The Powerball lottery drawing on October 19, 2022 produced a single winner for the $700 million jackpot. This is the fifth largest jackpot in Powerball history. With the cash option selected, the winner will take home an estimated $496 million before taxes. However, the final amount received after taxes will be substantially lower. In this article, we’ll break down the various taxes and deductions the winner will face and calculate the actual take-home amount.
Federal Tax Withholding
For lottery winnings over $5,000, the IRS requires 24% of the winnings to be withheld for federal taxes. This applies to U.S. citizens and resident aliens. For the $700 million Powerball jackpot with the cash option, 24% of $496 million equals $119 million withheld for federal taxes.
That leaves $377 million after the initial federal tax withholding. However, additional federal taxes will be owed on the winnings when the winner files their tax return for the year. The top federal tax rate of 37% applies to income over $539,900 for single filers and over $647,850 for married couples filing jointly in 2022. With millions in winnings, the winner will certainly be in the top tax bracket and owe about $184 million in additional federal tax (37% of $496 million).
Federal Tax Summary
|Cash option selected
|Federal tax withholding (24%)
|Remaining after withholding
|Additional federal tax owed (37%)
After paying the additional $184 million owed, the winner will have paid $119 million + $184 million = $303 million in total federal taxes.
State Tax Withholding
In addition to federal taxes, state taxes will also be due on the lottery winnings. State tax rates vary widely across the country from zero income tax in states like Florida and Texas to over 13% in California and New Jersey. The Powerball jackpot could be subject to state tax withholding in the state where the ticket was purchased.
For example, if the ticket was bought in California with a state income tax rate of 13.3%, about $66 million would be withheld from the $496 million cash prize for state taxes there. If the ticket was purchased in Texas, there would be no state income tax withholding.
After Federal and State Withholding
To illustrate, let’s assume the ticket was bought in California and estimate $66 million was withheld for state taxes along with the $119 million withheld for federal taxes we calculated earlier.
|Federal tax withholding
|California state tax withholding
|Remaining after withholding
After the initial 24% federal tax and 13.3% California state tax withholding, this would leave $311 million remaining from the original $496 million prize.
Additional State and Local Taxes
Our winner will also owe additional taxes to California and potentially local jurisdictions like city and county depending on the winner’s residence. The additional California state tax owed would be about $66 million (13.3% of $496 million). Local taxes could add another 1-2% depending on location.
To keep our example simple, let’s assume just the additional California state tax is owed.
|Remaining after withholding
|Additional California state tax (13.3%)
|Remaining after additional state tax
With the additional $66 million paid to California, around $245 million remains from the original $496 million prize amount.
Federal Gift Tax
For a prize this large, the winner may want to gift some of the money to family and friends. However, gifts exceeding $16,000 per person per year are subject to federal gift tax.
This tax is paid by the gift giver, not the recipient. The gift tax rate is 40% in 2022 on amounts above the $16,000 annual exclusion. With the unified estate and gift tax exemption currently at $12.06 million per person, smaller gifts likely won’t incur tax. But any substantial gifts above that level would face the 40% federal gift tax in addition to income tax.
Financial Advisors Recommendations
Most experts recommend establishing trusts and other entities to reduce gift and estate taxes when gifting large amounts. The winner will need advice from financial and legal professionals to navigate gift and estate tax planning.
Proper planning could significantly reduce the gift tax, but the winner will still face substantial taxes to gift large amounts.
Coming into sudden wealth makes winners vulnerable to creditor claims, lawsuits, and scams. Lottery winners are often advised to set up trusts and limited liability companies to shield their assets. The winner may want to purchase umbrella insurance policies to provide added liability coverage from lawsuits.
Good legal advice can help protect lottery riches from both unscrupulous claims and legitimate legal action. Effective trusts and corporate structures can safeguard the bulk of winnings for the winner and their heirs.
For philanthropically minded winners, donations to IRS-approved charities and nonprofit organizations are tax-deductible. Donations can offset some of the tax burden on lottery winnings.
The tax deduction is up to 60% of adjusted gross income for cash donations. Other rules apply for donating appreciated assets like stock. Documentation is required for all charitable deductions over $250.
Of course donations shouldn’t be made solely for the tax benefits. But charitable giving can play a role in tax planning for lottery winners.
Charitable Donation Strategies
– Donor advised funds allow contributions now for future distributions to charities over time. These provide an immediate tax deduction while creating an ongoing charitable giving fund.
– Private family foundations give more control over grants and investments but have higher costs to establish and administer. They allow winners to formalize their legacy and philanthropic priorities.
– Major gifts to educational institutions and hospitals can name buildings, programs, research projects, and more in the winner’s honor. These “naming rights” gifts require millions in donations.
– Conservation easements permanently protect land from development while providing income, property, and estate tax deductions. The eased land can still be enjoyed recreationally and passed on to heirs.
