Whether you’re sitting on a pile of cash you recently won or, like most people, you’re just dreaming, you may not know how taxes will come out of your winnings. You’ll owe on your prizes, whether they’re in the form of trips, a new car or cold hard cash. Before you even pick up your prize, though, you may see taxes taken off the top, which can be a problem if you win a non-cash prize, since you may owe tax dollars before you even claim the item. Understanding what to expect can make it less of a shock when you do claim your windfall.
The taxes you pay on prize money depend on the amount you win, the state where you win it and the type of prize.
Calculate Taxes on Winnings
Winnings are taxed as ordinary income, so you’ll pay the IRS just as you would pay on the money you earned through any other source. But unlike work earnings, you may not be handed a form from the prize issuer, which means you’ll need to track your winnings and claim them yourself. You’re technically supposed to report even the smallest winnings and pay taxes on them, but prize issuers are required to report winnings of $600 or more to the IRS using Form W2-G. You will then get a total of what you won on Form 1099-MISC at tax time. The amount you won will be listed in Box 3, Other Income.
When you’re filling out your Form 1040, you’ll input the information from your 1099 on Line 21, Other Income. You’ll add it to any other miscellaneous income you’re claiming for the year. Your winnings will be taxed along with your other income, following the rate that goes along with your tax bracket. If you’re accustomed to paying a certain tax rate, it’s important to be aware that your winnings can throw you into a higher tax bracket, which means you may have a bigger tax bill than you’re used to in April. Paying 24 percent of a $1,000 prize is one thing, but if you’re suddenly paying an additional 2 percent on everything you earn within that bracket during the tax year, you’ll likely feel the tax liability much more.
Winnings and Tax Brackets
To better calculate the tax on winnings, you should familiarize yourself with the tax brackets, especially since they’ve shifted under the Tax Cuts and Jobs Act. If you’re an individual filing singly and your income falls in the $38,701 to $82,500 range, you’re in the 22 percent tax bracket, which means you’re responsible for handing the IRS 22 percent of your earnings within that tax bracket. If you’re filing as a couple, though, you’ll only qualify for the 22 percent tax bracket if you make between $77,401 to $165,000.
If you’re on salary throughout the year, your employer pulls taxes out of your earnings and submits them to the IRS. This means when you file at the start of the next year, you’re basically making sure you’ve paid enough in throughout the year. If you haven’t, you’ll owe extra, but if you paid in too much, you’ll get a refund check. If you win $2,000 at the horse track, but your salary is $82,000, you’ll suddenly find yourself in the 24 percent tax bracket, which applies to earnings of $82,501 to $157,500. This could increase your tax bill or result in a smaller refund when you file. If you win millions in the Powerball, it will automatically throw you into the highest tax bracket, forcing you to pay 37 percent in taxes on all income within that tax bracket.
Part of the taxes on prize money you’ll pay will be handled for you, provided you win more than $5,000. The IRS requires 25 percent to be withheld on any prize of that value, which means when you pick up your check, you’ll see a lower value than you’d expected. But in some states, there are local laws regulating the amount that will be withheld. New York is one of those states, and it’s the state where you’ll see the least cash in hand if you win money.
So how does this work if you win a noncash prize? This is where it can get sticky. If you win a cash prize with a fair market value of more than $5,000, the organization can simply withhold the 25 percent from what they give you. If, on the other hand, you win a new car or high-value piece of jewelry, there’s nothing for the prize issuer to withhold. This means, before you can take the item, you’ll be required to pay 25 percent of its value.
State Taxes on Lottery Winnings
The federal government isn’t the only authority you’ll have to pay if you win. Just as you’re supposed to report your winnings as income to the IRS, the same rules apply to the states that tax winnings. The highest tax rate is in New York, which takes 8.82 percent of winnings. Maryland and D.C. are also at the top of the highest tax list when it comes to prizes.
To maintain as much of your winnings as possible, it helps to live in a state that doesn’t tax winnings at all – 10 states, Puerto Rico and the U.S. Virgin Islands don’t tax lottery winnings. So, you would only need to worry about the part of your prize the IRS wants. If you buy your ticket in a different state than the one where you live, you’ll need to pay close attention to whether the government overseeing the purchase location charges state taxes for nonresidents who win. Some states only charge taxes on lottery winnings distributed to those who live in the state.
