Dreaming of winning mega bucks in the lottery? Bet paying the taxes aren't part of that wonderful scenario. If you should ever be that one in a million who beats the incredible odds and hits the jackpot, you will be (unhappily) amazed at how much you end up owing Uncle Sam.
Many people opt for a single lump sum payment when purchasing lotto tickets. In the event of a win all of the taxes due on the prize money must be paid before the winnings are collected. While this can amount to a huge bundle of cash, it may actually be less than you would pay if you took the winnings over time, considering that tax rates can change. The standard federal percentage for lotto winnings was 35 percent as of 2012. For a $100 million prize this adds up to $35 million, leaving you with $65 million before state and local governments take their share. Since lotto winnings are taxed as income, they are subject to whatever the current federal rate may be.
When opting for installments over time, you avoid making a single, large tax payment up front. Instead, the payments and the taxes on them are spread out over a period of 26 years. If federal, state and city or county income taxes remained at the same rate for the next 26 years, there would be no impact on your winnings. If they rise, you would pay more in taxes than a winner who opted for the single lump sum payment.
State and Local Taxes
State and local taxes are assessed on top of the 35 percent federal rate and vary by location. Some states have no income tax at all while others, like New York, had a state rate around the 9 percent mark and a local rate near 4 percent, as of 2012. When a large jackpot is awarded its often not only the winner who benefits. States that participate in multiple state drawings and levy an income tax stand to collect a bundle if one of their own wins the prize.
Once you've paid all the income taxes, certain other taxes may come into play depending on what you choose to do with your money. If you plan to distribute some of your wealth to friends and family, be aware that such good deeds come with their own 35 percent tax rate, payable for each gift made over $13,000. Anything under that is tax free as long as its made just once a year to separate individuals. Gifts between spouses are permitted up to a maximum cap of $10.24 million over your lifetime, according to tax law in 2012. Heirs will get hit with a tax of 35 percent on anything they inherit over $5 million, as of 2012.
Donations to charity are tax free and can help reduce your total taxable income, including the amount of tax you pay on your winnings. If you make your donations in the same year that you win a lump sum payment, they are immediately deductible. If you opt for a payment plan, make smaller donations over the long haul to maximize the deductions.
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