Get Your Free Guide to Lottery Winnings Taxes

Understanding Lottery Winnings and Federal Taxes

When someone wins a lottery prize, the winnings are considered taxable income by the Internal Revenue Service (IRS). This means that federal taxes apply to lottery winnings just as they do to wages, salaries, or other forms of income. The IRS treats lottery prizes as ordinary income, and the amount owed depends on the size of the prize and the winner's total income for the year.

Learn About Maryland Tax Refunds →

Federal tax withholding on lottery prizes works differently than withholding on paychecks. When you claim a lottery prize, the lottery commission is required by law to withhold 24% of the winnings for federal taxes before paying you the prize money. This 24% is a mandatory federal withholding requirement. However, this withholding amount is often less than the actual tax owed, especially for large prizes. Winners may owe additional taxes when they file their tax return.

For example, if someone wins a $100,000 lottery prize, the lottery commission would withhold $24,000 for federal taxes. The winner would receive $76,000. However, depending on their tax bracket and other income, they might owe more than $24,000 in total federal taxes. This additional amount becomes due when filing their annual tax return.

The tax rates on lottery winnings can be significant. For federal purposes, lottery winners are taxed at ordinary income tax rates, which can range from 10% to 37% depending on their total income and filing status. This means that larger lottery prizes can result in substantial tax bills. Understanding this upfront helps lottery winners plan for their actual take-home amount and avoid surprises at tax time.

Practical Takeaway: Lottery winners should expect to owe federal taxes on their entire prize amount. The 24% withholding by the lottery is just the beginning—additional taxes may be owed based on the winner's overall income for the year and tax bracket.

State and Local Tax Considerations for Lottery Prizes

In addition to federal taxes, most states impose their own income taxes on lottery winnings. State tax rates on lottery prizes vary considerably across the country. Some states do not have an income tax and therefore do not tax lottery winnings, while others tax lottery winnings at rates ranging from 3% to over 10%. This means that a lottery winner in a high-tax state could face a combined federal and state tax burden of 40% or more on their prize.

Learn About Merrick Bank Credit Card Account Access →

Nine states currently have no state income tax: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming, and New Hampshire. Winners in these states are not subject to state income tax on their lottery prizes, which can result in significantly higher take-home amounts compared to winners in other states. However, even in these states, federal taxes still apply.

Other states impose substantial taxes on lottery winnings. California, for instance, does not have a separate state lottery tax, but winners pay the state's regular income tax on their prize. New York imposes both a state income tax and a city income tax on lottery winnings for New York City residents. A resident of New York City winning a large prize could face combined federal, state, and local taxes exceeding 50% of the prize amount.

Some states allow winners to claim lottery prizes in different ways that may affect taxes. For example, some lotteries offer both lump-sum payments and annuity options. The tax implications can differ between these options. Additionally, some states withhold state taxes from lottery winnings at the time of payout, similar to federal withholding. Winners in states with income taxes should research their state's specific lottery tax rules and withholding requirements.

Local taxes may also apply in certain jurisdictions. Some cities and counties impose local income taxes that apply to lottery winnings. This is less common than state taxes but can add another layer to the overall tax obligation.

Practical Takeaway: Research your state and local tax laws regarding lottery winnings. Winners in states with no income tax have a significant advantage, but all lottery winners should understand their state's specific tax obligations before claiming a prize.

Lump-Sum Versus Annuity Payouts and Tax Implications

Many major lotteries offer winners a choice between two payment options: a lump-sum payment or an annuity paid over many years. Each option has different tax consequences that winners should understand before making a decision.

Get Your Free IRS Debt Information Guide →

The lump-sum option provides the winner with a single, immediate payment. However, this lump-sum amount is typically less than the advertised jackpot. For example, a lottery with a $100 million jackpot might offer a lump-sum payment of around $60 million. The difference represents the present value calculation—the amount that, if invested, would theoretically grow to equal the full jackpot amount over the annuity period.

With a lump-sum payment, the entire tax obligation is calculated on that single payment. If a winner receives a $60 million lump sum, they owe federal, state, and possibly local taxes on that $60 million in the year they receive it. This can push the winner into the highest tax brackets, resulting in a significant tax bill all at once.

The annuity option spreads payments over time, typically 20 to 30 years depending on the lottery. With an annuity, the winner receives an initial payment and then regular payments for many years. The tax advantage of an annuity is that each individual payment is taxed separately in the year it is received. This may result in lower overall tax rates because the income is spread across multiple years and tax brackets, potentially keeping the winner in lower tax brackets than a lump-sum winner would be.

For example, a winner who receives $3 million per year over 20 years may pay less total tax than a winner who receives $60 million all at once, depending on their other income and tax situation. However, the annuity option has disadvantages too. The winner does not receive the full amount of money upfront, and if the winner passes away before receiving all payments, the remaining payments may go to their estate.

The choice between lump-sum and annuity depends on individual circumstances, financial goals, and tax considerations. Some winners prefer the lump sum for immediate access to capital, while others prefer the annuity for potentially lower tax rates and steady income over time.

Practical Takeaway: Before claiming a lottery prize, investigate whether your lottery offers both lump-sum and annuity options. Consider how each option affects your tax liability in different years, and consult with a financial professional about which option aligns with your financial goals.

How to Report Lottery Winnings on Your Tax Return

Lottery winners must report their winnings on their federal tax return. The process involves specific IRS forms and procedures. Understanding how to report lottery winnings correctly is essential for avoiding penalties and ensuring accurate tax filing.

Budget Car Rental Customer Service Contact Guide →

When you claim a lottery prize of $600 or more, the lottery commission is required to issue you a Form W-2G (Certain Gambling Winnings). This form reports the gross amount of your winnings and the amount of federal tax withheld. You will receive Copy 1 for filing with your federal tax return and Copy 2 for your records. The lottery also files copies with the IRS and your state.

If your lottery winnings were subject to state or local withholding, that information may appear on the Form W-2G or on a separate state form, depending on your state's requirements. Some states issue their own versions of gambling winnings forms.

To report your lottery winnings on your federal tax return, you will enter the information from the Form W-2G into your tax return. If you are filing Form 1040 (the standard individual income tax return), lottery winnings are typically reported on Schedule 1 as "other income." The gross amount of the winnings is reported as income, and the withheld taxes are claimed as a credit against your total tax liability.

It is crucial to report all lottery winnings, even small ones. The IRS uses data matching to compare Form W-2G information with tax returns filed. Failing to report lottery winnings that the IRS already knows about can trigger an audit or result in penalties.

If you won lottery prizes from multiple drawings or multiple lotteries, you may receive multiple Forms W-2G. Each one must be reported separately. Your total lottery winnings for the year should be accurately reflected on your tax return.