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Winning the Lottery: Dream or Nightmare?

A house. A vacation. A thousand dollars a day for life. Who wouldn’t want to win a huge prize or the lottery? Actually, a lot of people—once they realize these jackpots aren’t free, as most prize winnings are taxed as income by the Internal Revenue Service (IRS).  

Key Takeaways

  • You are taxed on anything you win, whether it’s a prize or cash.
  • Taxes are payable on any winnings at the federal and state levels.
  • Most tangible prizes like cars and homes are taxed at their fair market value.
  • Taxes on lottery winnings are based on whether you take a lump sum or decide to take annuities paid over a certain number of years.

Taxes and the ongoing costs of ownership can quickly turn some windfalls into major burdens. What follows is an analysis of some common prizes we’ve all dreamed of winning and how much it costs to win them.

You must report any and all of your winnings to the IRS regardless of their value.

The Cost of Winning a House

After winning a home, you’ll be responsible for paying the federal income tax based on the value of the home. You may also be liable for state income tax, depending on your state of residence. And, as with any prize, you’ll be paying those taxes at the full marginal tax rate because the value of the prize is reported on Form 1040 as other income. This is, of course, on top of any other earnings from employment and investments.  

Unless you already own a home you plan to sell; many people can’t afford to pay such a significant sum all at once, even with several months of notice. Furthermore, consider that most prizes in the form of dream homes are worth more than $500,000 and are located in high-cost-of-living areas.

Of course, if you can afford the tax bill, you’re getting a home for the price of a generous down payment. But the costs of this type of prize don’t end there. On top of income taxes, you’ll also have higher recurring expenses such as property taxes, homeowner’s insurance, and utility bills, not to mention the cost of general maintenance and upkeep. You may have gained a rich new asset, but you could end up being house poor in the end.

A Brand New Car

Just like that dream home, you’ll be responsible for federal and state income taxes on that brand new car you just won. This figure is based on its fair market value—you can estimate the authorities will collect about one-third of its value.   This may not be so bad if you win a $15,000 Ford Fiesta—you get a brand new car by paying $5,000 to the IRS—but if you win a sports car that retails for over $100,000, you may not consider yourself quite so lucky. Since the cars that are given away as prizes are often luxury models, the new wheels could boost your income quite a bit, maybe even into a new bracket.

Don’t forget that you’ll have to pay registration and licensing fees in order to get that car on the road. Then there are the ongoing costs associated with auto ownership. You can bet things like insurance premiums and maintenance are higher with a higher-class car. Oil changes on the cheapest Ferrari, for example, are pricey. And your shiny new 500-horsepower bullet probably doesn’t get the gas mileage your current commuter car does.

A Vacation

When you win a trip, you are taxed on the fair market value of the trip, and, depending on the sort of holidays you take, the taxes might be as much as you’d normally spend on an entire vacation.   As the winner, you’ll be liable for taxes on the whole prize even if multiple people come along—unless you can get them to pitch in.

On the other hand, sometimes the fair market value is lower than you’d expect because the sweepstakes sponsor was able to get a special deal or discount, which will make your tax bill seem like a bargain. So, while it won’t be a completely free trip, it’ll probably be a pretty opulent experience.

In many cases, you will still be expected to cover some expenses on this supposedly free trip. Say you enter a contest in which the prize is a trip for two to Paris. It includes airfare from New York to Paris, hotel, ground transportation, and half a day of sightseeing. But if you don’t live in New York, you are responsible for travel expenses to get there, all your food costs, sightseeing, tips, and all other spending money. Needless to say, these expenses could easily add up to the winnings the contest provider was shelling out.

A Dream Wedding

With a recent bridal survey pegging the average cost of a wedding in 2018 at $44,000, it’s no wonder many couples jump at the chance to score stylish nuptials for free.   But a contest-financed affair often comes with additional costs.

Take a wedding prize package offering a “designer wedding” worth more than $30,000, including a stay at a spa resort in Mexico and an engagement photoshoot in New York. However, only transportation to Mexico is covered. Bridesmaids’ dresses and a designer wedding gown were included, but costs for alterations weren’t.

Even if key parts of the trip are covered, and the contest is explicit about what’s not included, it may not be a good deal. Such items can really add up for a cash-strapped couple (or their parents), and it’s harder to budget when someone else is calling the shots.

A prize wedding can sometimes mean having the wedding the prize-giver wants instead of the one the soon-to-be-married couple dreams of. They may stipulate that the cake, decor, and other details be chosen by the contest sponsor. Accepting a prize wedding may make having a wedding your way next to impossible—and for many people, that’s worth something, too.

