Yes, lottery winnings are considered taxable income by both the federal and California state governments, even if you live or bought the ticket near San Francisco. You must report lottery winnings on your tax return and pay applicable taxes.
Federal Taxes on Lottery Winnings
At the federal level, lottery winnings are considered “gambling winnings” by the IRS. As such, any prize over $600 will be reported to the IRS by the lottery operator using a W-2G form. This $600 threshold applies to the total amount won from a single lottery drawing, so even if you buy multiple tickets, your winnings are combined when determining if taxes apply.
Federal tax rates on lottery winnings can be as high as 37% for the top tax bracket. In addition, you may have to pay an additional 3.8% net investment income tax on winnings if your modified adjusted gross income exceeds certain thresholds.
So for a lottery jackpot prize, a good portion of it often goes to paying federal taxes. However, there are some mitigating factors:
- You can offset lottery winnings with gambling losses, which reduces your total taxable gambling income.
- Instead of taking a lump sum, you can opt for an annuity paid out over 30 years. This spreads out your income and tax liability over time.
- If you donate some of your winnings to charity, you can claim a deduction for charitable contributions.
But in most cases, if you have a large lottery win, you should expect to owe a significant amount in federal income taxes.
California State Taxes on Lottery Winnings
In addition to federal taxes, residents of California must pay state income taxes on lottery winnings. The state income tax rate in California is progressive, ranging from 1% to 12.3% depending on income level.
The first $8,932 of lottery winnings for single filers would fall under the 1% bracket. Amounts over $599,012 would be taxed at the highest rate of 12.3%. For joint filers, the rates are doubled but the same concept applies.
One important difference is that California does not allow deductions for gambling losses to offset lottery winnings. So your state tax liability may be higher than federal if you had significant gambling write-offs.
California does not impose any additional net investment income taxes on lottery winnings.
Lottery Winnings Tax Requirements
If you win more than $600 from the lottery, you can expect to receive a W-2G form from the lottery operator. This will have the details of your winnings that will be reported to the IRS and California tax authorities.
You must report all lottery winnings on Form 1040 Schedule 1 Additional Income at tax time. The taxes owed will flow through to your total tax calculation. For California, you would report lottery winnings on Form 540 Schedule CA Taxable Income Adjustments.
Most lotteries will automatically withhold federal taxes at a flat 24% rate when you claim a jackpot prize. However, this may be insufficient if you end up in a higher tax bracket. California does not require any automatic withholding.
So you should think about making estimated tax payments on big lottery wins to avoid penalties for underpayment. You may need to make quarterly estimated payments to the IRS and California Franchise Tax Board.
Special Rules for Lottery Annuities
As mentioned above, you can take some lottery prizes as an annuity instead of a lump sum. This provides a stream of annual payments over many years – often 30 years for major jackpots.
Taxes on lottery annuity payments only apply once you receive each payment. So your tax is spread out and deferred into the future rather than all being due immediately.
Do keep in mind that if you die before the full payment schedule completes, your heirs would be responsible for the tax liability on any remaining payments.
Lottery Winnings and Gift Tax
What if you decide to gift some of your winnings to family or friends? For exceptionally large amounts, you may trigger federal or state gift tax rules.
In 2023, up to $17,000 can be gifted by one individual to another without filing a gift tax return or paying gift taxes. Spouses can jointly gift up to $34,000 tax-free.
Beyond these annual limits, you would need to file Form 709 to the IRS to report gifts above the threshold. You can apply $1 million of your lifetime exemption before paying actual gift tax.
California also levies a gift tax if lifetime gifts exceed $1 million. So keep these limits in mind if gifting a portion of lottery winnings.
Claiming Lottery Prizes Anonymously
Can lottery winners maintain anonymity and avoid the spotlight in California? Unfortunately there is no way to claim a lottery prize completely anonymously.
California law requires the California Lottery to publicize the details of all major prize winners, including the name, city of residence, and amount won.
The only recourse is to form a trust or limited liability company to claim the winnings. This keeps the individual winner anonymous to the public, but the lottery organization and tax authorities will still know the ultimate beneficiary.
As far as taxes go, there is no advantage to claiming winnings through an entity – the individual beneficiaries still must pay income tax and report it under their own Social Security number.
Impact on Means-Tested Benefits
For those relying on means-tested government benefits such as Medicaid, food stamps (SNAP), or SSI, a lottery windfall can cause loss of eligibility.
Most of these programs have income limits to qualify, so a major lottery prize would push you over the threshold. Even for programs like ACA premium tax credits where benefits phase out gradually, a big win means you’d lose all subsidies.
So if you currently rely on needs-based assistance, tread carefully when claiming lottery prizes. Speak with a social services caseworker first about impacts.
Lottery Winnings and Bankruptcy
Some people facing bankruptcy think winning the lottery will resolve their financial woes. But under 2005 bankruptcy reform laws, lottery winnings can be fair game for creditors.
If you receive a large lottery prize prior to filing bankruptcy, the winnings would be considered an asset. Creditors can claim them, and they would impact your eligibility for Chapter 7 vs. Chapter 13 bankruptcy.
That said, receiving lottery winnings after already filing for bankruptcy is a different story. Those new assets are generally protected and not subject to claims.
Scams Involving Lottery Winnings
Unfortunately, lottery scams are common. Here are some examples to watch out for:
- A letter saying you won a foreign lottery you never entered. They ask for a “processing fee” to claim your winnings.
- Someone contacts you saying they can hack or influence the lottery if you pay them a large upfront fee.
- You are asked to pay various taxes and fees before receiving lottery winnings that don’t exist.
- A fake lottery website looks real but is designed to steal your personal and financial information.
As a rule, if someone promises lottery winnings but asks you to pay money or give personal details first, it’s likely a scam. Report such scams to authorities.
Key Takeaways
- Lottery winnings are fully taxable by the federal government as well as the state of California.
- Winnings over $600 will be reported to tax authorities and you must report them on your tax return.
- Tax rates on lottery winnings can be over 50% combined for federal and California income taxes.
- Having taxes automatically withheld when claiming prizes helps avoid penalties.
- Gifting lottery winnings is tax-free up to annual limits.
- Unfortunately lottery winners cannot claim prizes 100% anonymously in California.
- Major lottery prizes can impact eligibility for means-tested benefits programs.
- Be very wary of lottery scams asking you to pay money or fees for fake winnings.
