The Taxing Truth of Lottery Winnings


While most of us are smart enough to know that money can't buy happiness, we also know it can buy us a lot of good stuff we all need and want. With that in mind, millions of Americans lined up last week to take a shot at the record Powerball jackpot of $588 million. Two tickets achieved the nearly improbable feat of matching all six numbers – one in Missouri and one in Arizona.

Even if you didn't play, it’s easy to imagine what you would do with all that money – the comfort, security, and fun it would bring. What probably isn’t included in your lottery daydream is the inescapable tax obligation such a windfall would bring. No matter where or how you would choose to spend lottery winnings, the largest slice of it would certainly be earmarked for the IRS (those nice folks at the Multi-State Lottery Association who hand you a giant check at the ceremony would send the IRS a Form W-2G alerting them to your good fortune).

Your first decision would be whether to take your prize in a lump sum immediately or in an inflation-adjusted annuity over the next 30 years. As all large financial decisions must, taxes need to be taken into consideration. Receiving your winnings all at once means paying the top federal income tax rate of 35%. It may sound like a lot (and depending on how much you win, it could be), but at least you'd know exactly how much the tax would cost. You may receive a larger overall payout by receiving installments, but it would mean paying whatever tax rate is in effect the year an installment is paid. As the “fiscal cliff” is teaching us, you never really know what the tax landscape will look like from year to year. That kind of uncertainty – even if it gives you more money in the long run – may not be worth it.

The federal government isn't the only one who would be calling on you should you win the lottery. Forty-three states tax lottery winnings as ordinary income. Some states even tax your winnings based on where you purchased it, not just on your state of residence. So, if you live in Pennsylvania (which does not tax lottery winnings) and work in New York (which does), don't buy your ticket around the corner from the office unless you want to share 8.82% of your winnings with the Empire State.  

As with all income you receive, there are several strategies you can employ to soften the blow of tax obligations. One of the most important things to do if you win the lottery is consult a financial advisor and/or tax professional, who can help you make sense of your newfound wealth!