Two lucky winners in Arizona and Missouri will be able to claim the record-shattering $580 million Powerball jackpot after Wednesday night’s drawing, but they will also face taxes and need financial advice.
Experts say that the first thing a lottery winner should do is sign their ticket, put it in a safety deposit box and consult a financial advisor or attorney before stepping forward to claim their winnings. It would also be a good idea to check with an accountant and tax planner, especially with tax rates scheduled to rise next year unless Congress and the White House can agree what to do about them.
"While the winner will have a big tax bill, the silver lining may be that it will be a lot less than it could be next year if we go over the fiscal cliff, prompting higher income tax rates, as well as when other tax increases go into effect," said CCH principal tax analyst Mark Luscombe.
While lottery winners typically have anywhere from 90 days to a year to claim their winnings—the Powerball winner may want to make sure to claim their winnings in 2012 to avoid potential tax increases in 2013, when the maximum income tax rate could increase to 39.6 percent. Lottery winnings are generally taxed in the year in which they are received.
The next choice the winner will need to make—within 60 days of claiming the prize under current tax law—is whether he or she wants to take the lump-sum cash option, estimated at more than $360.2 million, or take the annuity option, which pays out the full amount over 29 years (30 payments). Under the annuity option, the winner is taxed on the income each year as it is received.
While it's generally advisable to postpone any taxes to future years when possible, that's often not the case with lottery winnings, and particularly not this year—when income taxes may very well be lower than they will be in 2013 and beyond.
The highest tax bracket today—35 percent for taxable incomes of more than $388,350 for single or joint filers—is set to increase to 39.6 percent in 2013 for taxable incomes of more than $398,350 for single or joint filers, if Congress does not act.
If the shock of winning is unfortunately heart-stopping, the winner's heirs would be faced with a current estate and gift tax rate as high as 35 percent for 2012 with a $5.12 million exemption amount. And, unless Congress acts to extend the current rules, the maximum estate tax rate will jump to 55 percent with a $1 million exemption rate starting in 2013.
Other considerations include state and local taxes, which will likely take the winnings down even further. And investing comes into play also as investing will get more costly under the fiscal cliff: the winner can expect to be paying higher capital gain rates as of 2013, when the maximum capital gains rate under a fiscal cliff will increase from the current 15 percent to 20 percent.
One potential way to offset some of the taxes is to make sure to deduct for eligible gambling losses. Gambling losses, including those from the lottery, are tax deductible up to the amount of gambling winnings. So, if the Powerball winner spent $200 dollars this year on losing tickets before hitting the jackpot, they can deduct their losses as an itemized deduction.
16 Comments
Our firm has been involved in analyzing a couple of large lottery wineers' tax implications.
Obviously the likely significant federal tax increases kicking in for 2013: http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2012/CorpTax/2013TaxChangesPlanning.jsp
will change my general preference to take an annuity, since annuitizing the prize allows multi-year graduated rate benefits on the first $300,000+, and the ability to implement longer term tax planning. Before claiming the prize, winners need to have thorough discussions with their attorney and CPA regarding whether any oral partnership agreements exist with family and friends which would allow the prize to be split - thereby allowing multiple graduated rate benefits and mitigating gift and estate issues. Here is an older analysis (pre-2013 tax hikes) to consider: http://www.blakechristian.com/blog/tax-general/tax-strategies-for-lottery-winners-lump-sum-vs-installments/
Posted by: blakec@hcvt.com | November 30, 2012 11:01 AM
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Unfortunately, AMT is not going away. There is simply too much money coming in to eliminate it.
Posted by: nraacct | November 30, 2012 8:34 AM
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Tax and investment issues are really technical matters that specialists can provide solutions for. But those issues are secondary to the far more serious issue facing these winners: how their lives and their relationships with others will be affected, and whether they will truly be happier people for having "won."
Posted by: CuriousDave | November 29, 2012 11:31 PM
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Not one of the posters suggested to give $2.00 to a charity
SO VERY SAD !!!!
