The Mega Millions jackpot has risen to $1.1 billion, up from $810 million. With eye-popping numbers, it’s easy to get lottery mania.
Winning would be great, but the taxes are big too. Lottery winnings are taxed, with the IRS taking up to 37%. Curiously, though, only 24% is withheld and sent directly to the government. That means you may have to come up with as much as an extra 13% on your own when tax time comes. Then, depending on whether your state taxes lottery winnings, you may have to add state taxes too. Some people may even try to quickly move states, though it can be too late.
You can take your winnings in a lump-sum cash payment, which would be about $602.5 million, before taxes. Alternatively, you can be paid out in many annual payments — 30 installments over 29 years. Either way, you have to think about taxes.
Just imagine magnifying the problem a hundred fold. Making sure that you can come up with that extra 13% is important. Since the tax withholding rate on lottery winnings is only 24%, note the big spread between 24% and 37%. Some lottery winners do not plan ahead, and can have trouble paying their taxes when they file their tax returns the year after they win.
There is also the cash versus annuity question. Whether lump sum or paid over time, taxes will come due.
Apart from paying taxes, some lottery winners find that friends, family or co-workers might expect share of the loot. Office pools, informal understandings, and casual deals to split winnings can all bring trouble, tax and otherwise.
It might start with an innocent comment that someone says was an oral agreement. After all, remarks about splitting winnings can be misinterpreted. Some winners face lawyer fees for defending against the claims, and the fallout from lottery lawsuits can be messy.
For one thing, claims by co-workers, former spouses and others who say they deserve a share can tie up the money for years, so be careful what you say and to whom. One case upheld a 20-year-old oral agreement to split lottery winnings. Some suits over lottery winnings are with co-workers and (former) friends. Some disputes are with family members or with the IRS.
In Dickerson v. Commissioner, an Alabama Waffle House waitress won a $10 million lottery jackpot on a ticket given to her by a customer. The trouble started when she tried to benefit her family and to spread the wealth. The IRS said she was liable for gift taxes when she transferred the winning ticket to a family company of which she owned 49%. The waitress fought the tax bill, and eventually landed in Tax Court. But the court agreed with the IRS, so she lost.
Some tax advice before the plan might have avoided the extra tax dollars, generated because her tax plan was half-baked. In short, she shouldn’t have assigned her claim in a waffle house.
Time and again, lottery winners have trouble paying their taxes and resolving disputes. The stakes and tax problems can grow larger on bigger lottery prizes.
With $1 billion at stake, creative claims could arise. And the usual tax problems on winnings can get even more complex. Unless there is a tax partnership, a winner may be taxed on it all, yet only be allowed a partial write-off for the damages paid to those claiming a share. In fact, the tax rules for litigants are complex, made more so by 2018 tax changes. How legal settlements are taxed is tricky, and some plaintiffs have to pay on their attorney’s fees too.
Plainly, winning would be awfully nice, but just be careful if you do.