written by: Olivia Emisar•edited by: Ronda Bowen•updated: 7/8/2013
Many of us look at the 'cash value' of our potential winning ticket and make plans for that remaining amount. Very few are aware that the cash value of that ticket is subject to IRS laws that deal exclusively with gambling and winnings. Is there federal withholding tax on lottery jackpots? Yes!
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All lottery ticket winnings are subject to taxation after the state(s) have deducted their share. What makes this form of taxation a bit more complex is the proliferation of states joining in what is called 'Power Balls' and the presumed cash value if the winner decides to take the full lump sum rather than annual disbursements. The tax on lottery jackpots starts at $25% in addition to the amount deducted by the participating states. The good news is that there are deductions that can be applied to reduce the amount owed to the IRS, but these deductions must be well documented. Generally speaking, the total taxes paid between the state, city, county and federal withholdings can easily approach 45% depending on the state of residency and where the ticket was won.
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The IRS allows gamblers to itemize and deduct gambling losses from their overall yearly winnings as long as gambling losses do not exceed winnings. For habitual gamblers this provision may be of little comfort if they have a tendency to live on credit, which far supersedes their yearly income. However, for lottery winners getting huge sums at once, the accumulation of non-winning tickets in that year is a tax deduction as well as any expenses associated with gambling.
For those who chose to take annual installments and continue to play the lottery, all non-winning tickets in those years are tax deductible. This deduction includes any casino gambling done with the winnings after taxes as well as any income generated through employment and investments. All deductions must be documented via cancelled checks, credit card statements and losing tickets.
While the IRS states "Gambling losses aren't subject to the 2% of adjusted gross income floor on miscellaneous itemized deductions. Nor are they subject to the 3%-80% overall limitation on itemized deductions." it is best to hire a financial planner and an accountant that will clearly state what is considered a deduction, the types of documentation required to file itemized deductions to offset the tax rate, and what types of investments will continue to generate passive income for life.
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When Are Lottery Winnings Taxed?
The lottery jackpots federal taxation begins in the year of the first disbursement.
In the event of a lump sum cash out, the entire amount is subject to taxation on that year alone.
Earned Income on lump disbursement:
The remaining amount that is invested and receiving interest will be taxed as personal income at a different rate from lottery winnings, since the interest is considered investment income and is eligible for itemized deductions.
For those who chose yearly installments, only the amount received per year is taxed. Any interest earned afterward will be taxed as personal or investment income and eligible for itemized deductions.
It is essential to keep accurate records to avoid unpleasant surprises or making costly errors when filing. Very few lottery winners have managed to keep their money and have ended up in worse financial shape than before they won the coveted price. It is highly recommended to be patient and speak with more than one financial planner before deciding on indulging every fantasy.
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What Amounts Are Taxed?
The current federal withholding tax on lottery jackpots is 25% on winnings from $600.01 up to $5,000. The state that issues the checks is the one that sends the winner a W-2G form to file with the IRS and deducts the federal withholding tax. Keep in mind that the issuing state will also withhold a portion and there may be taxes to pay in the state of residence as well as city and county taxes.
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Department of Revenue "Gambling and Lottery" http://www.irs.gov/uac/Gambling-Winnings-Are-Always-Taxable-Income; http://www.irs.gov/instructions/iw2g/ar02.html
U.S.A. Mega Millions "Frequently Asked Questions" http://www.usamega.com/mega-millions-faq.htm