Lottery Jackpot

We play the lottery jackpot when we are feeling lucky. But how does a winner ensure they stay lucky when they hit it big? Hitting the lottery jackpot might seem like a dream come true: by spending a few dollars and selecting a few numbers, a person can win an enormous amount of money. But it is never that simple. With the bump in a winner’s bank account, a lottery winner might also hit some bumps in their financial and estate plans. As such, the intersection of tax planning and estate planning becomes particularly critical after winning a sum of money in the lottery.

Federal Financial Implications
If one thing in life is certain, it is taxes. Winning the lottery jackpot does not exempt a person from paying the federal and state taxes on their new income.

What Do I Report?
Lottery jackpot winners who have a Social Security number will be subject to the federal tax rate of 24 percent. For those jackpot winners who do not have a Social Security number, the federal tax rate moves to 28 percent. Jackpot winners who live outside of the United States are subject to a federal tax rate of 30 percent. 

Lottery jackpot winners who have a Social Security number will be subject to the federal tax rate of 24 percent. For those jackpot winners who do not have a Social Security number, the federal tax rate moves to 28 percent. Jackpot winners who live outside of the United States are subject to a federal tax rate of 30 percent.

The American government automatically withholds the applicable federal tax from the prize amount before disbursing the remainder of the prize money to the winner. The lucky taxpayer just needs to report their winnings as “other income” on their Form 1040 tax return.

Show Me the Money!
Arguably the most important decision for lucky winners is whether to pocket the prize money as a present value lump sum or to elect an annuity plan.

The tax on the lump sum prize money would be immediately withheld at the federal tax rate of 24 percent, and winning taxpayer(s) would be taxed on their total income for that year at a progressive tax rate, which is typically the highest tax bracket of 37 percent. However, taxpayers may avoid paying taxes on the same winnings twice with the help of Form W-2G which lets the taxing authority know that taxes were already withheld as shown in Box 4 of Form W-2G for federal, and Boxes 15 and 17 for state and local tax withholdings, if applicable. Thus, taxpayers essentially pre-pay a portion of their income taxes via the withholdings and are responsible for the remainder owed at the progressive rate.

For the savvy taxpayer (you!) looking to minimize their tax liability, an annuity plan might be beneficial. An annuity plan, which pays out an installment portion of the prize money every year, helps protect against the possibility of outliving lottery assets and reduces the tax burden as taxes are based on each smaller disbursement instead of the whole lump sum.

One caveat to the annuity plan is that disbursements will end upon the death of the annuity owner. However, a taxpayer can select an annuity with a death-benefit provision that allows the owner to designate a beneficiary to receive the greater of either all the remaining money or a guaranteed minimum.

State Financial Implications – Who, What, When, and Where?
If you happen to be a resident of California, you are in luck! Despite having one of the highest income tax rates in the country, California is one of a minority of states that does not tax lottery winnings, although some exceptions may apply. California lottery winners are therefore only required to pay their federal taxes on the lottery winnings.

If a lottery winner lives in a state that does tax lottery winnings, the winner would pay both federal and state taxes on their new income. But what happens if a taxpayer purchases a winning lottery ticket in a state other than the state in which they are currently domiciled? In that case, the taxpayer would pay state taxes on the lottery money to the state in which they purchased the lottery ticket, and to the state in which they reside. However, this double tax would only occur if there was a difference in the state tax rate and amount owed between both states. If the tax rates are the same in both states, the taxpayer would only need to pay tax on their winnings to the state in which they bought the lottery ticket.

Anonymity
Although there are states that allow winners to remain anonymous, California does not allow lottery jackpot winners to maintain anonymity. In fact, California’s disclosure laws require the lottery to publicize a winner’s full name, the name and location of the business that sold the winning ticket, and the total winnings.

Although disclosure is inevitable, California lottery winners can take advantage of the three-month period every winner is given to collect their prize. Waiting to present a winning ticket allows the public pandemonium to settle first, which can have a profound impact on the safety and security of a winner. Oftentimes, coming into sudden wealth can position a winner as the target for harassment and requests for money from people who feel entitled to a share of the winnings.

As such, a prudent winner should use the waiting time wisely. And, creating an estate plan is very wise, indeed.

Estate Planning Implications
For many, winning the lottery jackpot is life changing in more ways than one. Beyond enjoying a large sum of money, winning the lottery affords winners the opportunity to create a legacy of generational wealth and security.

Before booking a month-long trip to Europe or posting about hitting the jackpot on social media, a judicious lottery winner should assemble their financial and legal team to maximize the protections available to them and their new income. This team should ideally consist of an attorney, a financial advisor, a tax advisor, and an insurance professional for expert assessment and advice about important next steps.

Trusts
An experienced trusts and estates attorney can create a trust for the prize money that helps protect the earnings. This can be especially helpful for winners in states that do not allow for anonymity.

Trusts can be revocable, or changeable during the lifetime of the trustor, but creditors can still collect from such trusts. Irrevocable trusts afford a trustor greater asset protection because changes can only be made if all parties to the trust, including the trustor, trustee, and beneficiaries, agree to the changes. This can be useful for singular winners who want to ensure their assets are in order, and it can help diffuse or prevent disputes among winners who agreed to partake in the lottery as a group.

Winners may also elect to choose a trust structure that affords even greater anonymity by using a blind trust. Such a trust can be revocable or irrevocable, and it requires that beneficiaries have no knowledge of the amount contained in the trust. In fact, a blind trust can circumvent California disclosure laws; if a winner donates their winning ticket to the blind trust before claiming the winnings, the trust is named as the winner. This prevents any winning individual’s name from being released to the public, thereby ensuring greater privacy and protection.

Leaving a Legacy
In addition to creating a trust, winners can also make thoughtful decisions regarding their estate. One important consideration for any lottery winner is identifying the beneficiaries of a winner’s estate. The beneficiaries can include a winner’s heirs or other family or friends. Winners can also designate charitable organizations or other institutions as beneficiaries.

For more information about the benefits of estate planning, please visit: https://irssolution.com/blog/benefits-of-estate-planning-why-updating-your-estate-plan-helps-you-keep-up-with-lifes-contingencies/

RJS LAW
Our clients make us feel like we won the lottery every day, and jackpot winners are no exception! If you find yourself in need of an updated estate plan, the experienced trusts and estates attorneys at RJS LAW, Brian Malloy and Steve Mattia, are well-equipped to assist you. We understand the benefits of estate planning and the value in protecting your assets. Contact us at (619) 595-1655 or via the web at https://irssolution.com/

Written by Remy Hogan

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