Winning the lottery can supply you with more money than you could spend in several lifetimes. Recently, the Powerball jackpot surpassed $2.04 billion, which shattered the previous record. As you can probably imagine, the total take-home prize will be significantly smaller after taxes get taken out.
The IRS considers lottery winnings to be taxable income. For tax purposes, the IRS views your payout similarly to wages earned from your job. As such, becoming a lottery winner also means becoming a significant taxpayer.
The amount of taxes you will pay can vary significantly based on three criteria. Unfortunately for seniors, age isn’t one of them, as lottery winnings are taxed the same even if you’re retired. The three criteria that will impact your tax obligation are as follows:
1. The Payment Method You Choose
Most winners take their prize money in a lump sum. You’ll receive a one-time payment when you redeem the ticket, and the matter will be considered closed.
- For prizes of $599 or less, you can redeem the ticket at a lottery retailer (gas stations, convenience stores, and grocery stores).
- For prizes that are $600 or more, you’ll need to redeem them at the state lottery commission.
- For jackpots and large prizes, the commission will ask if you want a lump sum payment or an annuity payment.
Annuity payments for lottery winnings typically pay out in 30 different installments. You’ll receive a portion of your windfall on the day and one payment each year for the next 29 years. You could lose a lot of money depending on your chosen payment method. The reason is the advertised prize isn’t the actual jackpot.
Let’s say you won the recent Powerball jackpot of $2 billion. The lump sum payment would only be about $1.24 billion. It’s a common misconception that the reduction comes from paying taxes. You will be paying taxes on your winnings (more on that later), but taxation has nothing to do with the drop.
The lottery is advertised as $2 billion because it’s a rough estimate of accrued interest. Remember that annuity payments get paid out over 30 years. The money doesn’t just sit there; it’s invested on your behalf. Over 30 years, the $1.24 billion is expected to generate enough interest to reach $2 billion, which is why that’s the advertised jackpot.
Based on that information, taking the lump sum would be foolish. However, the main benefit of the lump sum is that you’ll only be taxed once. Annuity payments will be smaller, and you’ll be taxed (often severely) every year until the end of the payments.
2. The Amount You’ve Won
In the case of most jackpots, taking the lump sum will force your personal finances into the highest federal tax bracket. By taking the annuity, your payments might fall into a lower tax bracket and get taxed at a lower percentage. Another factor that plays a role in how you file your income tax return. If you file a joint return, you might fall into an even lower tax bracket.
These are the 2022 federal income tax brackets:
- 10% for individual filings of $10,725 or less, head of household filings of $14,650 or less, and joint filings of $20,550 or less.
- 12% for individual filings of $10,725 to $41,774, head of household filings of $14,650 to $55,899, and joint filings of $20,550 to $83,549.
- 22% for individual filings of $41,775 to $89,074, head of household filings of $55,900 to $89,049, and joint filings of $83,550 to $178,149.
- 24% for individual filings of $89,075 to $170,049, head of household filings of $89,050 to $170,049, and joint filings of $178,150 to $340,099.
- 32% for individual filings of $170,050 to $215,949, head of household filings of $170,050 to $215,949, and joint filings of $340,100 to $431,899.
- 35% for individual filings of $215,950 to $539,899, head of household filings of $215,950 to $539,899, and joint filings of $431,900 to $647,849.
- 37% for individual filings of $539,900 or more, head of household filings of $529,900 or more, and joint filings of $647.850 or more.
It’s important to note that the tax brackets can shift. It’s very common for them to change annually. The lump sum guarantees you'll pay about 37% in federal taxes. The thresholds for each tax bracket will likely increase over the next 30 years. You might be able to fall under a smaller tax burden in the future.
3. The State Where You Bought the Ticket
You will pay federal taxes no matter what state you buy your ticket in. The federal government automatically withholds about 25% of all lottery prizes over $5,000.
The good news is these taxes apply to your annual tax return. The bad news is that you’ll have to make up the difference if you land in a higher tax bracket. Taking the lump sum will mean you’ll probably pay an additional 12% in federal taxes to make up the difference.
You might also end up paying a state income tax as well. Just as tax deductions and tax refunds can vary from state to state, each state taxes lottery winnings and gambling winnings in a distinct way. When you pick up a lottery ticket for the Mega Millions or Powerball, you’ll want to know about the state and local tax regulations.
