The following is provided for informational purposes only.
If you discuss the dreams and opportunities that come with winning the lottery amongst a group of friends, there’s inevitably one person who points out you’re going to have to pay half of it in taxes. It can be a bummer, but it’s also not necessarily true.
Depending on where you live and how much you win, you could wind up paying a good portion in taxes (although, likely not half). There are also less direct costs that can impact lottery winners and those around them. But let’s start by answering the initial question—how much will you pay in taxes?
You’ll Pay Federal Income Taxes On Your Winnings
The IRS considers lottery winnings as gambling winnings and taxes the income the same as other types of ordinary income. This means you’ll pay federal income taxes on your winnings, although the amount depends on how much you win, your other income, and your tax deductions or credits.
Winning the lottery could push you into a higher tax bracket, and the highest bracket is 37% if you make over $518,400 in 2020. But remember, the federal tax brackets are marginal brackets, and you won’t pay 37% on all your winnings.
You only pay the 37% rate on each dollar above the $518,400 mark. Even if you win millions, you’ll still pay 10% on your first $9,875, 12% on the $9,876 to $40,125 portion of your income, and so on.
You’re also still be able to take deductions and lower your tax bill and qualify for tax credits that can offset the taxes you owe.
State Income Taxes May Also Apply
The state where you live may also want a cut of your winnings. If you live in one of the nine states that don’t have a general income tax (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming), you might be in the clear. Two additional states, California and Delaware, don’t tax lottery prizes. And Arizona and Maryland’s tax rates can vary depending on if you’re a resident or bought a ticket while visiting.
For both federal and state taxes, know that your withholding rate (the amount that’s automatically taken out of your winnings and sent to the IRS or state) may be different than the actual taxes you owe.
There Are Smart Costs — Attorneys and Advisors
There are smart ways to spend a windfall gain, and they’re the same whether you get a winning lottery ticket, a tax refund, or bonus from work. Pay down high-rate debts, save for emergencies, invest, and spend a little often make the list. And if you win thousands, or tens of thousands, then you could follow through on your own.
However, if your lucky numbers lead to six-figure winnings or, as you’re likely dreaming about, millions, then hiring an attorney and financial advisors are likely smart moves.
For example, you may want to remain anonymous, but your options can depend on where you live, if you form a company or trust to claim the winnings, and whether you signed your winning ticket. An attorney may be able to help you understand your options and stay anonymous so you can avoid the onslaught of phone calls from people and charities looking for investments or donations.
You may also want to hire financial advisors — both financial planners and accountants — who can help you decide between taking a lump sum or annuity and make a plan for your winnings. These financial professionals can show you various plans and outcomes so you can take measured steps to ensure your newfound wealth doesn’t go to waste.
It Can Cost Your Neighbors, Too
A 2016 study of lottery winners in Canada found that the neighbors of lottery winners were more likely to declare bankruptcy. You’re not responsible for how your neighbors spend their money, but it’s certainly an interesting outcome to think about and a potential lesson to learn from.
Winning the lottery can free up your finances and allow you to spend money on discretionary expenses that were once out of reach. Your neighbors may notice and increase their spending as well. The keeping up with the Joneses effect is in full force here — and you’re the Joneses in this case.
Keep in mind, lottery winners themselves aren’t immune from financial ruin. Stories of lottery winners declaring bankruptcy, ruining relationships, and winding up worse off than before make for tantalizing headlines. You don’t want to find yourself among one of those listicles in the future.
Take It Slow and Steady
In spite of the potential taxes and downsides, winning the lottery remains a fantasy for many, and with good reason. While money won’t solve all your problems, freeing yourself from the stresses of day-to-day financial concerns is certainly a dream come true.
Fortunately, you don’t need to play the lottery to tackle your finances. Whether you’re struggling with credit card debt, student loans, or following a budget, there are trained and certified credit counselors who can help.