If you are lucky enough to win a big lottery prize, you may be wondering how many times you have to pay taxes on your windfall. The short answer is that lottery winnings are taxed twice – once at the federal level and again at the state level in most states that have a state income tax.
Federal Taxes on Lottery Winnings
At the federal level, lottery winnings are taxed as ordinary income based on the tax brackets you fall into. Here’s a quick rundown:
- For single filers, you pay 10% on the first $10,275 of taxable income, 12% on income between $10,276 and $41,775, 22% on income between $41,776 and $89,075, and higher rates on any income above that.
- For married joint filers, you pay 10% on the first $21,525 of taxable income, 12% on income between $21,526 and $83,550, 22% on income between $83,551 and $178,150, and higher rates on any income above that.
- The top federal tax rate is currently 37% on income above $541,900 for single filers and $647,850 for married joint filers.
So if you win a $1 million lottery prize, you would pay 10% federal tax on the first $10,275 or $21,525 depending on your filing status. You would then pay 12% on the next chunk of income, 22% on the next portion, and continuing graduating up through the tax brackets.
In addition to ordinary income tax, you may also owe the Alternative Minimum Tax (AMT) on your lottery winnings. The AMT is a supplemental tax designed to ensure that wealthy taxpayers pay at least some minimum amount of tax regardless of deductions, credits, or other loopholes. Lottery winners are especially susceptible to the AMT since their ordinary income tax can be much lower in the year they receive the lump sum prize.
State Taxes on Lottery Winnings
In addition to federal taxes, most states that have an income tax will also tax your lottery winnings. Here’s how it works:
- 43 states plus the District of Columbia have a state income tax. Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming do not have a state income tax.
- Of the states with an income tax, only a handful – California, Delaware, New Hampshire, Pennsylvania, and Montana – do not tax lottery winnings.
- The remaining 38 states with an income tax will apply their own state tax rates to your lottery winnings in addition to the federal taxes you owe.
- State tax rates range from about 3% to over 13%, with most states in the 5-7% range.
For example, say you live in Massachusetts and win a $10 million lottery prize. Massachusetts has a flat 5% income tax rate. So on top of your federal taxes, you would owe an additional $500,000 in Massachusetts state income taxes on your lottery winnings.
Some states allow you to deduct your federal taxes paid when calculating state taxes. But either way, you end up getting taxed twice on lottery winnings in most states.
Tax Withholding on Lottery Winnings
Now that you know how many times lottery prizes can be taxed, the next question is when you actually have to pay those taxes. For large lottery winnings, tax withholding requirements come into play:
- For lottery prizes over $5,000, the lottery is required to withhold 24% for federal taxes before paying out your prize.
- Many states also require state tax withholding, often at a rate of around 5-7% of your total prize.
- You will receive a W2-G form reporting the taxes withheld, which you then claim on your tax return.
- If the withholding doesn’t cover your total tax liability, you must pay the additional taxes when you file your return.
- Conversely, if too much tax is withheld, you get a refund when you file your return.
For example, on a $1 million lottery prize:
- The lottery would withhold $240,000 (24%) for federal taxes
- The lottery would withhold another $50,000 (5%) for state taxes in a state like Massachusetts
- This totals $290,000 withheld upfront before you receive your $1 million prize
- When you file taxes, you calculate your total tax bill and get refunded any overpayment
One option winners have is to opt for the annuity prize instead of the lump sum. Annuity prizes spread out your winnings over several decades, so less tax is withheld upfront. You can get a larger initial check, but owe more when you file your returns each year.
How Lottery Winnings Are Reported
It’s very hard to avoid having your lottery winnings reported to the IRS. Here’s why:
- The lottery commission reports all prizes over $600 using a W2-G form. This is sent to both you and the IRS.
- For larger prizes, the lottery commission withholds taxes upfront before paying you.
- If you try to avoid having winnings reported by putting the lottery ticket in a trust or LLC, the IRS requires these entities to have a Taxpayer Identification Number which can be traced back to you.
- If you share winning lottery tickets with a group of people, each person’s share of the prize still must be reported on a W2-G form.
- It is illegal not to report gambling winnings by intentionally failing to provide a Taxpayer Identification Number.
As you can see, there is no way to avoid having your lottery winnings reported to the IRS and state tax authorities. The good news is that this reporting ensures you don’t mistakenly fail to pay taxes on lottery prizes. Just be sure to keep good records so you can file accurately and claim any refunds when due.
Special Considerations for Non-US Citizens
For non-U.S. citizens and foreign nationals, lottery winnings in the United States are still subject to U.S. tax withholding and income taxes. Here are some key points if you win the lottery while visiting or residing in the U.S. temporarily:
- Only permanent U.S. residents (green card holders) are subject to the same taxes as U.S. citizens on lottery winnings. Non-resident foreign nationals typically pay a 30% tax rate on gambling winnings, regardless of the prize amount.
- Tax treaties with some countries like Canada and the U.K. may allow you to file a U.S. tax return and reclaim some of the 30% withheld after filing.
