Taxes and the Lottery

by Alia Nikolakopulos, Demand Media

    No one wants to think about paying taxes after winning the lottery, but the reality is that you have no choice. The Internal Revenue Service views lottery prizes as taxable income. If you don’t claim your winnings on your return, you could face penalties if the IRS ever finds out. In many cases, your winnings are reported to the IRS before you file your taxes, but even if they aren't, the IRS could still discover your winning if you’re ever audited. Although you got lucky with the lottery and beat the odds, it’s best to play it safe when it comes to the IRS.

    What Percent Is Taxed if You Win the Lottery?

    All of your lottery winnings are subject to income tax. If you win less than $600, the lottery commission generally does not report your prize to the IRS, but technically, the amount is still taxable income -- and you should include it on your return. However, you can deduct your gambling losses up to the amount of your winnings.

    What Percentage of Lottery Winnings Do You Owe in Taxes?

    Lottery prizes are subject to income tax, but the percentage you’ll owe depends on additional factors including your income from other sources, deductions and exemptions. Your tax rate is calculated based on the sum of all your taxable income for the year-- and your filing status. The highest tax bracket is 35 percent for all households that earn more than $379,150. Depending on the size of your lottery winnings and other income, you might remain below the top tax bracket -- especially if you decide to take payments rather than a lump sum amount. A large lump sum payment is likely to land you in the highest bracket.

    How Much Federal Taxes Are Held From Lottery Winnings?

    The state lottery commission that pays out your prize withholds federal income tax before you get your check. If you prize is more than $5,000, the IRS requires the state to deduct 25 percent from your winnings for taxes. Your state might also deduct an amount to cover state income taxes, but the amount varies by state.

    Can You Put Lottery Winnings in a Trust Fund & Not Pay Taxes on It?

    You can inherit from big lotteries in annuity payments. These installments include investment earnings -- and you can set up a trust for them. But IRS trust laws are tricky. If you set up the trust so that you retain control over the winnings in the trust, you must report trust activity on your 1040 income tax return, which means you still end up paying the tax on the winnings. However, you can set up a trust in such a way that you are not in control of the assets in the trust. In this case, the trust has to file a tax return and pay income tax on the earnings of its assets -- but you don't. If you assign beneficiaries to receive income from the trust, the beneficiaries must pay income tax on what they receive – and the trust pays income tax only on undistributed earnings. However, if winnings are distributed to your beneficiaries before money is set aside for all the taxes the trust owes, then the trust can accrue tax liabilities. If annuity payments are still due when you die, your beneficiaries may lose a portion of future distributions as a result of the debt. If you're thinking about setting up a trust for your lottery winnings, it’s best to discuss it with an estate attorney before you claim your prize to ensure you're setting up the type of trust that's best for your circumstance.

    Can Lottery Winners Split Winnings on Tax Return?

    If your lottery prize is split amongst a group, the state decides the minimum prize amount eligible for splits. If your group wins a prize large enough to qualify, the state lottery commission will issue checks separately to each winner, as well as issue separate W2-G forms. The W2-G forms works like a W-2. It indicates the amount of the winner’s prize and amount of income tax withheld, if any, from the award. This document is sent to the IRS and each winner will only report his own share of the prize. However, if your group doesn’t qualify for prize splitting, the person who receives the check from the lottery commission must report all the winnings on his own tax return because he is the only person who will receive a W2-G. Check with your state lottery commission for specific rules about shared prizes.

    About the Author

    With a background in taxation, Alia Nikolakopulos specializes in business and personal finance topics. She is an IRS enrolled agent pursuing a Bachelor of Science in accounting and journalism at the Metropolitan State University of Denver.