NOTE: this article on lottery winnings tax is for information purposes only and should not be understood in any way as expert or legal advice. Consult a tax or financial specialist if needed.
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Federal lottery tax - lump sum vs. annuity options
Selling lottery payments - and taxes
Lottery winnings are usually taxed in one of 2 ways depending on how you are receiving your lottery prize, in a lump sum or in annual payment installments.
In some states, it's not allowed to take the winning in a lump sum, so what you are left with is the annuities option.
For our purpose here, let's talk about tax consequences of selling lottery winning annuities for a lump sum (i.e. if you did choose at first the annuity option, but later on want to cash out your lottery payments for an immediate lumpsum; lottery winning tax obligations may be an important issue to consider).
Before we get down to this, let's first mention briefly the lottery winnings tax differences in general between choosing the annuity or the lump sum lottery prize option.
Annual Lottery Payments, or a Lump Sum?
Should lottery winners take the annual payments option or a lump sum where its is allowed? This is a much debated topic of interest to lottery winners and financial advisers with proponents and opponents to either side.
While the majority of advisers and wealth management experts apparently favor the annuity option, most lottery winners do appear to go for the lump sum. Sandra Hayes was one of them, as she tells me in our interview here.
I'll not get into the depths of the issue here, but only mention briefly some of the tax differences between the two options, as discussed further down in this article.
One major difference between choosing the lump sum or annual lottery payment options is as follows:
Whether your federal lottery winnings taxes will be withheld when you choose the yearly payments option, or deferred to be paid in the years of receiving the annuity payments - may depend on the following:
Based on your answers to these questions, you may be required to pay the remainder of your [estimated] federal taxes all in advance or given the ability to pay them off in future years upon receiving your lottery payments.
What if you have selected the annuities option and then one day decide to sell your lottery payments? here's another question to be asked:
Think about it.
If you are selling your lottery winning and are unsure of the effect of taxes on the sale of future payments, give me a call to discuss - 1-800-355-5657
In addition to federal lottery winnings tax, you may have to pay State taxes on your lottery winning.
Not all states require to pay state taxes on lottery winnings - although the majority do - and some don't have lotteries at all. Some states also don't have income tax requirement.
Among states where state taxes ARE mandatory, the tax percentage may vary. It may as low as 3-4%, or as high as 10% or more.
The sum of your lottery winnings tax obligations thus depends on the specific state.
Here are some quick facts about the State lottery winnings tax (true as of December 2013).
Finally, let's discuss taxes on a lump sum derived from selling future lottery payments.
It would be nice if you could convince the IRS that your proceeds from a sale of future lottery payments are capital gains, in which case your tax obligation on the earned money would be reduced substantially.
To have an idea - while federal taxes on lottery wins may reach as high as 39% of your prize value, earnings that are considered capital gains may be taxed at just 15%.
...a HUGE difference.
Unfortunately, reality isn't always consistent with our wishes.
No, your lumpsum from selling lottery payments can't be recognized as capital gains. It is considered regular income. So, it will be taxed accordingly.
Why? Simple. because...
Another important consideration when selling lottery annuity payments is that the lumpsum earned by the sale is taxed in its entirety in that year of the transaction and can't be deferred.
(There are more considerations for lottery winnings tax, including deductions, estate planning issues, gifts, donations.... Consult a qualified attorney / wealth management expert to help you with all lottery taxation issues. Do not rely on the information here whatsoever.)
A unique situation when selling future lottery payments may be considered is upon the death of a lottery winner who had selected the annual payments option.
Annual lottery payments can be made for 26 years. What if the winner dies leaving some of the future payments unclaimed? There will be a heavy estate tax applied to it.
The problem is the taxes are due immediately, while the payments will come only over the years.
What if the family is lacking the means to afford the taxes advance?
The problem gets milder in states where selling future payments is allowed. The heirs of the lottery winner can simply sell the future payment rights and use the earned money to pay off the taxes.
Of course, they'll get far less in a lump sum for selling the payments than would be the total value of the future payments. They should try obtaining a fair price, however, from prospective buyers.
Let me just add that selling future lottery payments may not be allowed in all states. In such instances, you may, however, be permitted to pay taxes just on the Present Value of the future payments. This amounts to far less than you'd pay in taxes on the future value of the lottery payments.
There may be more tax exclusions. Talk to a qualified tax consultant.
Are you a beneficiary of a lottery winner willing to sell the future payments to fund the estate taxes (where allowed)? Call me now to discuss - 1-800-355-5657
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