners.
Lottery Winnings Are Taxed as Ordinary Income
In the eyes of the IRS, money won from the lottery is no different than regular wages earned from a job or other ordinary income. Lottery winnings must be reported as taxable income when filing federal taxes for the year the prize was received. This means big lottery prizes often bump the winner into a higher tax bracket for that year.
Just like with regular income, federal taxes of up to 37% may need to be paid on lottery winnings. However, the top tax rate of 37% would only apply to prize money that exceeds $539,900 for single filers and $647,850 for married couples filing jointly in 2023. Winnings below these thresholds would be taxed at the lower rates of 10%, 12%, 22%, 24%, 32%, and 35%.
State taxes must also be paid on lottery prizes in most states that have an income tax. State tax rates on lottery winnings range from about 3% to 8% depending on the state.
So a $1 million lottery prize would be subject to $370,000 or more in combined federal and state taxes right off the top, considerably reducing the winner’s net gain.
Lottery Winnings May Push Winner into Higher Tax Bracket
One important thing for lottery winners to keep in mind is that their prize can push them into a higher tax bracket for the year they receive the payout. So even income earned before winning the lottery may end up being taxed at a higher rate.
For example, say a single taxpayer had $150,000 in ordinary income from their regular job in 2023. Based on the 2023 tax brackets, this would put them in the 24% bracket for federal taxes. However, if they also won a $1 million lottery prize, their total taxable income for the year would be $1,150,000. This would push them into the top 37% bracket for incomes over $539,900.
So the taxpayer would owe 37% on the lottery winnings. But they may also end up owing tax at the higher 37% rate on part of their ordinary income that was previously in the 24% bracket. This bracket bump can significantly increase the total tax bill.
Withholding on Lottery Winnings
To ensure taxes are paid on large lottery prizes, most state lotteries automatically withhold taxes before winners receive their lump sum payment or first annual installment.
Federal taxes withheld are usually around 24% of the prize. Some states also require withholding for state income taxes at rates ranging from 4% to 8%.
So right off the top, around a third of a big lottery prize is removed for taxes before the winner ever sees the money.
Estimated Tax Payments May Be Required
The amount withheld from a lottery prize may not cover the winner’s full tax liability. This is especially true if the winner has other income that year that bumps them into a higher tax bracket.
If insufficient taxes are withheld from lottery winnings, the IRS requires the winner to make estimated tax payments during the year to avoid penalties for underpayment. Form 1040-ES is used to calculate and pay estimated taxes on a quarterly basis.
Estimated payments may need to be made even if taxes were withheld from the lottery prize to ensure enough taxes are paid throughout the year. Failing to pay enough in estimates can lead to underpayment penalties when final taxes are due.
Reporting Lottery Winnings
To properly report and pay taxes on lottery winnings, the winner must fill out a Form W-2G provided by the lottery commission. A W-2G is required for any gambling winnings over $600. This includes cash prizes from slot machines, raffles, and sweepstakes in addition to lottery winnings.
A copy of the W-2G must also be sent to the IRS by the payer of the prize money. So the IRS will be on the lookout for this form when lottery winners file their tax returns. Failing to report gambling winnings can lead to tax evasion charges and penalties from the IRS.
The Form W-2G shows the gross amount won, taxes withheld, the winner’s name, address, and Social Security number. The winner must then claim the gross amount of lottery winnings as income on Form 1040 when filing their annual tax return. Any taxes paid through withholding during the year can then be deducted to determine taxes still owed or refunded.
Special Rules for Jackpot Annuities
For giant lottery jackpots, winners sometimes have the choice between receiving a lump sum payment or annual installments over 30 years. Opting for the annuity avoids being pushed into the top tax bracket in one year. But special rules still apply when it comes to paying taxes.
Winners who choose an annuitized jackpot receive a portion of their winnings each year. However, the entire prize amount is considered taxable income in the year the jackpot is won, regardless of when the annual payments are actually received.
So for a $500 million jackpot, the $500 million would be reported as income on the winner’s tax return in the year they claimed the prize. Taxes each year would then apply to the portion of the prize paid out annually.
This means winners who choose annuities may need to carefully plan to have funds available each year for the taxes due on their annual prize installment. Failing to stay current on taxes could lead to the IRS seizing a portion of future annuity payments.
The IRS Deducts Taxes Before Paying Refunds
When Americans file their annual tax returns, many end up being due a refund from the IRS because they overpaid taxes during the year through withholding or estimated payments. However, if you owe any additional taxes, delinquent taxes from prior years, penalties, or interest, the IRS will deduct these amounts from your refund first before paying out the balance.
So winning the lottery may trigger a tax bill from the IRS that exceeds the amount already withheld from your prize. If that happens, you can still file your tax return as normal. But all or part of your refund would then be applied to the taxes owed on your lottery winnings before you receive any refund cash.
Special Rules for Non-U.S. Citizen Winners
For non-U.S. citizens, claiming a lottery prize can be much more complicated when it comes to taxes. Non-resident aliens are subject to a flat 30% tax rate on their gambling winnings. This tax rate is generally higher than the percent that would apply based on the regular income tax brackets for citizens.
The 30% flat tax is taken out of the gross winnings first before the remaining amount is paid to the winner. There is no allowance for recovering any of this tax withheld by filing a U.S. tax return.
