What will you do if you win Friday's $494 million Mega Millions jackpot? Invest it? Retire immediately? Go on a shopping spree? Whatever is running through your mind, scale it back some because, in reality, the winner will end up with quite a bit less after taxes on the lottery winnings are taken out. So, if you bought a ticket for Friday's drawing, read this before you come up with plans for a $494 million prize.
The advertised amount – $494 million in this case – is the value of annuity payments over 30 years. If you opt for an immediate lump-sum cash payment, your payout will be a "mere" $247.9 million — before taxes. And make no mistake: Your tax bill will be significant and unavoidable!
The top federal income tax rate is 37% on 2022 income of more than $539,900 for a single person ($647,850 for married couples filing a joint return). That means you'll pay about $91.7 million in federal income taxes if you take the lump sum (which most people do), reducing your spendable winnings to around $156.2 million. (The IRS will automatically take 24% of your winnings, and you'll owe the rest at tax time).
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Your state may want a piece of the pie, too. Residents of Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming are off the hook because those states have no income taxes. (Alaska and Nevada don't sell Mega Millions tickets, but residents can buy them out-of-state.) California winners also get a break because the state exempts state lottery winnings from taxes — as long as you buy your ticket in California. But if you live in another state where Mega Millions lottery tickets are sold, you'll have to pay state income taxes at top rates ranging from 2.9% (North Dakota) to 10.9% (New York). Also expect some state taxes to be withheld from your jackpot payout if you bought your winning ticket in a state with an income tax.
You'll receive an IRS Form W-2G (opens in new tab) in the mail by January 31, 2023, with your winnings listed in Box 1. The amount withheld for federal and state taxes will also be reported on the form. Don't forget that the IRS will receive a copy of the form, too. So, don't even think about reporting a different amount when you file your 2022 tax return next year!
Rocky is a Senior Tax Editor for Kiplinger with more than 20 years of experience covering federal and state tax developments. Before coming to Kiplinger, he worked for Wolters Kluwer Tax & Accounting and Kleinrock Publishing, where he provided breaking news and guidance for CPAs, tax attorneys, and other tax professionals. He has also been quoted as an expert by USA Today, Forbes, U.S. News & World Report, Reuters, Accounting Today, and other media outlets. Rocky has a law degree from the University of Connecticut and a B.A. in History from Salisbury University.
The Mega Millions jackpot has risen to$1.1 billion, up from $810 million. With eye-popping numbers, it’s easy to get lottery mania.
Winning would be great, but the taxes are big too. Lottery winnings are taxed, with the IRS taking up to 37%. Curiously, though, only 24% is withheld and sent directly to the government. That means you may have to come up with as much as an extra 13% on your own when tax time comes. Then, depending on whether your state taxes lottery winnings, you may have to add state taxes too. Some people may even try to quickly move states, though it can be too late.
You can take your winnings in a lump-sum cash payment, which would be about $602.5 million, before taxes. Alternatively, you can be paid out in many annual payments — 30 installments over 29 years. Either way, you have to think about taxes.
Just imagine magnifying the problem a hundred fold. Making sure that you can come up with that extra 13% is important. Since the tax withholding rate on lottery winnings is only 24%, note the big spread between 24% and 37%. Some lottery winners do not plan ahead, and can have trouble paying their taxes when they file their tax returns the year after they win.
Mega Millions logo displayed on a phone screen and Mega Millions website displayed on a laptop ... [+] screen are seen in this illustration photo taken in Krakow, Poland on June 14, 2022. (Photo illustration by Jakub Porzycki/NurPhoto via Getty Images)
NurPhoto via Getty ImagesThere is also the cash versus annuity question. Whether lump sum or paid over time, taxes will come due.
Apart from paying taxes, some lottery winners find that friends, family or co-workers might expect share of the loot. Office pools, informal understandings, and casual deals to split winnings can all bring trouble, tax and otherwise.
It might start with an innocent comment that someone says was an oral agreement. After all, remarks about splitting winnings can be misinterpreted. Some winners face lawyer fees for defending against the claims, and the fallout from lottery lawsuits can be messy.
For one thing, claims by co-workers, former spouses and others who say they deserve a share can tie up the money for years, so be careful what you say and to whom. One case upheld a 20-year-old oral agreement to split lottery winnings. Some suits over lottery winnings are with co-workers and (former) friends. Some disputes are with family members or with the IRS.
In Dickerson v. Commissioner, an Alabama Waffle House waitress won a $10 million lottery jackpot on a ticket given to her by a customer. The trouble started when she tried to benefit her family and to spread the wealth. The IRS said she was liable for gift taxes when she transferred the winning ticket to a family company of which she owned 49%. The waitress fought the tax bill, and eventually landed in Tax Court. But the court agreed with the IRS, so she lost.
Some tax advice before the plan might have avoided the extra tax dollars, generated because her tax plan was half-baked. In short, she shouldn’t have assigned her claim in a waffle house.
Time and again, lottery winners have trouble paying their taxes and resolving disputes. The stakes and tax problems can grow larger on bigger lottery prizes.
With $1 billion at stake, creative claims could arise. And the usual tax problems on winnings can get even more complex. Unless there is a tax partnership, a winner may be taxed on it all, yet only be allowed a partial write-off for the damages paid to those claiming a share. In fact, the tax rules for litigants are complex, made more so by 2018 tax changes. How legal settlements are taxed is tricky, and some plaintiffs have to pay on their attorney’s fees too.
Plainly, winning would be awfully nice, but just be careful if you do.