Congratulations! Now pay up!

March 09, 2018 by Selena Quintanilla
Colorful balls with numbers

In August, the Powerball was all the rage. The impact it had on communities was similar to Willy Wonka's Golden Ticket contest. People were rushing to their nearest corner store for last-minute ticket purchases, and you couldn't turn to a news station without it being the topic of discussion. It wasn't until the winnings reached $758,700,000 that the lucky lady, Mavis L. Wanczyk, came forward.

Conversations around me shifted almost instantly from how we could each benefit from the winnings to conspiracy theories, and there was enough moping to make even Positive Patty curl up into the fetal position. I, on the other hand, was only concerned with one thing. "I sure hope Mavis knows how to report her winnings." I couldn't help it; where Patty is optimistic, I'm logical.

My concern, though inconceivable to others at the time, is well rooted. Most people aren't aware of the tax obligations associated with such a prize, as it feels more like a gift or miracle than hard earned wages. Be that as it may, lottery earnings are generally reported to the winner on a Form W-2G, taxed as ordinary income, and expected to be reported as “other income” on the federal tax return. So, while family and friends gather in hopes of benefiting from their now wealthy relative, Uncle Sam sits silently in the corner eager to claim his share. Oh, and your in-laws at the state aren't to be forgotten either. Many states have different rules for gambling winnings, so it may or may not be taxable.

Just how much of Mavis' winnings will be taxed? Well, as far as Uncle Sam is concerned he wants nothing less than 25% withheld, which comes out to about $18,967,500 paid and reported to the IRS by the issuer, not including State tax which can vary between 0-13.3%. Though this doesn't seem like much considering the jackpot, a prize of this size would easily move Mavis to the top tax bracket of 39.6%, which means when she does her taxes she’ll have to pay the difference between the 25% withheld and the actual amount she owes. And if she gets caught up in the excitement and forgets to pay her tax bill, she could end up with a hefty penalty that may leave her looking for a part-time job. In addition, the added taxable income affects many other numbers on the tax return, which include the taxable amount of Social Security, disallowance of the IRA deduction, the disallowance of the contribution to a Roth IRA that you have already done, and the current disallowance of the rental real estate losses you have.

My advice to Mavis? Make some room in the budget for a financial advisor, and come tax time hire a professional tax preparer or file through TurboTax, where you get way more than your fair share of expertise for a bargain. The thing about luck is, good or bad it runs out, and the IRS is one organization I would not want to gamble with.
 

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Karen Thomas-Brandt, EA
Corporate Trainer

 

Karen Thomas-Brandt, EA, is a Corporate Trainer at TaxAudit, the largest and fastest-growing audit defense service in the country and the exclusive provider of TurboTax® Audit Defense. With more than 16 years in the tax field, Karen has prepared thousands of tax returns and defended hundreds of taxpayers in audits. In her current role, Karen specializes in researching complicated tax topics, developing workshops, and training tax professionals on effective audit representation and tax return analysis.


 

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