How to Know Lottery Winnings are Being Sheltered From Taxes
When you play the lottery or scratcher tickets or you gamble at a casino, you could win big. You could also end up paying more than one-third of your winnings in taxes. You need to know how to savvily and legally shelter your winnings, so you pay fewer taxes on your found money.
How to Shelter Lottery Winnings From Taxes
To do this, you need to determine the best way to receive your winnings. When you win a small dollar amount in the lottery, your only option becomes taking the lump sum payment. Let’s say you win $600. You’ll get the whole amount all at one time.
If you win a large amount, such as a jackpot amount, you get the option of taking annuity payments. This means that each month or year, for a specified number of years, you receive a portion of the winnings. Over the time period of the total annuity plan, you receive the entire jackpot. Typically, you get the option for an annuity if you win more than a million dollars.
The winnings that fall in between those two sizes, you usually get as a lump sum payment. If you win $50,000, the lottery pays you that all at once...
Uncle Sam and Your Lottery Winnings
Good ole’ Uncle Sam, also known as the Internal Revenue Service, takes part of its cut right off of the top if you win big. Your scratcher that you turn in at the store, you get the full amount for a small dollar win. You won $50. They hand you $50. But, if you won more than $600, it will take a few weeks to process, and the IRS will take 25 percent from your winnings immediately via withholding. That way, they get their cut.
You’ll still owe a little bit at tax time, but it won’t be that much. The most you’ll pay in taxes to the IRS regardless of win size is 37 percent.
The same tax brackets that apply to the money you earn, apply to the money you win. That means that if you win $600, you pay less tax on it than if you won $6,000,000. The winnings place you in different tax brackets. The smaller lottery win probably won’t move you from one bracket to another, but the $6 million wins probably will. That puts you in the 37 percent tax bracket.
Reducing the Taxes Paid on Lottery Winnings
Using an annuity provides the best method for how to shelter lottery winnings from taxes. When you use an annuity, instead of getting the $6 million winnings in a lump sum payment less the 25 percent to the IRS, you get to divide the payment into monthly or annual income. You still have state taxes to pay, too. Let’s say you’re in Ohio. That state charges four percent on your winnings. With the lump-sum payment, you would only get $4,260,000 and you would immediately need to pay more taxes on it in April – about another 12 percent. You paid $1,740,000 in total taxes as soon as you won and then you paid your regular taxes in April.
Five states – Alabama, Alaska, Hawaii, Nevada and Utah – do not have state lotteries.
Let’s look at taking the money as an annuity
Each year, for 30 years, you accept an annuity payment of $200,000. You still have to pay the 25 percent withholding, but your annual tax bill drops from the sky-high bracket to a reasonable income bracket. You pay a lot less in April each year. Let’s assume you’re married, filing jointly, and you have two kids. You’ll have an effective tax rate of 13 percent and a marginal tax rate of 24 percent. You can figure out your tax bracket using this tax calculator. The withholding now covers all of your tax bills on the lottery winnings.
Another plus of the annuity system is that it helps you better manage the money. Many big winners in Powerball blow through the money quickly. What should have been a positive, life-altering event becomes one year of living in excess. Taking the annuity option ensures that you have an income for life. You’ll always have a comfortable, reliable income – for 30 years at least.
With large winnings, you still get enough with the annuity method that you can purchase a nice house, a car, a business. You still carry a mortgage, but you also know you can make that mortgage.
Considerations on How to Shelter Lottery Winnings From Taxes
Some websites suggest taking the lump sum and placing it in high-yield savings or placing it in a private annuity. This method means you pay the higher tax bracket though. Certainly, you do create a way to dole the money out to yourself, but you have less of it.
Donating some of the lottery money to charity is also an option. That's because you can usually deduct charitable contributions from your taxable income.
Of course, you can also use the winnings to purchase property and other assets, such as stock. You then place those items into a trust. If you choose the right type of trust, you won’t pay taxes on anything in the trust.
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In Conclusion
The best thing to do is to consult a tax attorney and a financial consultant if and when you win big at the lottery or a casino. They can help you legally shelter the money, so you do pay your taxes and reduce the tax bill to the absolute minimum.
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