It’s a common collective dream to win the lottery. Whether you prefer scratch tickets or regularly stop by your favorite gas station or convenience store to play your lucky numbers, the hope is the same — to be on easy street. But often, lottery winners find that a huge influx of cash comes with some major drawbacks.
If you’re not prepared for taxes on lottery winnings, it can throw you for a loop. So, how much can you expect to pay in taxes? In this article, we break down the fine print of winning the lottery, and how taxes on lottery winnings are applied at the federal and state level.
Table of Contents
- 1 Federal Taxes on Lottery Winnings
- 2 Taxes on Lottery Winnings by State
- 3 Lump Sums vs. Annuity Payments
- 4 How to Pay Less in Taxes on Your Lottery Winnings
Federal Taxes on Lottery Winnings
First, it’s important to understand that the federal government views lottery winnings as income. So by default, this might push you into a higher tax bracket — which means you’ll pay significantly more in taxes than you normally would on your regular income. On the federal level, the Internal Revenue Service can demand anywhere from 24% to 37% of your lottery winnings depending on how much you won. Your tax rate is based on your total earnings for a tax year — which includes your regular wages plus any lottery winnings.
And typically, the IRS will withhold 24% before you ever get your first payment — regardless of whether you opt for an annuity or lump sum payment.
Taxes on Lottery Winnings by State
For taxes on lottery winnings by state, things become more fluid. As you know, not all states require income taxes. So, if you live in a state that doesn’t require income taxes, you only need to worry about paying out to the IRS. If your state does require income taxes, then you’ll also need to be mindful of the tax bracket within your jurisdiction. Again tax rates vary by state, with some states taxing over 15% on income.
What If I Bought My Ticket in a State Where I Don’t Live?
Thankfully, for the most part, you don’t have to worry about paying double income taxes like you might if you work in a state other than where you reside. It’s fairly common for people who play the lottery to buy tickets in another jurisdiction. In fact, in the United States, 44 states participate in multi-state lotteries.
For the most part, you’ll only need to pay taxes in the state where you live. However, be aware that if you buy lottery tickets in Maryland or Arizona and aren’t a resident of either state, you will be taxed by both your place of residence and whichever of these two states you bought your ticket in.
Lump Sums vs. Annuity Payments
So which is the best option? Should you opt for a large lump sum payment or create a slow but steady income stream with an annuity plan? The reality is that there are valid arguments for both options.
Pros of Taking a Lump Sum
One of the biggest benefits of receiving a lump sum after paying out the initial taxes to the IRS is that you’ll have full control over all of your money at one time. This can be an intimidating concept, but it can also open up a world of possibilities such as more money for investments that will help you grow your money wisely.
On the bad and ugly side, we’ve all heard stories of lottery winners going bankrupt only a few years later. Getting all of your money at once — especially if you don’t plan properly — may encourage you to make bad financial decisions. These range from overextending yourself on expensive homes, buying multiple cars, or indulging in extravagances without properly saving or growing your winnings. You may also get hit with unexpected tax bills such as gift taxes triggered by sharing your winnings with friends and family.
Pros of Taking Annuity Payments
As opposed to getting all your money at once, you can opt to receive consistent annuity payments. One of the biggest benefits of an annuity is that each payment is taxed at a lower rate as opposed to receiving a lump sum. And if you’re the type who isn’t comfortable with more high-risk investments, an annuity is a safer option as you’re less likely to spend through your entire lottery winnings in a short period.
So Which Is Better?
The answer is that it will depend entirely on your goals and financial plans. The answer will be different for every lottery winner. However, lump-sum disbursements are best suited for winners who are financially responsible and are willing to create a concrete financial plan — and stick to it.
How to Pay Less in Taxes on Your Lottery Winnings
So now you know what to expect in terms of taxes, but what can you do to help reduce your tax risk? One of the best ways to reduce your total taxable income is to look for deductions you can claim. But to do so, you need to choose to itemize your deductions when filing your taxes instead of opting for the standard deductions.
Charitable donations can be offset against your total income, thereby reducing the total amount of taxes you’ll owe. But keep in mind that there are limits on how much you can donate to offset your taxes. The government limits your charitable donation deductions to 50% of your total taxable income. So, keep this in mind when you start writing those checks to charity.
It’s common that lottery winners routinely play the lottery. Even if you’re only playing $1 tickets, that can add up if you play regularly and lose. The government allows you to deduct the cost of those losing tickets. But again, there’s a catch. You’re not allowed to deduct more in losses than you won. So, if you spent $5,000 in scratch-offs and Powerball tickets, but you only won $2,500, you can only deduct $2,500 from your total taxable income.
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