– Charitable remainder trusts pay lifetime income to beneficiaries designated by the winner, with the remaining assets donated to charity after their death. These provide income tax deductions now while reducing estate taxes later.
Lump Sum or Annuity
Powerball winners have a choice between receiving their full share of the prize at once in a lump sum, or in installments over 29 years in an annuity. The jackpot cash value is estimated by lottery officials based on market interest rates.
The cash value is always substantially lower than the headline jackpot amount. For this $700 million prize, the cash value was estimated at $496 million versus 30 graduated payments that would total around $700 million over the full term.
There are advantages and disadvantages to each approach:
Lump Sum Advantages
– Full control over investment choices rather than relying on annuity provider
– Flexibility in charitable giving, trust distributions, large purchases, etc.
– Removes longevity risk – no dependence on company paying over decades
– Estate can inherit any remaining portion of winnings after death
– Provides stable annual income for life
– No investment decisions or responsibilities
– Less likely to be squandered quickly compared to lump sum
– Payments increase by 5% each year to help offset inflation
– Income taxed annually rather than all at once
From a pure financial perspective, the lump sum usually comes out ahead due to the ability to invest and earn returns at regular income tax rates. The annuity income is taxed at the winner’s top ordinary income rate each year.
Younger winners are often better off taking the lump sum, while older winners may prefer the simplicity and stability of the annuity. But there are good arguments on both sides, so it’s a very individual choice for each winner. Most financial experts can help model the options.
Coming into hundreds of millions of dollars requires significant financial planning and investment management. It’s crucial to set aside enough to pay the taxes first before making any other big moves. Some key considerations include:
It will be tempting to pursue aggressive investments promising high returns, but preserving principal should take priority. Losing even 10% of such a large amount is devastating. Capital preservation and risk management are vital.
Strategies and investment vehicles that minimize taxes, such as retirement plans, HSAs, municipal bonds, ETFs, etc can optimize after-tax returns.
Mix of Investments
A diversified portfolio of cash, bonds, stocks, alternative investments, and real assets can provide adequate growth while managing risk. Blending different uncorrelated return streams smooths out volatility.
Individuals without experience handling such large investments can easily make costly mistakes. Reputable wealth management firms provide fiduciary advice, access to institutional investments, tax strategies and other valuable guidance. Their fees are well worth the incremental management gains.
Limiting annual distributions to a safe percentage, say 3-5%, preserves principal while still providing ample income that can grow with inflation. Remaining balances can pass tax-efficiently to heirs.
A massive financial windfall can dramatically change every aspect of the winner’s life. Some important considerations around lifestyle changes include:
Sudden wealth is disorienting. Counseling and grounding from trusted family and friends can help maintain perspective. The initial excitement will fade, but the money can keep improving lives for generations if managed prudently.
Winners forfeit anonymity. It helps to unlist phone numbers, deactivate social media, and even consider relocating to protect family and personal relationships in the media glare. Setting up trusts rather than claiming prizes individually preserves more privacy.
The urge will be strong to help family and friends financially. This is fine, but within reason. Implement a thoughtful process for requests to avoid conflict and perceived unfairness. Make sure gifts don’t enable unhealthy behaviors.
Focus on Goals
Wealth removes barriers to achieving goals. Winners should ignore social pressures to live lavishly and thoughtfully map out their aspirations for the money. Focus on improving lives, not accumulating “stuff.”
Learning to make the windfall last starts with an understanding of money management basics: budgeting, saving/investing, debt management, financial planning. Many winners lack this education and would benefit greatly from its guidance.
Impact on Future Generations
Responsible management of a lottery fortune can positively impact generations to come. But winning can also create problems like entitlement and remove the motivation to become self-sufficient. Some best practices for generational planning include:
Trusts allow control over how and when heirs receive distributions. Incentive provisions can tie disbursements to achieving education, career, and other milestones.
Teaching Financial Literacy
Heirs should learn money management skills. This equips them to handle distributions and financial decisions responsibly.
The family can define shared values and priorities for giving. This creates a tradition of good stewardship and community purpose.
Family meetings, mission statements and clear guidelines on conduct can help manage relationships and expectations over generations.
Making gifts to heirs during life while reinforcing standards of financial responsibility can be better than large bequests after death that encourage excess and entitlement.
A Powerball jackpot win has the ability to transform lives for the better when handled responsibly. But lottery riches also come with complex planning challenges around taxes, investments, lifestyle changes, privacy, security, charitable giving, and generational impacts.
Navigating these terrain successfully requires assembling the right team of advisors and maintaining grounded perspectives. The substantial taxes and fees paid will still leave life-changing wealth to fuel dreams and provide security.
Lottery fortunes enable amazing possibilities but require diligence to maximize the benefits and minimize harm. With wise planning and stewardship, Powerball billions can change families and communities for the better for generations.