If You Win the Lottery, How Much Does the IRS Get?
The amount of federal taxes you owe the IRS upon winning the lottery and when they're collected depends on the amount you win. Although a certain amount may be withheld for federal taxes before the prize is paid, the final tax liability depends on your total annual income and deductions for the tax year.
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Federal Withholding
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Lottery prizes are taxable regardless of their amount, both by state and federal governments. If the prize is between $600 and $5,000, you're issued IRS Form W-2G, which you must attach to your federal income return at the end of the applicable tax year. If the prize is less than $600, you're not issued a W-2G, but you must still report the earnings at the end of the year.
If the prize is more than $5,000, your state's Department of Revenue withholds 25 percent of the prize for federal taxation and issues you proof of this withholding. This doesn't mean, however, that the rate of your federal taxation is 25 percent. Depending on your total net income for the year, the ultimate tax rate may be higher or lower.
Annuities vs. Lump Sum
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Lotteries may give winners the option to either accept a one-time lump-sum payment or an annuity, in which the earnings are spread over a number of years and paid periodically. Like any deferred payment, you receive more money if you wait. The same withholding threshold, however, applies. If the total payout is more than $5,000, a quarter of it is withheld for federal taxes, even if each check you receive is less than $5,000. If, for instance, you win $40,000, to be paid out over 10 years, you may receive a check of $4,000 once a year. A quarter of this, or $1,000, is withheld each time, because the total prize is more than $5,000.
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Net Tax Rate
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The withholding rate usually doesn't equal the final tax rate. At the end of each year in which you received cash prizes, you must report the payments as income. You add income from other sources to this figure and subtract deductions. If the total federal taxes you owe are less than the amount withheld, you receive a tax return. If your tax liability is greater than the amount withheld, you must pay the difference to the IRS.
Tax Brackets
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The amount of total federal tax you must pay depends on your net annual income. For the 2010 tax year, most single filers making less than $8,525 paid 10 percent. If your income was between $8,525 and $34,650, this rate climbed to 15 percent, while those making between $34,650 and $83,900 paid 25 percent. The tax rate was 28 percent if your net income for the year was between $83,900 and $194,150, and 36 percent for incomes between $194,150 and $380,500. Filers who earn more than $380,500 must pay 39.6 percent in federal taxes. In other words, the IRS likely takes around 40 percent of the money if you win a very large sum, as most people don't have sufficient deductions to bring down their net income below the $380,500 threshold if they win $1 million or more.
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References
- Photo Credit lottery image by dinostock from Fotolia.com