Gambling Jackpot

Uncle Sam wants to encourage the habit of gambling because the tax bill on any money you win from gambling can be offset by any money you have lost. However, you’ll only get this benefit if you itemize your taxes rather than taking the standard deduction, and you can’t deduct more than the amount you have won. Winnings from horse races, betting, and casinos are all considered gambling income by the IRS and must be reported as such on your return.

Depending on the type of game and the amount you win, you may have to fill out a payer-provided Form W-2G separately for an estimated tax when you receive the prize—gambling winnings are generally subject to a flat 24% tax—which the awarding entity will withhold and send to the IRS on your behalf.  

The Lottery

Playing the lottery counts as gambling. So should you win big, the proceeds will be considered gambling income, with all the implications detailed above. Payouts of jackpots over $5,000 minus the wager automatically have 24% withheld for federal taxes.   Most states charge taxes too, and depending on where you live; your total tax bill could be as high as 50% based on your other income.

Unlike winning a house or car, there are no ongoing costs associated with winning the lottery. That is except, of course, for annual income taxes owed should you opt to take your winnings as an annuity–more on that below.

$1.586 billion

The value of the largest lottery jackpot in the world, split between three Powerball tickets in Jan. 2016.

Options for Dealing With Prizes

Now that you know the strings attached to a big win, what can do you do? With most prizes, you have five options:

  1. Keep the prize and pay the tax. This is the best option if you can afford the tax bill and can use the prize.
  2. Sell the prize and pay tax on the proceeds. If you don’t want the prize or if you can’t or don’t want to pay the taxes on it, you can still benefit from your win by selling the prize.
  3. Receive a cash settlement instead of the prize. If you take money instead of a tangible object or amenity, at least you’ll have the money to pay the tax that’s due.
  4. Forfeit the prize. If the prize isn’t worth the trouble to you, you can just refuse it.
  5. Donate the prize. In some cases, you can donate the prize to a government agency or tax-exempt charitable organization without paying tax on it.

Minimizing Lottery Jackpot Taxes

Obviously, winning the lottery is a tad different, and most of the above options don’t quite apply. But you do have choices in handling the windfall.

The biggest one concerns how you’ll actually get the money. As mentioned above, you’ll have to decide whether to take the payment as a single lump sum or as an annuity (annual payments spread out over years or decades). Each choice has its financial implications, and you may want to consult with a tax attorney, certified public accountant (CPA), and/or certified financial planner (CFP) to discuss them before deciding.

Strictly from a tax viewpoint, the annuity has some advantages. Let’s say you win a $1 million jackpot. If you take the lump sum today, your total federal income taxes are estimated at $370,000 figuring a tax bracket of 37%. Instead, let’s look at what happens if you take the million dollars as 20 payments of $50,000 a year, assuming for simplicity’s sake that you have no other income and are only pushed up to the 22% bracket.

Your total federal income taxes are estimated at $11,000 per year or $220,000 after 20 years since we’re assuming the tax rate for this example won’t change. You have saved $150,000 over the 20-year period.

Winning the lottery is both a dream come true and a nightmare. Make sure you account for taxes and other hidden fees when claiming your prize.

Man visits 40 stores to find sole remaining $5 million scratch-off prize

July 29 (UPI) — A North Carolina man on the hunt for the final top prize in a scratch-off lottery game said he visited about 40 different stores before scratching off the $5 million winner.

Kevin Clark of Candler told North Carolina Education Lottery officials he read there was only one top prize remaining in the $5,000,000 Mega Cash scratch-off game, so he set off Thursday to buy as many of the $20 tickets as he could locate.

“I had a real good feeling it was going to be in the western part of the state,” Clark said. “I went to about 40 different stores and bought every single last Mega Cash ticket I could find.”

Clark’s pricey gamble paid off when he scanned a ticket he purchased from the Stop N Go on U.S. 70 in Swannanoa.

“I scanned it with my phone and it told me to go see a retailer,” he recalled. “So, I scratched it off and when I scratched it off I couldn’t believe it! I started shaking. And then I cried.”

Clark took the option of accepting his prize as a $3 million lump sum, which amounted to $2,122,506 after taxes.

“I’m a simple man and I mow grass,” Clark said. “But I’ve always been interested in real estate, so my biggest plans with the majority of the money is to invest in real estate and some small businesses.”

A North Carolina man on the hunt for the final top prize in a scratch-off lottery game said he visited about 40 different stores before scratching off the $5 million winner.