How to Not Pay a Lot of Taxes on Large Sums of Money
Winning the lottery, selling a stock that quadrupled in value, and getting a big advance on your novel can all make you richer. They can also push up your tax bill when you add them to your regular income for the year. There are strategies and tactics you can use to push your bill back down, but be very careful to stay within the tax laws.
Lottery winners have the option to take a lump sum payment or installments over months or years. Stretching out unexpected windfalls into several tax years may keep you in a lower tax bracket so you end up with a lower overall tax bite. If you earn a surprise large sum at the end of the year, see if you can postpone getting the payment until next year. That gives you 12 months to figure out a good tax strategy.
Donate to Charity
When you itemize deductions on Schedule A, you can write off every penny you donate to a qualified charity. Even if you don't normally itemize, it may be worth doing so when you have a large sum to dispose of. If you donate enough to make itemizing worthwhile, you can also claim other Schedule A deductions, such as mortgage interest and state income tax. Another option is to invest your money in a charitable trust. You can collect the interest, save on taxes and the money goes to charity when you pass on.
The alternative minimum tax can be a nasty trap when you've had a good year. The AMT rules require you recalculate your taxable income, without personal exemptions or many of your itemized deductions. You can reduce the risk of paying AMT by steps such as contributing more to to your traditional IRA and 401(k), lowering your taxable income. Charitable donations help, as you get credit for them even under the AMT tax rules.
With good advance planning, you can cut capital gains when you sell stocks or real estate. For example, if you hold capital assets for more than a year, the long-term capital gains rates you'll pay are lower than the short-term rates. No matter which tax bracket you're in, the long-term rates are always lower than your ordinary income tax rates. If you move into a rental house and live there for at least two of the five years before you sell it, you can exclude some of the gain. The exact amount depends on several factors, including how long it was rented out before you moved in.
- Blake Christian: Tax Strategies For Lottery Winners – Lump Sum vs. Installments?
- Citibank: What to Do With a Financial Windfall
- Fidelity: The AMT and You
- The T. Rowe Price Program for Charitable Giving: Understanding AMT's Impact on Charitable Giving
- Internal Revenue Service: Ten Facts About Capital Gains and Losses
- Internal Revenue Service: Hardship Can Reduce Capital Gains Tax Liablity
- Cupertino Homes: Primary Residence Capital Gain $250k/$500k Exemption Loophole Closed
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.