Reviewed by David KindnessFact checked by Pete RathburnReviewed by David KindnessFact checked by Pete Rathburn
Who wouldn’t want to win a huge lottery prize? You might be surprised. For one thing, these jackpots aren’t free: most prize winnings are taxed as income by the Internal Revenue Service (IRS). Add in a few financial missteps, and that windfall can quickly turn into a major burden.
Here are some common prizes and the often-overlooked costs to keep them—and what you can do to safeguard your winnings if you do score a big jackpot.
Key Takeaways
- You are taxed on anything you win, whether it’s cash, a trip, or a car.
- Winnings are subject to federal and state income taxes.
- Most tangible prizes like cars and homes are taxed at their fair market value.
- Lottery winnings are taxed for the year in which they are collected, allowing winners who choose annuities to spread out the tax bill.
- If you win a house, boat, or car, prepare to pay for their upkeep.
The Cost of Winning a House
After winning a home, you’ll be responsible for paying the federal income tax based on the home’s value. You may also be liable for state income tax, depending on your state of residence. As with any prize, the home’s fair market value must be reported on Form 1040 as other income, and will be taxed at your marginal income tax rate.
Unless you already own a home that you plan to sell, you probably can’t afford to pay such a significant tax sum all at once, even with several months’ notice.
Of course, if you could afford the tax bill, you’d be getting a home for the price of a generous down payment. But your costs wouldn’t end there. On top of income taxes, you would also have higher recurring expenses such as property taxes, homeowner’s insurance, and utility bills, not to mention the cost of general maintenance and upkeep. Despite striking it rich in the sweepstakes, you could end up house poor in the end.
Important
You must report any and all of your winnings to the IRS regardless of their value.
The Cost of Winning a Brand New Car
Just as with that prize of a home, you’ll be responsible for federal and state income taxes on any car that you win. These amounts will be based on the vehicle’s fair market value. The combined federal and state bill might add up to about one-third of the car’s value.
If you win a sports car that retails for over $100,000, for example, the tax bill would be quite high. Since the cars that are given away as prizes are often luxury models, your new wheels could boost your taxable income quite a bit, maybe even into a new bracket taxed at a higher marginal rate.
Don’t forget that you’ll have to pay registration and licensing fees in order to get that car on the road. Then there are the ongoing costs associated with auto ownership. You can bet that costs for insurance premiums and maintenance are higher for a more expensive car. Oil changes can get pricey. And your shiny new car probably doesn’t get gas mileage that could rival your previous ride’s.
The Cost of Winning a Vacation
When you win a trip, you are taxed on its fair market value. Depending on the sort of holidays you take, the taxes might be as much as you’d normally spend on an entire vacation.
In many cases, you will still be expected to cover some trip expenses. Say you enter a contest in which the prize is a trip for two to Paris. It includes airfare from New York to Paris, hotel, ground transportation, and half a day of sightseeing.
But if you don’t live in New York, you are responsible for the travel expenses to get there, all your food costs, sightseeing beyond what is offered, tips, and other spending.
The Cost of Winning a Dream Wedding
The average wedding cost $29,000 in 2023, so it’s no wonder many couples jump at the chance to win a stylish wedding at the prize sponsor’s expense.
However, there are often additional costs. For example, say that a wedding prize package offering a designer wedding worth more than $50,000 includes a stay at a spa resort in Mexico and an engagement photoshoot in New York. Transportation may be covered only to Mexico, however. Bridesmaids’ dresses and a designer wedding gown are included, but costs for alterations aren’t.
Even if crucial parts of the trip are covered and the contest is explicit about what’s not included, it may not be a good deal. Such items can add up for a cash-strapped couple (or their parents), and it’s harder to budget when someone else is calling the shots.
The Cost of Winning at Casinos
The tax bill on any money you win from gambling can be offset by any money you have lost. However, you’ll only get this benefit if you itemize your taxes rather than take the standard deduction. Plus you can’t deduct more than the amount you have won in the same year. Winnings from horse races, sports betting, and casinos are all considered gambling income by the IRS and must be reported as such on your return.
Depending on the game and the amount you win, you may have to fill out a payer-provided Form W-2G when you receive the prize, from which a standard rate of 24% of your winnings will be withheld and sent to the IRS on your behalf.
The Cost of Winning the Lottery
Playing the lottery counts as gambling. So if you win big, the proceeds will be considered gambling income. Payouts of jackpots over $5,000 automatically have 24% withheld for federal taxes.
Most states tax lottery winnings as well; depending on where you live your total tax bill could be as high as 50% of the prize, based on your other income. In contrast to a house or a car, there are no unavoidable ongoing costs associated with winning the lottery. That is except, of course, for annual income taxes owed should you opt to receive your prize as an annuity–more on that below.
Options for Dealing With Prizes
Now that you know the strings attached to a big win, what can you do? With most prizes, you have five options:
- Keep the prize and pay the tax. This is the best option if you can afford the tax bill and can use the prize.
- Sell the prize and pay tax on the proceeds. If you don’t want the prize or if you can’t or don’t want to pay the taxes on it, you can still benefit from your win by selling the prize.
- Receive a cash settlement instead of the prize. If you take money instead of a tangible object or amenity, at least you’ll have the money to pay the tax that’s due.
