Taxes are always tricky to deal with because of the multitude of laws governing it, and it doesn’t get any easier when you win the lottery. Usually, all lottery winnings are treated as taxable income. The applicable tax debt wouldn’t be too complicated to calculate if there weren’t other, not-so-clear legal provisions governing lottery taxes.
The amount of tax you pay on a $10,000 lottery ticket will depend on your income tax bracket, the tax rate in the state you live in, and whether you’re a US resident. It will also depend on whether the winnings are taxed “at source” or further local taxation applies.
Read on to find out how these three factors will affect your tax burden on a $10,000 lottery ticket, how you can calculate that tax debt, and the different ways you can keep it as low as possible.
The Basics of Lottery Game Taxes
Lottery taxes are the unfortunate side of winning big in lottery games. While you may not always be liable to tax on each lottery win, the IRS has made it mandatory for everyone to report their winnings when filing tax returns. Failure to do so or remitting the tax due late can attract fines, which can add up to 30% of the total debt.
Once your returns are filed, the amount of tax due will be calculated using a progressive tax rate method, which is typically based on federal tax brackets.
In this taxation method, the government applies lower tax rates to earnings in the lower tax brackets, with the rate increasing as you go up the tax brackets. That means the more your earnings, the higher the taxes you pay. For example, people whose taxable earnings fall into lower tax brackets may be charged as low as 10%, while those in higher tax brackets may pay as much as 35%.
Also worth noting is that your state lottery agency is required to disclose the total of your winnings to the IRS via the W-2G form. However, it’s only required to send you the same form if your lottery prize is more than $600. The agency may also withhold 25% of your winnings as income tax provided your lottery winnings exceed $5,000. If your lottery wins are less than $5,000, you will pay no taxes.
Lastly, you will be required to include a copy of your Form 1040 when reporting your winnings to the IRS.
How Winnings From a $10,000 Lottery Ticket Are Taxed
Winnings from a $10,000 lottery ticket may be taxed in two ways:
- At source
- Further local taxation
Let’s take a deeper look at each.
Lottery Winnings Taxed at the Source
Some lottery companies usually allow the federal government to tax your winnings before you even touch the price. Based on the updated tax brackets, a $10,000 win taxed this way for a person filing their returns as a single taxpayer (as opposed to filing jointly as a married couple) would pay the federal tax debt the sum of 12% of $9,875 and (22% of $10,000-9,875).
In such a case, the total sum you receive would be after-tax.
Further Local Taxation
Further local taxation applies to lottery winnings that aren’t deducted at the source. If you win $10,000 on lottery tickets, some companies might choose to give you the full amount as your cash price, which would be denoted as “$10,000 pre-tax.”
In such a case, the amount tax you’d pay would depend on your country of residence (if you reside outside the US) and would include income tax and other types of tax that may apply in your country. Local taxation is your responsibility, and it’s up to you to capture your winnings when submitting your income statement to your country’s tax collection agency.
And while you might be thinking about leaving out the windfall in such a situation, failing to include all of your lottery winnings when filing your tax returns usually attracts extra charges and/or penalties in most countries, so this might not be the best move.
Estimating the Amount of Tax You’ll Pay on a $10,000 Lottery Ticket
The size of your tax debt on a $10,000 lottery win may vary according to the type of lottery. To help you estimate your tax burden, let’s take a look at some of the most popular lotteries today.
The US Powerball
The Powerball is a well-known lottery company that sells its tickets in Oregon. It allows the federal government to tax your winnings at source using the following tax bands:
- Tax band 1 covers up to winnings up to $599. Winning in this bracket are tax-exempt (meaning they aren’t taxed).
- Tax band 2 covers winnings between $600 to $4.999.99, which are taxed at 30% for non-residents.
- Tax band 3 applies to any winnings over $5,000, which are taxed at 38% for non-residents.
The US Mega Millions
This lottery has three tax bands, each with the following stipulations:
- Tax band 1 exempts tax on cash prices up to $599
- Tax band 2 applies to cash prices of amounts between $600 to $ 4,999.99, which are subject to 30% tax for non-residents
- Tax band 3 stipulates that any cash price that is more than $5,000 will be taxed at 38.82% for non-residents.
The prices for this lottery are taxed at the source based on the following tax brackets:
- Tax band 1 allows for zero taxes on cash prices up to $600.
- Tax band 2 stipulates that cash prices from $600.01 to $5,000 are subject to a 30% tax rate for non-residents.