Posted by: mel howard | November 29, 2012 7:21 PM
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All of the comments are good. The winners are now on target by the state issuing the winning ticket, the resident state of the winner, and possibly other states claiming nexus of the tax payer. Knowing all of this it is best to work with a fee only financial planner and/or other tax advisors aware of any dynasty trusts or other deferral methods. Since we are often told we cannot trust ourselves to make the right decisions then set up a fixed immediate annuity (at least get paid for the term of the contract, typically 20 yrs) and the rest rely on the winners 'wisdom' with the advise of others to do whats right.... As a professional personal financial planner and individual tax coach, I wish the winners all the best to hold onto their fortunate gain for at least 5 to 10 year and behalps longer if they are professionally counseled by ethical persons....Be Well, ABacusTax Financial Services, CPA, PFS.
Posted by: Ed H | November 29, 2012 4:30 PM
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Mr Jones - could you update this thread if you get a chance and let me know why your client would not have been able to amend his NC return and claim a credit for taxes paid in VA?
Thanks Stephen
Posted by: SJCCPAPC | November 29, 2012 1:02 PM
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I agree with taking the lump sum, and here is another reason why. Based on the information given, it seems that the present value of a stream of equal payments totalling $580 million over 30 years, with a lump sum option of $360 million, equates to an interest rate of 3.5%. (I figured this out from the present value of an annuity table at mcgrawhill.com.) That means that if the lucky winner can get more than a 3.5% return on the lump sum, they will beat what the State would have given them in total individual payments.
Posted by: Hairold | November 29, 2012 12:57 PM
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MAKE SURE to get a fee paid advisor and NOT a commission based advisor and ask them UP FRONT BEFORE you sign any paperwork.
Posted by: DDTS | November 29, 2012 12:26 PM
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MAKE SURE to get a fee paid advisor and NOT a commission based advisor and ask them UP FRONT BEFORE you sign any paperwork.
Posted by: DDTS | November 29, 2012 12:26 PM
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Hope you are in a State where you can do a Family Limited Partnership.form one and take the CASH OPTION..
Posted by: DDTS | November 29, 2012 12:23 PM
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it is very silly to even allude to deducting $200 in gambling losses from HUNDREDS OF MILLIONS OF DOLLARS in winning. Spoils what was otherwise somewhat informative and credible.
Posted by: Dcase44 | November 29, 2012 11:42 AM
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Also, they can invest these money correctly and receive tax benefits.
Posted by: nadezdamindyuk | November 29, 2012 10:40 AM
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Sounds logical, but it is possible that they would do away with AMT in 10 years. Short term planning for long term issues. Also, you are less likely to blow the wad if you take annuity stream.
Posted by: Vanster | November 29, 2012 10:34 AM
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I would strongly suggest a large prize winner take the cash option. If you take the annuity and die before the end of the annity, generally the present value of the remaining annuity is included in your estate and you can owe more in estate taxes than the cash you have received to-date. Estate beneficiaries could potentially not see cash until the estate taxes are satisfied (which could take several years). Another important note is that not all taxes owed are typically withheld. Federal withholding is 25% and state withholding is typically 4%. With a large prize, the difference between the federal and state top tax rates and these withholding percentages times the cash amount received are the taxes remaining to be paid. Pay all the taxes due and get on with your life, but tax planning is important.
We had a client that lived in North Carolina but had purchased a winning ticket (the jackpot) from a Virginia retailer. He did his own return for NC, but later received a bill from Virginia for taxes on the lottery income (several millions $$) since he bought the ticket from a Virginia retailer. He asked us to review the matter and we had to inform the client unfortunately he had to pay state taxes to BOTH states without offsetting credit for taxes paid to other state.
Stephen M. Jones, CPA Norfolk, Va.
Posted by: Taxman2011 | November 29, 2012 10:33 AM
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Yes...I agree...take the lump sum, pay all taxes..walk away with $200m or so and invest...This way they do/will not need to fret over future tax rates and changes....Oh yes, don't forget to deduct the $200 in lotto losses for the year..... ;-) a good read...thanx !!
Posted by: rbonilla | November 29, 2012 10:19 AM
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I do not think these winners will care about the taxes. If they are smart, they will take the lump sum before Jan 1, pay the taxes and go on with their lives. Regardless of what state they reside in, they will each have an excess of 200 million dollars - nothing to sneeze at. However, before they deposit the checks, they should most definitely consult an attorney and/or a tax advisor.
Posted by: winkiebbs | November 29, 2012 10:07 AM
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