Do Lottery Winnings Count as Earned Income?

If your lottery prize exceeds $5,000, the lottery agency must report your winnings to the Internal Revenue Service. The agency will need your Social Security Number to complete IRS Form W-2G. It will give you a copy and send the original -- and 25 percent of your winnings -- to the IRS. The W-2G will show how much federal withholding the lottery agency deducted from your pay-out. You must report your lottery prize as income on your federal tax return, but you can claim the federal taxes withheld from your pay-out as a tax payment.

Even if your lottery prize is less than $5,000, but more than $600, you're expected to report it on your federal tax return. There's even a line for gambling winnings, Line 21 in fact, on Form 1040. This means if you have gambling winnings, you can't use either of the two simpler individual federal income tax forms, Form 1040A or Form 1040EZ.

It's possible to deduct gambling losses, but only if you've got the proper paperwork. The IRS wants to see every receipt, ticket and whatever else reflects your total wins and losses before it'll give thumbs up on a deduction. Even then you can only deduct gambling losses up to the amount of your winnings. For example, if you spent $250 on lottery tickets and won $200, $200 is as much as you can claim as a loss on line 28 of Schedule A.

Claiming your gambling losses as itemized deductions will increase your tax refund or reduce the taxes you owe. However, if the total of all your itemized deductions is less than the standard deduction that the IRS allows all taxpayers to claim, don't itemize. Use the standard deduction because it will lower your taxes.