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.