- Tax band 3 applies to cash prices that exceed $5,000.01, and these will be taxed at 36% for non-residents.
All winnings of this lottery are subject to taxation at the source. But unlike many other lotteries, this type has only two tax bands:
- Tax band one exempts taxes on cash prices that amount to $599.99
- Tax band 2 stipulates that all cash prices that exceed $600 are subject to a 30% tax for non-residents.
Disclosure: As you might have noticed, all the tax rates identified for the above lottery types only apply to non-US residents.
If you live in the US, these rates won’t apply to your winnings. Instead, your cash prize will be taxed according to the IRS’s latest rates, terms, and conditions, and there may be extra tax to pay depending on the rate in your state.
State and Local Taxes
The United States of America has fifty states, and each has its own tax rate (some don’t charge any income tax lottery winnings at all).
Now, let’s get one thing clear: the fact that you’ve paid federal taxes on a given lottery win doesn’t mean that your state won’t tax you. In other words, you’ll pay state tax in addition to federal tax.
Want an example?
Picture this: You live in New York City and have won a windfall of $10,000. In this situation, the federal government will deduct federal taxes (calculated using a progressive method, remember?) from that amount. Next, the state of New York will tax the balance at 8.82%. That means if you were to calculate your total tax burden, it would be the sum of the federal and state tax.
Since it’s clearly important to consider your state’s tax rate when calculating the total tax burden on your winnings, let’s review the tax rates for each state in the US in the next section.
Income Tax Rates for the Various States in the US
We mentioned earlier that some states don’t charge any income tax. In case you’re wondering what these are, they include:
- South Dakota
- New Hampshire
By contrast, below is a list of states that charge the highest income tax on lottery winnings:
- New York (8.82%)
- Maryland (8.75%)
- District of Columbia (8.50%)
- New Jersey (8%)
- Oregon (8%)
- Wisconsin (7.65%)
- Minnesota (7.25%)
- South Carolina (7%)
- Arkansan (7%)
- Connecticut (6.99%)
Here is also a list of states that levy the least charges on lottery winnings:
- Tennessee (1%)
- North Dakota (2.90%)
- Pennsylvania (3.07%)
- Indiana (3.23%)
- Michigan (4.25%)
- Arizona: (4.50%)
- Colorado (4.63%)
- Ohio (4.8%)
- New Mexico (4.90%)
- Illinois and Utah (4.95%)
Lastly, some states do not allow lottery games, which include:
If you buy a winning ticket in a state that you don’t reside in, most states (with the exemption of Maryland and Arizona) will not levy income tax on your winnings.
How to Offset Federal Taxes on Lottery Winnings
While a sudden windfall certainly increases your net worth, it also attracts a higher tax bill. That’s because lottery winnings are considered taxable income and are bound to put you in a higher tax bracket, which means a higher tax rate.
Luckily, there are some crafty ways to keep your tax burden after winning a lottery, which we will discuss below.
Donating to Charity
One way of reducing your tax obligation to both the state and federal governments is by making donations to charitable organizations. The law exempts both income and gift taxes on donations to organizations that qualify as per section 501(c)(3) of the IRS code. Some of the organizations that qualify for this kind of tax exemption include; hospitals, nonprofit schools, public charities, and hospitals.
By “exemption,” we mean that you’re allowed to deduct the total sum of your charitable contributions from your taxable income (which, obviously, reduces your tax burden). The law further stipulates that you may deduct charitable donations up to 60% of your adjusted gross income in a year. If your donation exceeds 60% percent of your gross income in that year, you can deduct the excess amount from your taxable income in the following year.
That said, it’s important to note that you will only receive this tax exemption on charitable donations if you itemize your deductions. This is because the standard deduction option doesn’t have tax incentives on charitable organizations.
Taking Advantage of Capital Gains
Another way of reducing federal and state taxes on your winnings is by investing it and making more money, which will be taxed at a lower rate. If you win $10,000 through a lottery ticket and invest it all by, say, buying corporate shares or buying property and renting it out, any profits that you make from selling these investments will be treated as a capital gain as long as you hold onto your investment for at least a year before selling.
Usually, short term (less than a year) capital gains attract a 37% tax rate while long term capital gains (more than a year) attract up to 20% tax rate. Thanks to this rule, holding onto your investment for more than a year before selling it will attract a lower tax rate, and consequently save you money.
According to the Internal Revenue Service (IRS), all lottery winnings are treated as gambling winnings. This means that the money you spend buying a lottery ticket that doesn’t result in a win will be considered a gambling loss. As such, you are allowed to deduct from your taxable income the total amount you spent on all past tickets provided they weren’t winning tickets.
