Lottery winnings and prizes are considered income by the IRS and are subject to federal and state income tax. You’ll owe taxes in the year in which you collect the winnings, which means that you can spread out your tax bill if you choose annuities instead of a lump sum prize.

While it may be a dream to win the Powerball or Mega Millions, you may have overlooked the costs associated with the prize. Financial missteps and taxes can quickly make your windfall turn into a burden, so it’s best to consult with a financial advisor and a tax professional at the earliest.  

How Are Lottery Winnings Taxed?

“Winning the lottery is thrilling! But the biggest mistake lottery winners make is not understanding the tax consequences and spending their winnings irresponsibly,” says Teresa Dodson, debt expert and founder of Greenbacks Consulting. Read on to learn more about the tax structure of lottery winnings.

When you win a lottery, the amount you win is considered to be gambling winnings, which is taxable. Any payout over $5,000 after deducting the cost of the wager will automatically have 24% withheld for federal taxes.

The actual rate at which you’ll have to pay taxes will depend on your federal income tax bracket. Here’s a breakdown of the tax brackets for 2023:

Tax RateSingleMarried filing jointlyMarried filing separatelyHead of household
10%$0 to $10,275$0 to $20,550$0 to $10,275$0 to $14,650
12%$10,276 to $41,775$20,551 to $83,550$10,276 to $41,775$14,651 to $55,900
22%$41,776 to $89,075$83,551 to $178,150$41,776 to $89,075$55,901 to $89,050
24%$89,076 to $170,050$178,151 to $340,100$89,076 to $170,050$89,051 to $170,050
32%$170,051 to $215,950$340,101 to $431,900$170,051 to $215,950$170,051 to $215,950
35%$215,951 to $539,900$431,901 to $647,850$215,951 to $323,925$215,951 to $539,900
37%$539,901 or more$647,851 or more$323,926 or more$539,901 or more

So, if you’re a single filer earning $50,000, your tax bracket will be 22%. If you were to win a lottery prize of $200,000, your total income for the year would be $250,000, which would put you in a tax bracket of 35% (assuming there are no deductions).

State-Specific Tax Laws

Other than the federal taxes, jackpot winners also have to pay state taxes, depending on where they live. For example, New York state has tax rates ranging from 4% to 10.9%. Most other states have tax rates ranging from 2.9% to 8.82%.

There are nine states that don’t have state income tax. These are:

  1. Alaska
  2. Florida
  3. Nevada
  4. New Hampshire
  5. South Dakota
  6. Tennessee
  7. Texas
  8. Washington
  9. Wyoming

If you purchase a lottery ticket in a state where you don’t live, the state where you purchased the ticket will typically withhold taxes. At tax time, you’ll need to file to determine how much you owe in state taxes.

5 Ways To Minimize Taxes on Lottery Winnings

If you don’t want to end up with a lot of tax debt, it’s essential to consult a tax professional to understand your liability. That said, there are a number of things you can do to minimize the taxes you pay.

1. Choose an Annuity Payment

One of the biggest factors that will have an impact on how much you’ll pay in taxes is how you’ll receive your winnings. You can either choose a lump sum payment or annual payments that are spread over several years, known as an annuity. Each option has different financial implications, but from a tax viewpoint, annuity offers distinct advantages.

For example, if you win a jackpot with a lump sum payout of $1 million, you’ll be in the top marginal tax rate of 37% for that tax year and pay $370,000 in federal income tax. If you opt for an annuity of $100,000 paid over ten years, you may have to pay only a 24% marginal tax rate, which will be $24,000 each year, or a total of $240,000 over ten years.

2. Work With a Financial Advisor

As soon as you win a lottery, you want to enlist a team of professionals such as an attorney, a CPA, and a financial advisor. These professionals can provide you with the financial guidance you need so you can plan for your future and ensure your winnings are protected. Avoid discussing your winnings with anyone until you’ve discussed them with these professionals. Working with professionals to plan your estate and ensure proper tax planning will help you avoid making any rash decisions.

3. File Your Tax Returns

Your tax liability will be determined by the income you report on your income tax paperwork. When you’re filing your tax returns, you’ll need to report any winnings in Box 1 of Form W-2G. This will include charity drawings, lottery winnings, raffle tickets, or sweepstakes. You can claim a deduction for the amount of your wager.

It’s also important to remember that while you can’t go to jail if you are unable to pay taxes you owe or miss a deadline, you may go to jail for tax evasion or tax fraud. These are serious offenses, so it’s important to ensure you file your tax returns accurately, with the help of a tax professional, once you win a lottery.

4. Choose Your Tax Deductions

Lottery winnings are subject to federal income tax withholdings. The payer will issue you a Form W-2 G. The IRS will automatically withhold 24% of your winnings. Lottery winners then need to file taxes to determine the rate at which their winnings will be ultimately taxed. Once you file your taxes, you’ll be required to pay any additional taxes that you owe.  

5. Donate to Charity or Find Another Exemption 

You can also minimize the taxes on lottery winnings by donating to a nonprofit organization. This may allow you to take advantage of some itemized deductions, which may lower your tax bracket. If you plan to share your winnings with family and friends, you may also be able to gift up to $17,000 (2023 annual limit) without having to pay a gift tax.

Examples of Taxes on Different Lottery Winning Amounts

Let’s consider a few examples to get a better understanding of taxes on lottery winnings and what you may owe.

Taxes on Winnings of $200,000

Let’s consider that you’re a single filer earning $50,000 a year. You won $200,000 in prize money, so your total taxable income increased to $250,000, and you’ll be in a higher tax bracket. This means that when you won the lottery, your marginal tax rate increased from 22% to 35%.

This doesn’t mean that you’ll pay an income tax rate of 35% on the entire $250,000 because marginal tax rates only apply to income that falls in a specific bracket. This means that you’ll pay 10% tax on the first $10,275 of your income, 12% on the next $31,500, and so on.

On a total income of $250,000, you’ll pay federal taxes of $56,721. You may also need to pay state taxes, depending on where you live.

Taxes on Winnings of $1,000,000

For this example, let’s assume that you’re a single filer with an income of $45,000 a year. If you won a lump sum of $1 million, your total income for that year will be $1,045,000. This means you’ll pay the highest federal tax rate of 37%. Assuming there are no deductions, you’ll be liable to pay $344,814 in federal taxes.

If you win a large sum of money in a lottery, it may change your life forever. The steps you take after winning a lottery can secure your future or may leave you broke. The first thing to do is to take a deep breath and analyze your current financial situation and how your windfall will affect it.

Next, speak to an accountant to determine taxes on lottery winnings and how you’ll cover your tax bill. Once you take care of taxes, you can work with a financial advisor to determine how to protect your money and ensure it grows over time. Make smart investments to ensure your money lasts for a long time.