Today is the anniversary of the largest Powerball lottery victory in the United States of $2.04 billion. Just over the $1.765 billion jackpot claimed last month (Oct 2023). What are some tax tips for lottery winners and what impact will taxation play when you hit it big in a lottery?
The first and most important thing to do (before you tell anyone else you have just hit the jackpot) is contact the lottery itself to determine the best way to secure your winning lottery ticket. For example, many lotteries recommend the winner immediately sign the back of the ticket and take a selfie with it to establish a date and time stamp. Heck, take a movie of yourself starting with a close up of the front and back of your (now signed) ticket before you start dancing around your home.
Notice the statement above: “before you tell anyone else”? Don’t tell anyone except your spouse until you have contacted and assembled the professional team needed to guide you through the rest of this process. Don’t tell your kids, don’t don’t don’t post to social media, don’t even tell your boss so that you don’t have to report to work the following day. We will not waste any time going through the examples of the types of people who disrupt the lives of lottery winners seeking some piece of your winnings for every reason imaginable under the sun. There are people you never want to meet and that is what your professional advisory team is for.
One of the best tax tips for lottery winners is the quality of your professional advisory team will increase the amount of the winnings you are able to keep. There is already a long line of agencies wanting to take a cut of your action. The Internal Revenue Service (IRS) is usually first in line to apply a 37% tax rate to your winnings. The good news is there is no income tax on lottery winnings here in California. California is one of the eight states that does not require lottery winners to pay income tax on their winnings (the others are Florida, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming). Your local city/town may also require your lottery winnings to be taxed as income and this can result in another line of deduction from your winnings.
You will have the time to assemble and consult your professional advisory team as most lottery rules provide at least 60 days for the winner to claim their prize. Your team could include a tax attorney and estate planning attorney (better if this is a single individual attorney), a banker and a financial planner and/or investment expert. There are several important decisions to be taken, beginning with whether to take a lump sum payout or the annual payment option (if you haven’t already specified that when you purchased the ticket).
Another of our tax tips for lottery winners is to have your team fully chart out and explain how the money will work in both scenarios: lump sum or annuity. What are the advantages and disadvantages of each option. For example, one of the biggest advantages of a lump sum payout is you have immediate access to the money you have won. A strong financial investment professional could help you to achieve a larger sum of accumulated earnings/interest versus the annuity. Tax rates are applied one time and this reduces the potential impact of tax changes down the road. The largest disadvantage of a lump sum payout is the high percentage of lottery winners who blow through their winnings in a few years. The internet is full of these types of stories and it is important to educate yourself and put protections in place to protect your long-term plan from those who would try to separate you from your winnings, including yourself.
The annuity provides guaranteed income for the next 30 years. “What if I don’t expect to live for 30 years?” The vast majority of substantial lotteries provide a death benefit for annuity plans which allow you to ensure remaining funds may pass to your heirs and beneficiaries. Your estate plan should include legal entities including at least one trust. The trust should provide the structure and instructions on how funds are to be managed after one’s passing. The annuity option is a protection against blowing through the winnings and allows you to enjoy the benefits of your winnings in a stable, well-planned environment. The lower cash payout of the annuity option can make it easier to say no to those charities, families, friends and others who would like to “share” in your good fortune. The only disadvantage of an annuity is you can’t access all of your winnings in the event of an emergency or a tremendous investment opportunity. Tax rates can fluctuate over the years and your tax attorney should be able to help you to assess this risk.
Another of our tax tips for lottery winners is to remember to ask about the impact of estate tax as you develop your financial and investment strategy. While there is presently no estate tax here in California, there is a federal estate tax. The present federal estate tax exemption in 2023 is $12.92 million. The federal estate tax rate ranges between 18% to 40%, so this can be a significant factor in your planning.
In summary, the best tax tips for lottery winners include:
- Secure your ticket – sign it, video it, take a picture with it.
- Keep this huge news to yourself – don’t tell anyone other than your spouse until you have assembled and consulted with your professional advisory team; 2b: absolutely avoid social media
- Assemble your professional advisory team including a tax attorney, an estate planning attorney (can be the same attorney), a banker and a financial planning/investment expert.
- Ask your team to thoroughly explain your options (especially annuity vs lump sum if applicable) and to lay out the advantages and disadvantages of the options available.
- Ask for a detailed break out of all taxes at each step including federal, state and local income tax (if applicable) as well as estate tax implications. Your professional team should be able to help you to assess the impact of tax rate hikes or reductions across the scope of your plan.
- Structure a long-term plan with your team that includes entities such as a trust to protect your lottery winnings, while positioning these financial assets to support your goals and objectives going forward
We hope you have found these tax tips for lottery winners to be helpful.
