If you find yourself holding a lottery ticket that doesn’t bear the winning numbers of an epic Powerball drawing, take heart. Although the odds of winning a Powerball grand prize are only 1 in 292 million, they improve to 1 in less than 12 million for the smaller $1 million prize. Here's an idea of what you’ll owe the IRS in taxes if you should win.
Choosing the lump sum payout vs the annuity option
If you choose to take the lump sum payout, a $1.5 billion jackpot is really worth about $930 million. That’s because $930 million is the actual jackpot and the $1.5 billion is the calculated worth if you choose the annuity payment plan.
The annuity option are annual payments stretched out over 29 years. When you choose this, you end up with more money over the long haul because the base amount — $930 million — accrues interest earned over an additional 29 years after the year in which you win. The money you haven't taken yet is invested for you.
You must pay federal income tax if you win
You'll fall into the highest tax bracket in the year you win if you take the jackpot in a lump sum. As of 2016, this means you'll likely owe the IRS at least 39.6% in taxes. If the bounty is spread out over 30 years, you may not be in the highest tax bracket each year, depending on the size of your prize and your other income.
All winnings over $5,000 are subject to tax withholding by lottery agencies at the rate of 25%. This potentially leaves a gap between the mandatory amount of withholding and the total tax you'll ultimately owe, depending on your tax bracket.
It works out something like this if you take the lump sum for the $930 million jackpot:
- $930 million, less 25% withheld = $232,500,000
- Less an additional $135,780,000 (to meet 39.6% tax rate)
- Total prize after federal income tax = $561,720,000
Gift and estate taxes
As of 2016, the Internal Revenue Code allows you to give away — by gift and from your estate when you die — a total of $5.45 million over the course of your lifetime. You'll owe an additional 40% gift tax for any cash or property transfers you make over $5.45 million, as well as a 40% estate tax on the value of your remaining estate.
Be careful with pool winnings
If you join a pool with others to buy a stockpile of tickets, your prize will be smaller because you're sharing it. But you're still subject to the income tax rate for the bracket your portion of the winnings places you into. If you personally claim the prize on behalf of everyone in your pool, protect yourself by documenting that the entire windfall isn’t yours.
If you collect the total winnings, then allot everyone else their share, the IRS may assume that you're giving the money away, which can result in the gift tax. You might also be responsible for paying income tax on the entire winnings. Have everyone enter into the pool with a written contract defining his or her shares, which you can then provide to the IRS if necessary.
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