Taxes
Big Tax Strings Attached to Billion Dollar Lottery Jackpot
Playing the lottery is a form of gambling. As a result, the usual federal tax rules apply to income and losses resulting from gambling activities. Generally, you can only deduct your losses from wagering up to the annual amount of your income from ...
Jan. 14, 2016
The Powerball jackpot on January 13 was a record-shattering $1.6 billion. Although the big winners can certainly afford to buy luxuries with their newfound wealth, they will also have to cough up millions to the IRS, not to mention a hefty state income tax bill.
Playing the lottery is a form of gambling. As a result, the usual federal tax rules apply to income and losses resulting from gambling activities. Generally, you can only deduct your losses from wagering up to the annual amount of your income from those activities. This includes all your forays to the casino, racetrack and even the bingo games at the local church.
If you have clients who are heavy gamblers, advise them to keep detailed records to preserve their deductions. For instance, you might keep a log of all gambling activities, including the date of the activity, the location, names of any people who were there with you, the amounts wagered, the type of gambling and your winnings and losses. Then you can supplement the log with receipts, tickets, statements and forms and the like.
The specific proof required by the IRS varies according to the type of gambling activity. For instance:
- Bingo and similar games: Keep records of the number of games played, the cost of cards purchased, and amounts collected on winning cards.
- Slot machines: Maintain a record of the machine number and all winnings by date and time the machine was played.
- Casino table games (e.g., blackjack, craps, poker and roulette): Write down the number of the table where you played and any casino credit information.
- Racing (horses, harness, dog, etc.): Keep track of the number of races, the amounts of your wagers and the amounts you won and lost.
On the other hand, income from gambling activities is fully taxable as ordinary income. Big-payout lottery winners can expect to be taxed at the top 39.6 percent rate on most of the income. Although you may reduce the tax somewhat by electing to collect the money in an annuity over a period of years instead of in a lump sum, you give up some control over the money. By taking the lump sum, smart investors may be able to maximize their earnings, but careless spenders could squander their fortune in a short period of time,
Note that the Uncle Sam will withhold 25 percent of the lottery winnings right off the bat. The winners will be responsible for paying the balance due at tax return time. At least that’s more than a year away for the latest Powerball millionaires.
Don’t discount the impact of state income taxes. Almost all of the 44 states participating in the Powerball lottery will want to take their cut. The applicable rate can be as low as 3 percent in New Jersey, while right across the river New York imposes a top 8.82 rate. Finally, some municipalities also pile on their own taxes. In New York City, a lottery winner may have to pay an additional 3.9 percent.
If one of your clients is lucky enough to hit it big, crunch all the numbers. This can help the client decide which type of payout to take.