Author: Taryn Larkin
Many of us dream of winning the lottery. But what would you do if that dream became a reality?
If you are one of the lucky people that win one of the large lottery drawings or receive other cash windfalls, taxes might be the last thing on your mind. But if you are not prepared for the high tax bill, it could set you back a large portion of your winnings. Proper tax planning could not only save you money, but it could also help make sure you are setting yourself up for future success.
When receiving lottery winnings of more than $5,000, the federal government will automatically levy a statutory flat tax withholding of 22% on your winnings. However, suppose your taxable income (including your lottery winnings) pushes you into one of the top tax brackets. Your marginal Federal tax rate can be much higher than the 22% withholding amount. The current highest marginal tax bracket is 37%. The lottery withholding could be 15% short of the actual Federal income tax and potentially incur a substantial tax bill when you file your return.
You would also need to consider state income taxes. Every state has a different tax rate and has other tax laws related to taxing lottery winnings. California does not tax their residents on lottery winnings, while Washington DC taxes them at 10.75%. If you live in New York City, you will pay NYS state income taxes and the local NYC taxes. There are many other items to think about in addition to the high tax bill when you become an overnight millionaire:
- Taking the payout as a Lump Sum vs. Annuity (30 payments)
- Splitting the winnings with family members
- Create a Wealth Plan – consult with financial professionals to ensure your investments and estate planning are setting you and your family up for success
- Estate planning – updating your will, creating trusts
- Charitable Contributions – contributing to 501(c)(3) organizations are tax-deductible, and various options, such as a donor-advised fund, could work best for your new situation.
- Gifting – in 2023, you can gift up to $16,000 per individual as the annual gift tax exclusion. Any amount of this would trigger the need for a gift tax return.
- Gambling Losses – you can still deduct gambling losses against any earnings.
It is important to see a tax professional before you redeem the winning ticket. A tax professional can help determine which type of payment suits you best and assist you with tax planning for future long and short-term goals, tax strategies, and charitable contributions. Even if you don’t win the lottery, we are here to help with your tax and estate planning strategies. Please get in touch with a Reynolds + Rowella tax advisor with any questions.
Reynolds + Rowella is a regional accounting and consulting firm known for a team approach to financial problem solving. As Certified Public Accountants, our partners foster a personal touch with our clients. As members of DFK International/USA, an association of accountants and advisors, our professional network is international, yet many of our clients have known us for years through the local communities we serve. Our mission is to operate as a financial services firm of outstanding quality. Our efforts are directed at serving our clients in the most efficient and responsive manner possible, delivering services that exceed the expectations of those we serve. The firm has offices at 90 Grove St., Ridgefield, Conn., and 51 Locust Ave., New Canaan, Conn. For more information, please contact Elizabeth Bresnan at 203.438.0161 or email.