Sooooooooo were you a bit disappointed when you woke up this morning and found out that you will have to put that purchase of your private island on hold for just a little bit longer?
Well by now I’m sure that you know, that no one won the Powerball jackpot on Saturday night. The Powerball lottery is now up to,
$1.3 Billion (as of this writing), the largest jackpot in U.S. history.
The winner of the jackpot can choose to take the mega-millions over a lifetime or opt to take a lump sum (cash value) payment. The lump sum is currently valued at $806 million.
But (Spoiler Alert) if you hold the winning ticket and choose the lump sum, do not plan on spending all $806 million just yet. By law, lottery officials are required to withhold federal taxes from lottery winnings, whether you win a few hundred thousand, a few hundred million, or even over a billion dollars. The rule is this: you may be subject to withholding of 25% of your winnings for federal income tax purposes if the winnings minus the wager are more than $5,000 and are from a lottery. Different withholding rules apply to certain other kinds of gambling like bingo, keno, or slot machines and non-cash winnings – or if you’re subject to backup withholding (most taxpayers are not). Since, however, the Powerball will pay out in cash, you should expect to pay out
$201.5 million in withholding alone, leaving you with a check worth about $604.5 million.
Withholding is the amount that the federal government insists the lottery
authorities hold onto, not your actual tax liability. It’s the same principal as
what happens with your paycheck: a certain amount is withheld and remitted to
the U.S. Treasury on your behalf. When you file your income tax return and settle your tax bill the following year, you figure your tax, get credit for what was withheld (plus any additional estimated payments you made along the way) and pay the difference (or you get a refund if you paid more than you owed).
So how much tax would you pay on $806 million? Somewhere in the neighborhood of $319 million. But OK, you want exact numbers. So it works out to $319,129,675 (using 2016 rates).
Lucky for you, the feds already have your $201.5 million, so, at tax time,
you’ll just have to write a check for $117,629,675 – plus potential underpayment
penalties if you didn’t pay any estimated payments, depending on your circumstances.
And no, for those of you who are wondering, the Net Investment Income Tax (NIIT), that extra 3.8% levy on certain investment income, doesn’t apply to lottery winnings.
But for full disclosure, I figured that amount for a single taxpayer, assuming no other income or deductions. You’ll have some of those – except forget about saving those medical receipts to use for deductions: you probably won’t even come close to the threshold of 10% of your Adjusted Gross Income (AGI).
And, I haven’t even mentioned legal and investment fees. You’ll pay those,
too. Fortunately, they’re also deductible.
There’s one more big deduction: state taxes. Like legal and investment fees,
state taxes are deductible on your Schedule A (i.e., the form used to itemize
your deductions). How much you’ll pay, however, depends on where you live.
There are 9 states, plus Puerto Rico, that will give you a pass on your lottery
winnings: California, Florida, New Hampshire, Pennsylvania, South Dakota,
Tennessee, Texas, Washington and Wyoming. That’s because those states either
don’t have a state income tax or they don’t impose a state tax on lottery
winnings. If you live outside of these states, be prepared to give up a chunk of
your winnings (Delaware used to exempt lottery winnings but no longer does).
Tax rates vary from state to state. Some states, like Utah, have a flat state
tax rate. Others, like Maryland, have a graduated tax rate, meaning that the
rate increases as income increases. And to make things even more complicated, three states have ten or more tax brackets. Most on that list? Hawaii, where you can pay anywhere from 1.4% to 11% – there are 12 brackets in all.
At the top end of the spectrum, California imposes a whopping 13.3% for high
incomes. But there’s a catch (of course there’s always a catch). California is one of those states that doesn’t impose a state tax on lottery winnings. If you take
California out of the equation, you’ll likely pay the most state taxes in Connecticut, Hawaii, Maryland, New Jersey, New York, North Dakota, Ohio, Vermont, and Wisconsin.
But don’t stop there, however. States aren’t the only ones that want a piece of
your winnings: local taxing authorities may want some, too. If you live in New
York state, you’ll pay 8.82%. But if you live in New York City, the local authorities will tack on an additional 3.876% to your state tax, bringing New York City residents to a top tax rate of 12.696%.
Be careful. Like the feds, New York State has a series of graduated brackets.
That means that you don’t pay a flat rate on your entire income but rather a
flat rate on each level of income. All single New Yorkers are subject to a state
tax of 4% on taxable income between 0 and $8,400 (2015 rate), whether you make $5,000 or $500 million and so on through the brackets. That means that the state tax payable on $806 million isn’t a flat 8.82%, or $71,089,200 but rather $71,088,503 (using 2015 rates). The New York City tax would subject you to an additional $31,240,129 (using 2015 rates) in tax on the same amount. The total tax for a New York City resident? $102,328,632.
The good thing is that you can deduct those state and local taxes on
your federal taxes, bringing your taxable income closer to $703,671,368. The
federal tax on that amount is $278,607,537. Add that to the state and local tax
for a New Yorker and after paying $89,336,989, you’ll still have just over
$438,055,474to play with. Again, that’s assuming that you’re single.
It’s worth noting that for the sake of keeping your head from exploding, I did
not reduce the deductions for the ‘Pease’ limitations, which would obviously
apply in the event that state and local taxes were due. The same goes
for the Alternative Minimum Tax (“AMT”).
That’s a lot of math. Here’s the math I’m guessing you really care about: your
chances of winning are 1 in 292.2 million.
One more thing: If you are the lucky winner, contact SOLID TAX SOLUTIONS.
We will help you keep more of your prize – (845) 344-1040.
Bruce – Your Host at The Tax Nook
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Website: SolidTaxSolutions.com (or just click on the icon on right sidebar of this page).