- Forfeit the prize. If the prize isn’t worth the trouble to you, you can just refuse it.
- Donate the prize. In some cases, you can donate the prize to a government agency or tax-exempt charitable organization without paying tax on it.
$2.04 billion
The value of the largest lottery jackpot in the world, won by just one Powerball ticket in November 2022.
Minimizing Lottery Taxes
If you win the lottery, you do have choices in handling the windfall. The biggest choice concerns how you’ll receive the money. You’ll have to decide whether to take the payment as a single lump sum or as an annuity (annual payments spread out over years or decades). Each choice has financial implications, and you may want to consult with a tax attorney, certified public accountant (CPA), or certified financial planner (CFP) to discuss them before deciding.
Strictly from a tax viewpoint, the annuity has some advantages. Let’s say you win a jackpot with a $1 million lump-sum payout. (Jackpot amounts are advertised based on the cumulative annuity payments winners would receive, and the lump-sum payout is usually significantly smaller.)
If you took the lump sum, you would owe $370,000 in federal income tax based on the top marginal tax rate of 37%. If you opted instead for an annuity paying $50,000 a year, you might only be taxed at a 22% marginal rate, paying $11,000 per year or $220,000 cumulatively over 20 years on the first $1 million of annuity payments.
By limiting the rate at which your winnings are taxed, the annuity would have saved you $150,000 in taxes on that first $1 million in lottery winnings.
Gross Winnings Paid After 20 Years | $1,000,000 | $1,000,000 |
Payments | 1 (Lump Sum) | 20 (Annuity) |
Paid Out in Year 1 | $1,000,000 | $50,000 |
Taxes in Year 1 | $370,000 | $11,000 |
Total Taxes Paid | $370,000 | $220,000 |
Tax Savings | $0 | $150,000 |
Net Winnings Received Over 20 Years | $630,000 | $780,000 |
Other Tips to Consider If You Win
Contain Your Spending
Even if you did win the lottery, you might not be able to hold on to the money. One of the first things a lot of people do after receiving their newfound financial freedom is quit their jobs. It’s also natural to go on a spending spree: a fancy second house, a new car, a luxury vacation. And then, maybe, help friends, family, colleagues—you might be surprised by the number of people asking for money.
Between the usual decision to forego earned income, the increased spending, the requests for gifts, and the ever-present hazard of scams targeting newfound wealth, it’s no wonder so many lottery winners eventually end up in financial distress.
Get Expert Help
To avoid such pitfalls, consider enlisting the help of professionals such as a financial advisor and financial planner. In addition, consider contacting a professional for estate planning issues and a CPA or another tax specialist to put the appropriate tax planning in place.
Get the financial guidance you need and take the time to plan for the use and protection of your good fortune. Refrain from making rash decisions—economic or otherwise. Certainly, helping those close to you is a good thing, but you need to set limits and learn to say no.
Tip
If you or someone you know has a gambling problem, call the National Council on Problem Gambling Helpline at 1-800-522-4700, or visit NCPGambling.org/Chat to chat with a helpline specialist.
Maintain Your Privacy
Don’t attract attention to the fact that you’ve won a substantial amount of money. By failing to do so, as mentioned above, you may discover that friends, family, and even those unknown to you seek a portion of it. You may also draw the attention of scammers and other malevolent individuals whose goal is to take what’s yours fraudulently.
Some states allow you to maintain anonymity after winning a lottery. They include Kansas, Maryland, North Dakota, Texas, Ohio, and South Carolina.
Note
Lottery and sweepstakes scams are a common type of fraud reported to the Federal Trade Commission (FTC).
What Are My Chances of Winning a Lottery Jackpot?
The chances of winning the top prize in the most popular lottery games with the highest jackpots are very slim. For example, in 2024, the odds of winning a Grand Prize Powerball jackpot were one in 292.2 million.
How Much Are the Taxes on Lottery Winnings?
The taxes owed on lottery winnings depend on a few variables, such as the amount you win, whether you take the money in a lump sum or as an annuity, and your state of residence. Lottery winnings are taxed as ordinary income by the IRS and most states. The exceptions are the states without an income tax, along with California and Delaware, which do not tax state lottery winnings.
Do You Owe Taxes on Prizes?
Yes. If you win a vacation, home, car, or other prizes, such as a literary prize or an academic award, you will be taxed on the fair market value of those prizes.
What Happens If I Win Powerball?
If you are lucky enough to win a Powerball jackpot, you will have to meet with lottery officials and provide the winning ticket for verification. You should also consider speaking with a financial advisor about the best way to collect your winnings—that is, as a lump sum or as an annuity (in annual installments).
The Bottom Line
If you receive a significant cash windfall from the lottery or other prizes, avoid the common mistakes. Don’t do anything rash or go on a spending spree before you’ve hammered out a wealth management plan and done some long-term thinking and financial goal-setting. With lotteries, this includes determining how you want to receive the jackpot, which will affect how much you get, when you will get it, and the taxes you’ll owe.
Before accepting any prize, consider the financial implications of keeping it. Decide if it will improve your financial situation in the long run. Otherwise, your big win could turn into a losing proposition.
Read the original article on Investopedia.