Most financial planners believe that for a jackpot that runs into hundreds of millions, the taxes levied are more or less the same. That is, the annual payment increases by a certain amount every year to help the winner deal with inflation.
There has been a lot of debate on whether taking winnings in annuity helps in saving tax dollars. This is because of the fact that the annuity still puts a person in the highest tax bracket. (usually, spread over 25-30 years). If Jim chooses the first method, the amount he will receive from the lottery agency will not be $500 million. Although the chances of winning a mega jackpot for an American are as low as 1 in 175 million, awareness about the taxation policy can be beneficial for everyone. On the other hand, some states give the winner 60 days, so that he can consult his attorney, or family members on the mode of payment. Still a lot of money we would say, but if there is someone, whose odds of winning a lottery are the highest – year in and year out – it is undoubtedly, our good ol’ Uncle Sam!
$144 million (approx.)
The total amount of taxes Jim has paid to the government till now is a whopping $143,990,890.
$166 million (approx.). The tax rate for New Jersey residents is 10.80% (refer to the table above), therefore, the amount Jim owes to the state government will be,
$17 million (approx.)
55/100 x $500,000,000 = $275 million
39.6/100 x $275,000,000 = $108,900,000
As Jim will receive this amount as a single payment, he would fall into the highest tax slab of 39.6%. Suppose, Jim is lucky enough to have the winning ticket for ABC Lottery, worth $500 million (face value). The lottery winnings are subject to the following:
If Jim happens to be a New Jersey resident, he will be further taxed by the state government. Usually, the first annual payment is 2.5% of the total ($500 million). Therefore, it is recommended to consult an attorney/tax-planner before making any decision.
So Jim, who had set his eyes on winning a $500 million jackpot, has paid $144 million to the government, and has about $100 million for himself. Many lotteries have progressive annual installments in place, so that the winners can offset the effect of inflation. However, as soon as the media proceedings are over, the winners sit down with their attorneys to know what percentage of their lottery winnings will go into the coffers of the treasury. The amount Jim will owe to the Federal Government will be,
Mentioned below is the withholding tax rate on lottery winnings in different states.
Let us take an example to understand the taxation on lottery winnings in US. The earnings are subject to ‘Tax Withholding’ by the Internal Revenue Service (IRS). Majority of the states also take their cut by levying a state tax on the winnings. There are two ways in which Jim can claim this amount,Jim can request to have the entire amount paid to him at one go. Jim can request for the amount to be paid in equal monthly installments. On the other hand, if a person has won a comparatively lesser amount, say $500,000, he can save tax dollars by opting to take the amount in yearly payments to prevent himself from falling in the top tax slab.
If Jim decides to share some of his winnings with his family or friends, he would need to pay ‘gift tax’ to the Federal Government. This is because of the concept of the Time Value of Money. According to this theory, it can be assumed that the lump sum amount paid to Jim can earn the face value of the prize by a fixed-rate investment over a period of time. Usually, lottery agencies offer 55%-60% of the face value if the winner decides to take a lump sum.
If ABC Lottery offers 55% of the face value of the jackpot to Jim, he will get,
Jim’s winnings after paying the Federal Tax will be,
$48,000,000 – $5,120,000 = $42,880,000
Winners of popular lotteries, such as Mega Millions or Powerball, are photographed holding a big, symbolic check, on which the face value of the jackpot is inscribed boldly. In cities such as New York, a winner is liable to pay an additional city tax as well. Lottery folklore is rich with tales of people who ended up accumulating huge debts because of ignorance about lottery winnings taxation. Although there have been calls for putting an end to the policy of taxing money earned in a lottery, the truth is that these taxes are here to stay as these help the government in raising revenue required for public welfare.
10.80/100 x $166,100,100 = $17,938,890
Jim’s winnings after paying the state tax will be,
40/100 x $42,880,000 = $17,152,000
In the United States, the amount that one wins in a lottery is classified as ‘gambling winnings’ or ‘earnings’, and is considered as taxable income. However, the tax rate has been increased from 35% to 40% (Forbes). Therefore, it is important that we know what we stand to win, or lose, before we buy a lottery ticket.
$166,100,100 – $17,938,890 = $148,161,210
In various states, it is mandatory for a person to specify the mode of receiving the reward before he buys lottery tickets. As the Senate passed the tax laws on New Year’s Eve, and The House of Representatives upheld it the day after, the exemption for ‘gift tax’ still stands at $5.12 million. In Jim’s case, the annuity is approximately $19 million dollars, which still makes him liable to pay taxes at the rate of 39.6%. Assuming that Jim decides to gift $48 million to his family and loved ones, the taxable amount will be,
The amount of Federal Gift Tax, Jim will have to pay will be,
$109 million (approx.)
$148 million (approx.)
$275,000,000 – $108,900,000 = $166,100,100
Considering the same scenario, if Jim decides to receive the payment as annuity, he can look forward to receive the whole $500 million over a period of, say, 25 years. In this case, Jim will receive an annual payment of $19, 250, 000 for the next 25 years. The decision to opt for lump sum or annuity depends upon other factors, such as winner’s age, financial health, debts, etc