In addition, winners from foreign countries may owe taxes in their homeland as well on lottery winnings claimed in the U.S. Owing taxes in two different countries is an expensive predicament for international lottery winners.
Standard Deduction Doesn’t Apply to Gambling Income
Taxpayers who don’t itemize deductions can claim the standard deduction to reduce their taxable income. For single filers, the 2023 standard deduction is $12,950. However, this deduction cannot be claimed against gambling winnings, including lottery prizes.
You also cannot deduct gambling losses against lottery winnings and other gambling income claimed during the same year. Gambling losses can only be deducted against gambling winnings reported in other years.
So the only deductions that can be made against lottery income are related expenses like the cost of traveling to claim the prize or professional advice sought in handling the windfall. But even these expenses are only deductible if you choose to itemize.
Past-Due Debts May Be Deducted from Winnings
If you are lucky enough to win the lottery but have outstanding debts, don’t assume your winnings are all yours to keep yet. The IRS and states allow certain creditors to make claims directly against lottery prizes to settle past-due debts.
State agencies can request lottery commissions to withhold funds from prizes to cover back taxes owed and delinquent child support payments. The IRS can also levy lottery prizes to put towards unpaid federal income taxes.
Even private creditors like credit card companies and hospitals can claim lottery winnings in some states if you have accounts in serious arrears.
Before receiving the full amount of a lottery prize, winners may need to resolve these outstanding debts or make arrangements to settle the balances over time to satisfy creditors.
Unclaimed Prizes Revert Back to the State
For winning lottery tickets never claimed, the money doesn’t simply disappear. Unclaimed lottery prizes ultimately revert back to the state running the lottery to be used in future games or go towards public education funding and senior services.
Each state has different rules on unclaimed prizes and when winning tickets expire. In some states, players have just 90 days to come forward with a winning ticket before it is voided. Other states give ticketholders up to a year to collect prizes before they lapse.
State lotteries continue to earn interest on unclaimed jackpots even after the claim expiration date. Eventually this interest and the prize money itself is turned over to state coffers. Hundreds of millions in unclaimed prizes accumulate each year across the various state lotteries.
The IRS Monitors Lottery Winnings Closely
Given that lottery prizes often reach into the multimillion-dollar range, the IRS keeps a close watch on winners to ensure taxes are being properly paid. In particular, the IRS looks for discrepancies between the winnings reported on Form W-2Gs issued by lottery agencies and the amounts reported on winners’ federal tax returns.
Underreporting of lottery winnings is a red flag for potential tax fraud. The IRS can cross-check W-2Gs against your tax return to verify you claimed all required income. Failing to report lottery winnings or any other type of gambling income can lead to tax evasion charges. Penalties for substantial underreporting start at 20% of the unpaid tax bill. Jail time is also possible in criminal cases.
The bottom line is there is no way to avoid paying taxes on lottery winnings. The IRS treats this income like any other and closely monitors lottery prizes to prevent tax dodging. While the taxman will take a healthy share of any jackpot, following the rules ensures you stay on the right side of the law as you collect your winnings.
Frequently Asked Questions
Do you pay taxes on lottery winnings?
Yes, federal and usually state taxes must be paid on any lottery winnings. The IRS treats lottery prizes like ordinary taxable income, meaning they are subject to the same income tax rates. Withholdings of around 24-30% are generally taken out of large lottery winnings before prizes are paid out to cover the taxes due.
Do you pay taxes if you win the lottery and donate it?
Even if you choose to donate some or all of a lottery prize to charity, you are still required to pay taxes on the winnings. From a tax perspective, it’s no different than if you had kept the full amount. You must claim the gross winnings as taxable income and can then deduct the charitable donation separately when filing your taxes.
Are lottery winnings taxed at state and federal levels?
In most cases, lottery prizes are subject to both federal and state income taxes in the jurisdiction where you claimed the winnings. Federal tax rates up to 37% apply to lottery winnings. States with income taxes also tax lottery prizes, typically at rates ranging from 3% to 8% depending on the state.
Can you avoid paying taxes on lottery winnings?
There is no way to legally avoid paying taxes on lottery winnings. Lottery agencies report all prizes over $600 to the IRS. If you try to evade taxes by not reporting winnings or underreporting income, you can face criminal tax charges and substantial penalties from the IRS. It is not worth the risk to attempt to avoid taxes on lottery winnings.
Do lottery taxes pay for education and other public services?
State lottery revenue, including taxes collected from prizes, helps fund education, senior services, and other public programs in many states. Unclaimed lottery prizes also eventually revert back to the state. So the taxes taken out of lottery winnings do serve a public benefit rather than just disappearing into government coffers. However, education funding usually only makes up a small fraction of a state’s overall budget.
The Bottom Line
Winning the lottery certainly provides an immediate financial windfall. But the IRS and state tax agencies view lottery prizes as a significant source of tax revenue. Income, withholding, and estimated taxes need to be properly handled on lottery winnings like any other income source. And the tax impact can be significant, taking out 30-50% or more of a jackpot off the top in many cases between federal and state taxes. While paying taxes on big winnings takes some joy out of the prize, following the rules keeps lottery winners out of trouble with the taxman.