- To claim a tax treaty benefit and get an Individual Taxpayer Identification Number (ITIN), you must file IRS Form W-7 with the IRS.
- Check if your country of citizenship has a tax treaty with the U.S. Lottery winnings are covered under the “Other Income” section of most tax treaties.
In summary, permanent U.S. residents face the same tax rates on lottery winnings as citizens. Non-residents may pay higher rates but can potentially claim refunds. Proper documentation like an ITIN is required either way.
Should You Form a Trust to Claim Lottery Prizes?
With multi-million dollar lottery jackpots, some winners consider using a trust to maintain anonymity and manage the funds. Here are some pros and cons to consider:
Potential Benefits of a Lottery Trust
- Avoids having your name publicly announced as the winner if you live in a state that allows trusts to claim prizes anonymously.
- Allows a team of professional trustees to manage the money on your behalf.
- May provide some asset protection from lawsuits, creditors, divorce proceedings.
- Can help manage investments and distribution of funds to heirs upon death.
- May allow you to avoid state income tax if the trust is set up in a state with no income tax.
Potential Drawbacks of a Lottery Trust
- Does not help avoid taxes – the trust must pay taxes on lottery winnings at your personal tax rate.
- Costs money to set up and maintain the trust.
- You give up control over the funds to the trustees.
- Does not protect assets from federal tax liens if back taxes are owed.
- Does not fully protect assets; creditors can force distributions.
In summary, a lottery trust can provide some benefits but is not a magic bullet. You still must pay full taxes on lottery winnings. And any anonymity benefit depends on the particular state’s lottery rules. Consult financial and legal advisors to weigh the pros and cons for your situation.
How to Invest Lottery Winnings
After paying taxes, most experts agree lottery winners should invest their windfalls conservatively. Some tips include:
- Set aside up to 6 months of winnings in cash to pay bills and expenses during the transition.
- Pay off all debts and mortgages to be debt-free.
- Max out tax-advantaged retirement accounts like IRAs and 401(k)s.
- Invest the bulk of winnings in a diversified portfolio of stocks and bonds.
- Limit exposure to risky assets like venture capital, collectibles, or speculative investments.
- Work with reputable fee-only financial advisors, not commission-based brokers.
- Create a wealth management plan with clear goals for earnings, withdrawals, and inheritance.
- Consider low-cost index funds instead of costly actively managed investments.
The key is being prudent with your newfound wealth and avoiding temptation to make overly risky bets. Investing lottery winnings conservatively can help ensure the money lasts.
Common Pitfalls for Lottery Winners
Many lottery winners end up losing some or all of their money to taxes, poor investments, or spending mistakes. Here are some common pitfalls to avoid:
- Taking the lump sum payment instead of annuity payments. The lump sum seems bigger but you lose a third or more to taxes immediately.
- Paying more taxes than necessary by not working with tax professionals.
- Splurging on luxury houses, cars, vacations immediately after winning and depleting funds quickly.
- Lending money freely to friends and family who may never pay it back.
- Making bad business or investment decisions due to inexperience.
- Being overwhelmed with requests for money from others.
- Not setting up a wealth management plan and spending aimlessly.
- Broadcasting winnings publicly and becoming a target for lawsuits, scams or abuse.
Essentially, avoiding reckless spending, unwise lending, and poor investing is key. Take time to learn about handling large windfalls before collecting your prize.
Claiming Lottery Prizes Anonymously
To avoid becoming an easy target after a big lottery win, you may want to keep your identity secret. Here’s how to potentially claim winnings anonymously:
- In some states like Delaware, Kansas, Maryland, etc., you can claim through a trust or other legal entity to remain anonymous.
- If allowed, have your attorney form and claim the prize on behalf of a blind trust, then distribute funds to you privately.
- For publicly announced prizes, engage a spokesperson to handle media requests on your behalf.
- Consider physically claiming your prize in a disguise to avoid being recognized publicly.
- Immediately take precautions like changing phone numbers, installing security systems, moving out of state, etc. if your identity gets disclosed.
However, true anonymity is difficult. Lotteries want publicity around big winners. And remaining anonymous for the long-term takes effort and being extremely cautious.
The Takeaway on Taxes and Lottery Winnings
To summarize the key points:
- Lottery winnings face double taxation – first at the federal level, then state for most states.
- Withholding takes out about 30% upfront, but taxes can be higher or lower based on your specific liability.
- It’s hard to avoid having your lottery winnings reported to tax authorities.
- Non-residents may pay up to 30% fixed tax on U.S. lottery winnings.
- Trusts involve trade-offs and don’t eliminate tax obligations.
- Invest wisely, avoid spending pitfalls, and keep a low profile if possible.
Lottery winners have great fortune in winning life-changing prizes. But taxes and other responsibilities come with that windfall. So be sure to educate yourself on the tax requirements and smart money management. This will help ensure your lottery fortunes bring you joy for many years to come.
