Many people would consider themselves extremely lucky if they won the lottery and could cash in their ticket. Remember that taxes and other expenses may cut your earnings, so don't start living the high life just yet.
Winnings from the lottery are considered regular income and must be reported to the Internal Revenue Service and state governments. Prizes in excess of $600 must be declared as income, just like a salary or wage on your tax return.
If you play the lottery or are just curious about how the lottery affects your taxes, read on.
There's a convoluted equation that factors in your annual income and the amount of state income tax you fork over. The government will receive between 24 and 37 % of your jackpot. The tax burden, however, will be determined by the following:
Imagine you're the lucky winner of the Mega Millions prize of $1.2 billion. The following are some of how your taxes may be affected by the method you select for receiving your lottery winnings:
It's possible that the highest tax bracket in effect for the year would apply to your lotto winnings if you received them all at once. You may be subject to a 37% tax rate because your $1.2 billion award is more over the threshold for the highest tax bracket ($539,901+ for single filers and $647,851+ for joint filers).
A single person who receives a $1.2 billion lump sum and has a taxable income of $50,000 would have a total income of $1,200,050,000 in the current tax year. Your earnings over $539,90 will be subject to a 37% tax rate, and your income below a certain benchmark will be subject to lower tax rates.
A massive tax bill of $444,322,275 could be in your future. Looking on the bright side, only the excess over the threshold was subject to the 37% tax rate.
Alternatively, if you are concerned about paying a sizable sum in taxes, you may want to consider receiving your prize money in installments over several years. Suppose you cashed in your prize every year for 40 years. That works out to $30,000,000 per year plus your $50,000. Although substantial, it is still not a trivial sum. However, you can spread your tax payment rather than make one large payment.
You may make yearly payments of $11,224,754 instead of a single $444,322,275 payment. The highest possible rate is still paid when the jackpot is extremely large, such as in this case. But if it's less, you might be able to drop the tax rate.
The lottery prize money is considered part of the winner's estate. As a result, your estate will be subject to Inheritance Tax (IHT) should you pass away. Your estate may consist of money, land, or other valuables.
The present rate of 40% for inheritance tax is extremely high. The catch is that you only pay tax on earnings beyond a particular threshold. This is referred to as the Inheritance Tax Allowance.
If the value of your estate is less than this threshold, your heirs will not be required to file an estate tax return. However, they must still report it to the tax authorities.
Prize money given as gifts is subject to IHT. To avoid paying Inheritance Tax on gifts made from your winnings, you must follow these guidelines:
The odds of winning the jackpot are reduced when you combine money with others to purchase many tickets. However, you'll still have to pay income tax at the rate that applies to the share of the prize money that you get. You should be sure to have proof that the full jackpot isn't yours if you plan to collect the award on behalf of everybody in your pool.
If you gather the full profits and then distribute them to everybody else, taxation bodies may believe you're giving the proceeds away, which could result in a gift tax. Withholding income taxes from your total prize money may also be your responsibility. Create a written contract outlining each participant's portion of the pool and keep a copy for the relevant taxation body.