How Do You Pay Taxes on Lottery Winnings?

Lottery winnings are considered taxable income by the Internal Revenue Service (IRS) and most state revenue departments. Understanding the tax obligations for a lottery prize is an important step for any winner. This involves navigating federal and state requirements, deciding how to receive the funds, and ensuring timely payment of all owed taxes.

Immediate Tax Withholding on Winnings

For any lottery winnings that exceed $5,000, the paying entity is required by the IRS to automatically withhold a flat 24% for federal income taxes. This is an initial deposit toward the total tax you will owe, and it is taken before you receive any of the prize money. The withholding happens before you receive a single dollar.

You will receive an IRS Form W-2G, “Certain Gambling Winnings,” to document this transaction. This form states your total gross winnings and the amount of federal income tax withheld at the source. You must use this form when filing your annual income tax return to report the income and the tax you have already paid.

In addition to federal withholding, many states also impose their own withholding requirements on lottery prizes. These state-level deductions vary widely depending on the laws of the state where the ticket was purchased. The amount withheld for state taxes will also be reported on the Form W-2G you receive.

Lump Sum Versus Annuity Payouts

A lottery winner must decide whether to take the prize as a single lump sum or as an annuity paid out over many years. Opting for the lump sum means receiving the entire prize in one calendar year, after initial withholding. This large influx of money will almost certainly push you into the highest federal income tax bracket for that year, meaning a portion of your winnings will be taxed at the top marginal rate.

The alternative is an annuity, which consists of a series of annual payments, often spread over 30 years. With this option, you only pay taxes on the amount you receive each year. This structure can be advantageous because it may keep you out of the highest tax bracket and can potentially lower your overall tax burden, assuming tax rates do not increase significantly.

An annuity provides a steady income stream and makes tax planning more manageable, as each payment is taxed as ordinary income in the year it is received. The lump sum provides immediate access to the prize but creates a more complex, one-time tax event.

Calculating Your Final Tax Bill

The 24% federal withholding is a starting point for your tax obligation. Your final tax bill is calculated based on your total taxable income for the year, which includes the lottery prize plus any other earnings like wages or investment income. This combined total determines which federal income tax brackets your income falls into, with a large prize pushing a significant portion into the highest marginal rate of 37%.

Because the 24% withholding rate is lower than the top tax rate, you will almost certainly owe additional federal taxes. The winnings reported on your Form W-2G are added to your other income on your tax return. The amount already withheld is then subtracted from your total tax liability to determine how much more you must pay.

State and local taxes also play a large part in the final calculation. Most states tax lottery winnings as income, with rates that can differ substantially, while a handful of states do not impose any income tax on prizes. It is important to understand the tax laws in your state of residence and in the state where the ticket was purchased, as non-resident taxes may apply.

Methods for Paying the Remaining Tax

Once you calculate your total tax liability, you must pay the amount owed beyond the initial withholding. The method for doing so depends on whether you chose a lump sum or an annuity payout.

Lump Sum

If you receive your winnings as a lump sum, you will likely owe a substantial amount of tax beyond the 24% withheld. To avoid underpayment penalties, you are required to make quarterly estimated tax payments for the year you receive the prize. These payments are made using Form 1040-ES, “Estimated Tax for Individuals,” and are due on April 15, June 15, September 15, and January 15 of the following year.

Annuity

For those who select an annuity, the tax payment process is more straightforward. Each year, you will receive a payment, and that amount is reported as income on your tax return for that year. You pay what is owed by the standard April tax deadline, and there is generally no need for quarterly estimated payments unless other circumstances create a significant tax liability.