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Taxes on Lottery Winnings

If you've never considered the cost of taxes on lottery winnings you might be in for a big shock if you ever win the jackpot. Along with federal income tax, most states participating in national lotteries also assess state tax. A few places, like New York City, throw in local tax as well.

Another factor affecting the rate of taxes on lottery winnings is how winners accept payment. Most people don't realize that the advertised jackpot amount isn't the full amount awarded if taken as lump sum cash. The only way to receive the total jackpot prize is to accept annuity payments over the course of 26 years.

The IRS classifies lottery winnings as ordinary income which carries a tax rate of 35 percent. National lotteries, like Mega Millions and Powerball, typically withhold 25 percent of federal taxes prior to making disbursements.

However, winners are responsible for paying the remaining 10 percent and could face hefty penalties and late fees if tax is paid late. For this reason, it is always advisable to talk with a tax accountant, as well as an estate planning lawyer.

Along with federal tax, winners might be subject to state income tax. Currently, 5 of the 42 states that participate in national lotteries do not impose state tax. Furthermore, 2 states exempt lottery winnings from state taxation. These include: Washington, New Hampshire, Texas, Tennessee, and South Dakota. Exemption states are Pennsylvania and California.

Accepting lottery jackpot winnings as lump sum cash can be tempting, but usually isn't the best approach. Unfortunately, winners lose about 28 percent of their cash right off the top. For example, if a person won $250 million and opted for cash payment, they would receive around $180 million instead.

Certainly, a person could get by pretty well on that kind of money, but why toss away $70 million that could be invested or passed along to future generations? With sound estate planning, lottery winnings could provide a very comfortable lifestyle to children, grandchildren, and great grandchildren.

Using the example above, lottery winners that accept annuity payments would receive around $9.6 million per year for 26 years. Of course, taxes would be deducted, but winners could engage in a variety of investments to maximize their newfound wealth.

Few people know how to take full advantage of cash windfalls, so it's crucial to employ trustworthy experts to provide financial planning advice.

While sharing good fortune with relatives and friends is a generous act, it can result in 35 percent federal gift or inheritance tax. Worse yet, the current gift and estate tax exemption of $5.12 million are set to expire at the end of 2012. If Congress doesn't act, the exemption will be reduced to $1 million; making the amount of taxes much higher next year.

Not all states impose gift, inheritance, and estate taxes. People residing in states that do, need to become familiar with estate planning strategies that can reduce tax burdens for their loved ones.

At Simon Volkov, we have put together a comprehensive personal finance blog focused on estate planning, financial and real estate investing, and important money matters such as personal bankruptcy and home foreclosure.

While it would be great to have no other worries than the rate of taxes on lottery winnings, most people are trying to figure out how to stay afloat. We aim to provide information and resources that are beneficial to our visitors and help them overcome any challenges they are facing.