If you won the lottery, congratulations! Now, you’ll need to decide whether to take a lump sum payment (one check for the single amount) or annuity payments (smaller annual payments equal to the total winnings). In this article, we’ll answer your most burning questions about taxes on lottery winnings and provide ideas for protecting your newly acquired wealth.
How much are lottery winnings taxed?
When you win the lottery, your winnings are considered ordinary taxable income. Your prize money is taxed at the same rate as your wages and salary income. The amount of tax you pay is ultimately determined by the tax bracket your taxable income falls into. Depending on your filing status and the taxable income (including your prize money), you are subject to a 10-37% tax rate.
If your prize is over $5,000, the IRS requires the payor to withhold 28% for federal taxes. In addition to federal tax on lottery winnings, your state may require a withholding too. You’ll receive Form W-2G, which provides the details of your winnings and withholdings.
State taxes on lottery winnings
Tax on lottery winnings vary by state, as each state has unique tax rates. If your lottery winnings exceed $5,000, the prize payor can withhold up to 15% for state taxes.
If you live in a state with no income tax (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming), you may not have to pay state taxes on your lottery winnings.
You should also consider the state where you bought the ticket. If you live in a different state from where you purchased your winning ticket, you might need to pay taxes as a non-resident. Even as a non-resident, you must still pay withholding tax if your winnings exceed the $5,000 threshold.
For example, if you reside in Florida but win the Georgia lottery, you won’t need to pay state income tax in Florida because they don’t have state income tax. However, you may still be required to pay taxes in Georgia by filing a non-resident return.
Should I take the lump sum or the annuity when I win the lottery?
There is no right or wrong answer. The best payout option depends on your current lifestyle and financial goals.
The annuity option pays the entire prize amount incrementally over 29 years. If you are close to retirement, you may see the annuity as a better option because it offers a guaranteed, steady income stream for the rest of your life. The lottery may even allow you to name a beneficiary for any remaining payments. The annuity structure also helps protect you from overspending your winnings.
The lump sum is a one-time payment, usually smaller than the total prize amount. If you have medical bills or large amounts of debt to pay off, you may see a greater value in receiving the cash up front. A lump sum also offers more flexibility in investing sooner.
Choosing annual payments vs. the lump sum will initially keep you in a lower tax bracket instead of facing the liability of that additional income at once. Being in a lower tax bracket means you’ll be taxed at a lower rate, which typically reduces your tax liability. The lump sum will place you in a higher tax bracket, but you’ll pay the taxes you owe in a single year instead of over the lifetime of the annuity.
Regardless of your choice, think about hiring a financial advisor to avoid making the same mistakes as many previous winners.
What federal taxes will I have to pay with a lump sum payment?
The IRS typically requires payors to withhold 28% of the lump sum payment for federal tax. It is standard practice for ordinary taxable income to have federal tax withholdings deducted before you receive payment.
You should receive Form W-2G, which reports the details of your winnings and withholdings. You must include this form when you file your tax return and pay any remaining taxes you owe.
What federal taxes will I have to pay with the annuity?
If you opt for annual payments, each installment is taxed when you receive it. The specific amount of tax you owe will vary depending on your total income and deductions for the year, which determines your tax bracket. Like the lump sum option, the payor may still withhold 28% for federal tax and expect you to pay the remaining amount when you file your tax return each April.
How to minimize taxes on lottery winnings
Charitable donations are one way to minimize your tax liability on lottery winnings. The IRS allows individuals to deduct up to 60% of their adjusted gross income in cash contributions to qualifying charities. However, you can only claim this deduction if you plan to itemize your deductions. Itemized deductions directly reduce your taxable income, so your donations could significantly impact your liability.
You can also gift money to friends and family. Keep in mind that you can give up to $18,000 per person per year before the gift tax applies. Another option is to put your money in a trust, which can help minimize taxes on your estate if something happens to you.
Can you put lottery winnings in a trust?
Yes! If you win a significant sum in the lottery, setting up a trust for any remaining money you don’t donate or spend helps protect your winnings. A trust allows a third party, known as a trustee, to hold financial assets on behalf of a person, known as a beneficiary. There are several kinds of trusts and ways to set them up. Trusts avoid settling an estate through a legal process known as probate.
A trust clearly defines who will receive which assets in case of death, and how taxes and debt will be paid. Establishing a trust allows your family and friends to acquire these assets more quickly.
What to know about investing lottery winnings
You might also consider investing your lottery winnings. Choosing to invest comes with a range of options like stocks, bonds, real estate, or cryptocurrency. Before investing, you should know that investment income is taxed as capital gains. Capital gains tax rates may differ from your ordinary income depending on how long you held the investment.
Taxes on lottery winnings FAQs
If you’ve hit the lottery, there are a few things you should know when filing a tax return. Here are some quick answers to get you started in understanding your reporting requirements.
Do you have to pay taxes on lottery winnings?
Yes. Lottery winnings are treated the same as money earned from a job. When you file your taxes, you’ll need to report the lottery winnings as part of your total income. This combined income determines the tax bracket you fall into, which ultimately determines the amount of tax you owe. You should plan to pay federal and state taxes if the payout state has an income tax.
Who is exempt from paying taxes on lottery winnings?
Unfortunately, no one is exempt from paying taxes on lottery winnings. You’ll likely be required to pay federal and state taxes. The good news is you may be able to reduce your tax liability if you donate or gift the money to qualifying charities or your friends and family.
How many times do you pay taxes on lottery winnings?
Lottery winners pay taxes at multiple levels. If you live in a state with income tax, your winnings are taxed by federal, state, and local authorities. For winnings over $5,000, the payor must withhold a minimum of 28% for federal withholdings and up to 15% for state withholdings. You will pay any remaining tax when you file your tax return.
Do lottery winnings affect Social Security?
Winning the lottery does not increase your overall benefit amount but it may affect your eligibility. The Social Security Administration (SSA) calculates your benefits based on earned income. Since lottery winnings are not considered earned income, they do not add to your Social Security benefits. However, if you hit the lottery while you are collecting social security, the SSA may temporarily suspend or reduce your benefits.
