If you've been lucky enough to hit a large lottery prize, taxes are still due on your winnings. Find out the details on taking the cash option versus the annuity and what federal and local withholdings are due in your state.
Lump Sum or Annuity
For large jackpots such as the Powerball and Mega Millions top prizes, winners have a choice of two options for how to receive their payout: A "cash option" lump sum paid all at once, or yearly annuity payments over several decades.
The lump sum gives you all the money currently in the jackpot pool, minus tax withholdings. After taxes, the cash option is typically worth about 60% of the total advertised prize. The amount is less because the advertised jackpot is based on the annuity value, where the money is invested over many years.
Most winners take the lump sum, which is fine - as long as you have a plan. Taking all the money at once means it's easier to make a mistake. One option to avoid that is to put the lump sum to work in investments, and pay yourself an annuity out of what it earns.
In some states you need to claim earlier if you want the cash option, so keep this in mind.
The annuity pays you a yearly amount over several decades, and you receive the full advertised jackpot value, minus taxes. The annuitized prize is distributed as 30 payments over 29 years (the first payment is made after you claim).
This has the effect of doing a basic level of budgeting for you - you can't access all the money at once. This may be an advantage or disadvantage depending on your situation. Many people prefer to have the lump sum with the option to invest it themselves. However, keep in mind you are getting less overall.
There are also different tax implications for the lump sum versus the annuity. Winners who choose the cash option will pay all the taxes on the lump sum at once, although they will still be on the hook for future taxes based on income earned from the initial payout. If you go with the annuity, taxes are due on each payment according to its value.
Sad but true - lottery jackpots are taxable income. Specifically, any prize above $5,000 is subject to federal taxes of up to 37%, depending on how big the prize is, and additional state and local taxes may also be payable.
Winners who take the lum sum option will have a 24% federal tax withholding deducted from the jackpot before it's paid out. Yes, Uncle Sam gets almost a quarter of the money before you see a penny - but at least you can dry your tears with wads of hundred-dollar bills.
Additionally, when the winner files their next tax return, they will be subject to the highest tax bracket. In tax year 2021, that's 37% for any income above $523,600 for a single return, or $628,300 for a joint return. Therefore, they must pay the difference between the 24% and 37% tax rates on applicable income. They will also be subject to taxes on income earned by investing the money.
The winner can give gifts of up to $15,000 per person to as many recipients as they wish without paying extra taxes.
State & Territory Taxes
State and local taxes can take another slice from the winner's pie. For example, if you live New York City, you'll be subject to the state tax of 8.82%, plus the local tax of 3.867%. However, other states charge no taxes whatsoever on lottery wins, or apply a flat tax on all income.
Taxes apply based on where you bought the ticket, not where you live. So if you purchased the ticket in a state like California, which has no state taxes on lottery winnings, consider it a bonus. Or you could think about moving before you strike it rich.
If it's any consolation, there are a couple of little deductions you can make on your federal tax return. You can write off state lottery taxes up to $10,000, or $5,000 if you're married and file separately. You can also deduct the cost of lottery tickets. Okay, these are small change if you've hit the jackpot, but every bit helps.
In Puerto Rico, a US territory offering Powerball, winners usually don't owe any income tax to the IRS, and Puerto Rico does not collect its own taxes on lottery wins either. In the US Virgin Islands, where both Powerball and Mega Millions are played, you'll owe federal income tax but no local taxes.
Here are the top tax rates across the Powerball and Mega Millions jurisdictions:
U.S. Virgin Islands
|No state tax on lottery prizes|
|District of Columbia||8.5%|