Taxes On Lottery Winnings: How Much Do You Owe?

Winning millions of dollars in the lottery is a dream for many people. They imagine the things they will buy, the places they will travel, and how their quality of life will improve with all this money. Unfortunately, one of the things that few people consider is the amount of money that they will owe in taxes. Most are unpleasantly surprised when they learn how much money they end up owing to Uncle Sam.

Single Payment
When a person wins the lottery, they have the option to collect their money in one lump sum or to be paid in installments over the course of 26 years. Individuals who choose to receive their money in a lump sum must pay all of the due taxes before they can collect their winnings.

Currently, the United States federal government charges a 35 percent tax on lotto winnings. This means that if an individual won $200 million, they would need to pay Uncle Sam $70 million. This would leave them with $130 million. That sounds like a large sum. However, state taxes and local government taxes also come into play. Remember, lottery winnings are subjected to income tax, and they will be taxed at whatever the current federal rate is.

Installment Plans
Some individuals opt to receive their money in installments over time. The benefit to this is that they do not have to pay that lump sum out of their pocket up front. Instead they will pay little by little every year for 26 years. If the federal rate, the state tax rate, and the county income taxes stay the same for 26 years, a winner who chooses installments will pay the exact same amount of money as an individual who collects their money in one lump sum. However, if over 26 years tax rates increase, the winner who is paid in installments will end up paying more.

Understanding State Taxes
State taxes vary based on the location. New York City, for example, has a state tax of about 9 percent and a local tax of about 4 percent. Other states have no income tax. Income tax is charged on lottery winnings on top of federal taxes.

Additional Taxes
You might think that once you have paid all of your income tax and once you have paid off Uncle Sam, the rest of the money is yours to use as you please. This is not necessarily the case. For example, if you choose to give money to your family and friends, you will be charged a gift tax of about 35 percent for any gift made over $13,000. Anything under the $13,000 mark is tax-free.

Spouses are able to give each other gifts of up to $10.24 million over their lifetime. Any money in the amount of $5 million or more will be hit with a 35 percent tax.

Donations
With all this talk of taxation, a lottery winner may be thinking, is there anything that I can do to minimize the amount I have to pay to Uncle Sam? The answer, in a word, is donations. Donations to a charity are completely tax-free and can go a long way in minimizing your taxable income. If a donation is made in the same year that a lump sum payment is received, the donation is immediately deductible. A person who chooses to take smaller payments over 26 years will need to make small donations annually to maximize their deduction.

You Won the Lottery, Now What?
Even with all of the taxes taken from lottery winnings, very few people would complain about spending one dollar on a lottery ticket and walking away with hundreds of millions of dollars in their pocket. If you find yourself in the enviable position of needing to decide what to do with your hundreds of millions of dollars in lottery winnings, it is a good idea to talk to a financial adviser as they can provide tips not only on tax related issues but also on other issues connected to handling large sums of money.