Casino and Gambling Winnings
If you log serious time at the casino, you’re likely familiar with gambling tax. You’re supposed to claim every dollar you make under other income on your 1040, even if you just win $10 on a slot machine. But there’s a point when the IRS really starts to care about your winnings. The IRS has strict reporting thresholds for certain types of winnings. Those are:
- $600 or more at a track if the winnings are at least 300 times your bet
- $1,200 or more if you win at bingo or a slot machine
- $1,500 or more in keno winnings
- $5,000 at poker
Once your gambling winnings reach one of those thresholds, the casino will withhold 25 percent of what you won and report the winnings to the IRS using Form W2-G. You’ll get a 1099 form and, if funds are withheld from your winnings, you’ll also receive a copy of WG-2. Your casino and other gambling winnings may be subject to state income tax.
Understanding Lottery Winnings and Annuities
Lotteries are taxed similarly to other types of prize winnings, as long as you take it in a lump sum. With the tax brackets, though, this can throw you into a tax bracket where you’re losing half your winnings before the money is even in your account, between state and federal taxes. Experts advise visiting with a tax attorney or financial planner to discuss the best options for you before taking your payment.
The only alternative to a lump-sum payment is to take your lottery winnings as an annuity. This involves taking your prize in installments, rather than all at once. If you took a $1 million jackpot in 20 installments of $50,000, you’ll save nearly $250,000 over a 20-year period. The government gets to keep its money and earn interest on it and you still get $50,000 a year, so it’s a win for both parties.
Navigating Non-Cash Prizes and Taxes
A prize tax isn’t only applied to cash winnings. You’ll owe the same taxes if you win a car, house, luxury vacation or any number of other items. It just gets a little more challenging for you, since you may not have the extra cash on hand to fork over. Sure, you could sell the prize and use the money to pay taxes and pocket the rest, but what if you want to pull together the money so you can enjoy your new item?
In addition to the taxes you’ll have to pay, you should also consider the ongoing costs of owning the item. That $1 million home you see listed as a “dream home” on TV comes with a hefty tax bill long after you move in. Not only will you pay federal taxes on the hundreds of thousands of dollars on your winnings, but property taxes on a $1 million home can be more than the average mortgage. Add to that the cost of homeowner’s insurance, utilities and living in an area with a higher cost of living, and that dream house can quickly become a financial nightmare.
You may have heard talk that you can deduct the money you’ve spent on lottery tickets on your taxes. This only applies if you win, and the same goes for gambling expenses. If you win, you can claim what you spent gambling or buying scratch-offs during that tax year, up to the amount of your winnings. But there’s a catch: to claim your gambling or lotto expenses, you’ll need to have a detailed record of every dime you’re deducting. That may not be easy if you don’t carry a notebook around the casino or you tend to buy lottery tickets on impulse. Your diary should include the following information:
- The date and type of each wager.
- The name and address where you made the wager.
- The name of anyone with you when you made the wager.
- The amount you won or lost.
You can’t simply report your winnings, deducting the amount you spent throughout the year. You’ll need to input your winnings under Other Income, then detail your losses on Schedule A, Line 28. Gambling losses include, but aren’t limited to, bingo, lottery and raffle tickets.
Paying Estimated Taxes
If you win a fairly sizable prize – cash or noncash – it might be well worth it to determine whether you should pay estimated taxes. These are paid four times a year, allowing you to pay a little of the taxes you’ll owe in April early. If you think you may owe more than $1,000 in April, it’s time to consider estimated taxes. If you wait until April, you’ll be seen as having underpaid your taxes and you may owe penalties in addition to the taxes due.
Paying four times throughout the year rather than all at once can also help you come up with the taxes on your prize. You’ll be able to divide the amount by four and pay a little as you go. You can submit a payment to the IRS at any time using your Social Security number and it will be applied to your account. Quarterly payments are due by mid-April, mid-June, mid-September and mid-January and must be mailed to the filing address for where you live. You can also pay online or by phone.
- Tate & Tryon: Reporting Requirements And Federal Tax Withholding On Raffle Prizes
- Forbes: The New 2018 Federal Income Tax Brackets & Rates
- Tax Foundation: What Percentage of Lottery Winnings Would Be Withheld in Your State?
- Charity Compliance Solutions: ONLINE RAFFLES: IS IT WORTH THE GAMBLE?
- Washington Post: The best and worst states for winning the $1.5 billion Powerball jackpot
- The Motley Fool: Are Gambling Winnings Taxed?
- Investopedia: Winning the Lottery: Dream or Nightmare?
- IRS: Publication 529 (2017), Miscellaneous Deductions