Winning the California lotto can quickly change your financial situation. While a small prize might not make a big difference, winning hundreds of thousands or millions of dollars puts a potentially life-changing amount of money in your pocket. You're not the only winner, either. The taxes that you'll pay can generate significant income for the government.
California Income Tax
According to the California Lottery's Winners Handbook, your winnings will be completely exempt from state and local income taxes. However, just because your winnings are exempt doesn't mean you won't end up paying taxes in the future. If you use your winnings to buy a house or a car, you'll still have to pay property taxes and registration taxes on these items. In addition, you may have to pay gift taxes if you send extravagant presents to friends or family.
Federal Income Tax Withholding
Your lottery winnings are completely subject to federal income tax. If you give the lottery your Social Security number, the California Lottery will take out 25 percent of your winnings and send the money to the Internal Revenue Service. Without your Social Security number, it takes 28 percent. If you don't disclose your citizenship status, the lottery will withhold 30 percent.
Federal Income Tax Liability
Just because the California Lottery keeps 25 to 30 percent of your winnings and sends it to the IRS doesn't mean you've paid all of your federal tax obligation. For the 2013 tax year, the highest tax bracket isn't 25 or 30 percent; it's 39.6 percent. If you were to win a $20 million prize that was completely taxable, at least $19.55 million of it, depending on your filing status, would be taxed at 39.6 percent. As such, you'd have to send an additional check to the IRS.
Reducing Tax Liability
When you win the lottery, you can write off any other gambling losses in the year you win up to the total amount of your prize. Charitable donations are also tax deductible, and you can put a portion of your winnings into tax-advantaged accounts, further reducing your liability. Another strategy is to spread your payments out over many years by taking installments. When you divide the prize this way, less of your money will be subject to the higher tax rates applied to large incomes. You can also make annual charitable contributions or contributions to retirement accounts, letting you shelter money every year instead of just one year.
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