However, there’s a catch: The law only allows lottery winners to deduct gambling losses only up to the amount of their windfall. For instance, if the total cost of your lottery tickets amounts to $1,000 and you only manage to win a $500 lottery ticket in that year, you will only be allowed to deduct up to $500 from your taxable income.
Sometimes, itemizing your gambling losses may also increase your deduction. The keyword here is “sometimes”: In some cases, your standard deductions may be higher than your itemized deductions. In such an instance, it won’t make sense to go with the itemized deductions when you can get a better deal by choosing the standard deductions.
Choosing Between Lump Sum and Annuity Lottery Payments
If you win a lottery prize, you will always be given two options: a lump sum payment or getting paid a certain amount of cash over a specified period (AKA annuities). Powerball, one of the biggest lottery companies, gives lottery winners a choice of either a lump-sum payment or an annuity payment (where they receive 30 payments for 29 years).
While both options will still allow you to get your cash price, there are several advantages and disadvantages to choosing either.
Advantages of Lump Sum Lottery Payments
Choosing a lump sum payment after winning a lottery will:
Help you avoid long term tax implications
With lump-sum lottery payments, all your winnings will be taxed at the prevailing federal and state tax rates at the time of your win. After this, you will be free to use your money as you please.
On the other hand, annuities will be taxed based on the tax rate for the year you receive each payment. That means if the tax goes up in the course of the annuity period, you’ll pay more tax compared to what you’d have paid if you got taxed at the time of your winning.
Sounds confusing? Let’s look at an example.
Let’s say you win a lottery in 2020 when the tax rate is, say 30%, and you choose to get pain annuities spread over the next 30 years. If the tax rate goes up by 5% in 2025, your annuity for that year will be charged at 35%, meaning you’ll pay more in taxes that year than you would have in 2020 if you chose a lump sum payment.
Allow you to take advantage of high-yield investment opportunities
Getting a one-time lump sum payment will put you in a better position to act swiftly in terms of investment because you won’t have to wait for your annuities to add up to the required capital. More often than not, high-yield investment opportunities don’t stay open for long, and raising money quickly can make all the difference.
Gives you certainty
Lump-Sum payments give you full control of how and when to use your money. This is important, especially if you are planning to offset personal debts or when misfortune hits you, and you need to raise a large amount of cash quickly.
Disadvantages of Lump Sum Payments
Though this has mostly to do with your money management skills, a lump sum payment might lead to:
Lump-Sum payments may cause you to blow through your money via impulse buying. To avoid falling into the old windfall-winner-gone-broke stereotype, get a trusted financial advisor to help you manage your money properly.
After getting a massive one-time payment, chances are you’ll be approached by all kinds of “business people” urging you to invest in “the next big thing.” Quite often, this leaves lottery champs frustrated after investing large sums in failed businesses, so you should be careful who you trust.
Advantages of Annuity Payments
Choosing an annuity payment can be beneficial in the following ways:
They protect winners from bankruptcy
There are countless stories about lottery winners spending their money and ending up worse off than before the windfall. If you don’t trust yourself with money, periodic cash payments may be more ideal because they’ll sustain you over the life of the annuity, which will help shield you from potential bankruptcy.
They allow you to take advantage of future reductions in tax rates
Remember when we talked about annuities putting you at risk of being taxed a higher rate in the future? This is the other side of it. Tax rates may go down in the course of your annuity period, in which case you’d pay less tax than if you opted for a lump sum payment.
Annuities provide you with peace of mind
Annuities give you the comfort of knowing you will be financially secure throughout your payment period, which is often more than two decades. This peace of mind also extends to your beneficiaries because annuities can be transferred to family members if the holder dies before the payment period elapses.
Disadvantages of Lottery Annuities
Annuities are inflexible
Because it is impossible to change the terms and conditions of annuity contracts, your annuity payment won’t be helpful when you need to raise money quickly due to an emergency. Such inflexibility also means that you won’t be able to take advantage of high-yield, short term investment opportunities.
The Bottom Line
As we’ve seen in this article, the amount of tax you’d pay on a $10,000 lottery ticket would be determined by three factors; the federal tax rate, your state’s tax rate, and the lottery company you bought your ticket from (if you’re not a US resident).
If you live in the US, you can calculate your tax debt by summing the applicable federal tax and the state tax (determined by the tax rate in your state). In case you get stuck, you can always consult with a financial advisor.
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