Each state has the right to determine whether or not to charge its residents with an income-based tax. They also have the right to decide how much tax is applied. The state where you buy the ticket will determine how much extra you’ll be paying in income taxes and whether or not you can be anonymous.
These are the 2022 income tax ranges for each state listed from lowest to highest:
- Alaska: 0%
- Florida: 0%
- Nevada: 0%
- Tennessee: 0%
- Texas: 0%
- South Dakota: 0%
- Wyoming: 0%
- North Dakota: 1.1% to 2.9%
- Pennsylvania: 3.07%
- Indiana: 3.23%
- Ohio: 2.76% to 3.99%
- Louisiana: 1.85% to 4.25%
- Michigan: 4.25%
- Arizona: 2.59% to 4.5%
- Colorado: 4.55%
- Oklahoma: 0.25% to 4.75%
- Illinois: 4.95%
- Utah: 4.95%
- North Carolina: 4.99%
- Alabama: 2.0% to 5.0%
- Mississippi: 4.0% to 5.0%
- New Hampshire: 5.0% (only on income from interest and dividends)
- Kentucky: 5.0%
- Massachusetts: 5.0%
- Missouri: 1.5% to 5.4%
- Arkansas: 2.0% to 5.5%
- Kansas: 3.1% to 5.7%
- Georgia: 1.0% to 5.75%
- Maryland: 2.0% to 5.75%
- Virginia: 2.0% to 5.75%
- New Mexico: 1.7% to 5.9%
- Rhode Island: 3.75% to 5.99%
- Idaho: 1.0% to 6.0%
- West Virginia: 3.0% to 6.5%
- Delaware: 2.2% to 6.6%
- Montana: 1.0% to 6.75%
- Nebraska: 2.46% to 6.84%
- Connecticut: 3.0% to 6.99%
- South Carolina: 3.0% to 7.0%
- Washington: 7.0% (only on income from capital gains)
- Maine: 5.8% to 7.15%
- Wisconsin: 3.54% to 7.65%
- Iowa: 0.33% to 8.53%
- Vermont: 3.35% to 8.75%
- Minnesota: 5.35% to 9.85%
- Oregon: 4.75% to 9.9%
- New Jersey: 1.4% to 10.75%
- District of Columbia: 4.0% to 10.75%
- New York: 4.0% to 10.9%
- Hawaii: 1.4% to 11.0%
- California: 1.0% to 13.
You can imagine how much of a difference the state income tax can make. Here are the total taxes that you’ll be paying if you take the lump sum of the $2 billion jackpot:
- If you were to win the lottery in Florida, you would only have to pay federal income taxes. The billion-dollar jackpot would start at $1.24 billion before $310 million (25%) is taken in taxes.
You would also have to pay an additional $111.6 million to meet the 37% tax burden. That would leave with a total of roughly $930 million at the end of the first year.
- If you were to win the lottery in California (like the person did in real life), you would have to pay both federal and state income taxes. The same federal taxes would be applied, lowering your year-end total to $930 million.
You would also have to pay an additional $164.9 million to the state of California. That would leave you with about $765 million at the end of the first year.
An annuity payment instead of a lump sum could lower your state tax burden. Some taxes have a flat tax rate, so it won’t matter if you choose an annuity or lump sum.
However, the states with a range have similar tax brackets, just like the federal income tax brackets. Depending on how much your annuity payment is, you might fall into a lower tax bracket.
“Nothing Is Certain Except Death and Taxes”
Benjamin Franklin said this phrase in 1789, and it’s still true nearly 250 years later. Hitting the lottery jackpot only happens to a handful of people each year. The federal government will win no matter which person or persons win the prize.
In most cases, they’ll be taking 37% of the winnings for each payment. It’s almost impossible to wiggle your way out of the federal tax rate.
The most significant tax discrepancy will come based on the state where you bought your ticket. If you purchase a ticket somewhere with no income tax, you’ll be able to save a significant percentage.
If you buy a ticket in a state with an income, you’ll most likely be paying the maximum rate on every lottery payment.
The recent $2 billion Powerball winner probably wishes they would have bought their winning ticket in a state with lower income tax rates. Paying such a large amount of taxes is one of the worst parts of winning the lottery. However, you’ll still be walking away with a life-changing amount of money.
Remember that taxes are inevitable. You can’t control how much you pay, so there’s no point in being upset by them.
Instead, you should enjoy the win as much as possible and focus on avoiding severe problems in your new life.