Best and Worst States to Pay Lottery Taxes
Some states are far kinder to lottery winners than others
Voltaire once referred to optimism as a form of madness, and when it comes to playing the lottery, he might not have been far off. The odds against anyone winning the last really big lottery jackpot were one in more than 290 million…and yet, someone always does.
Brace yourself for a bit of reality if that very lucky someone turns out to be you. First, you’re not going to receive that whole walloping amount that’s advertised if you take money in a lump sum. That’s reserved for those who take their winnings as annuities, paid out over a span of years. The advertised jackpot is the most you can win if you’re the patient sort.
Next, know that the tax man will cometh. Uncle Sam is going to want a piece of your prize, and most people can expect that their state taxing authority will have its hand out for a share also. But some states are much kinder than others when it comes to lottery taxes.
In fact, if you live in one of the worst states, you might want to consider using some of that money to pull up stakes and relocate…at least if you’re planning on playing the lottery again and you’re mad enough to believe you can win big twice.
It’s Federal Law
You’ll have to deal with federal law right off the top, before your state even gets involved. The Internal Revenue Service requires that lottery officials must withhold taxes from your winnings over a certain amount: 25 percent if you win $5,000 or more after subtracting the cost of your ticket.
This doesn’t necessarily mean that you’ll owe 25 percent when all is said and done. You’re still entitled to prepare your tax return at year’s end and claim every possible deduction and credit you can possibly qualify for. The Internal Revenue treats that 25 percent withholding just the same as it would if your employer withheld taxes from your paychecks. If you don’t end up owing that much, the IRS will send you a refund.
Of course, if you end up owing more than 25 percent—and that's probable given the tax bracket a really significant jackpot would push you into—you’ll have to dig into those winnings a little more to pay additional taxes.
What Taxes are Withheld?
FICA taxes—Social Security and Medicare—are employment taxes. They’re imposed on earned income, so you’ll dodge a bullet here. Lottery winnings are exempt because they’re not earned income. That 3.8 percent Net Investment Income Tax doesn’t apply to lottery winnings either.
But your winnings are considered unearned income, so you'll have to pay income tax on the money at the federal level and often at the state level as well. This shines a spotlight on tax brackets and tax rates because this is how much you’ll end up paying on what’s left of your winnings after you’ve taken all possible deductions and credits.
The top federal tax bracket as of 2018 is 37 percent on total income over $500,000, or $600,000 if you’re married and filing a joint return. Plan on paying income tax at this rate on the portion of your winnings that exceed the applicable amount.
One of the deductions you can take on your federal return to try to nip away a little at your tax bill is for income taxes you must pay to your state on your winnings. This helps…but not by much. The Tax Cuts and Jobs Act limits this itemized deduction to $10,000 for tax years 2018 through 2025, and $10,000 is just a drop in the bucket if your winnings are really significant.
But you’ll want to claim it anyway. At least you can get something in return for income taxes you might owe to your state.
The Worst States for Lottery Taxes
Some locations tax lottery winnings so heavily, you might want to consider other gambling ventures instead if you live in one of them. Obviously, states with the highest top income tax rates pose the toughest tax burden, and of these, New York takes top prize as being the absolute worst…at least if you live in Yonkers or New York City because the city will want its own cut of your winnings.
New York’s top rate is 8.82 percent as of 2018, but then you’ll have to add another 3.876 percent for the local tax. That works out to a hefty 12.696 percent of your winnings. That’s about $12.69 million if you win a $100 million lottery, quite a bit more than that $10,000 deduction you can claim for state taxes on your federal return. It’s even a lot more than $10,000 if you win just $1 million. Your tax bill still comes out to almost $127,000.
But if you live elsewhere in New York, the state actually falls to seventh place. Oregon comes in first with a 9.90 percent top tax rate as of 2018, and Minnesota takes second place at 9.85 percent. Then comes Iowa at 8.98 percent, then New Jersey at 8.97 percent. The District of Columbia and Vermont tie at 8.95 percent.
Rounding out the list of states with significantly high tax rates are:
- Wisconsin: 7.65 percent
- Idaho: 7.40 percent
- Maine: 7.15 percent
- South Carolina: 7.0 percent
You’ll pay less than 7.0 percent everywhere else…assuming your state participates in a national lottery and it taxes lottery winnings or has any income tax at all. For example, Hawaii’s top rate is a hefty 11 percent, but you can’t play Powerball here. It’s one of six states that don’t participate and it’s a very long swim to the mainland to purchase a lottery ticket elsewhere.
Other states that don’t participate in Powerball are Alabama, Alaska, Mississippi, Nevada, and Utah.
The Kindest States for Lottery Taxes
OK, now let's get to the good news. Obviously, your best bet for lottery taxes is one of the states that doesn't have an income tax at all as of 2018: Florida, South Dakota, Texas, Washington, and Wyoming. Alaska and Nevada don’t tax income, either, but they don’t participate in national lotteries.
Then there are an additional handful of states that kindly refrain from taxing lottery winnings. California, New Hampshire, Pennsylvania, and Tennessee will generously let you keep your jackpot tax-free. That’s particularly convenient in California where the top tax rate is even worse than what you’d pay in New York City: 13.30 percent as of 2018.
Delaware used to spare lottery winnings, but that’s changed as of 2018.
That leaves us with the states with the lowest top tax rates:
- North Dakota: 2.90 percent
- Indiana: 3.23 percent
- Michigan: 4.25 percent
- Arizona: 4.54 percent
- Colorado: 4.63 percent
- New Mexico: 4.90 percent
- Illinois: 4.95 percent
- Ohio: 4.997 percent
State Lotteries and Other Games Are Different
Keep in mind that these rankings are for national lottery winnings. The IRS doesn’t demand mandatory withholding from state lottery winnings, and it taxes other games of chance differently as well. As a general rule, other types of winnings are indeed income but they’re not subject to the withholding rule and they might not be subject to FICA taxes. This doesn’t mean you won’t have to pay any income tax on the money, however.
And if you spend more trying to win than you actually end up winning, you can deduct your losses if you itemize…but only up to the amount of your winnings. In other words, you wouldn’t have to pay a tax on your prize, but you couldn’t use the balance of your losses to offset your other income.
When it comes to winning a big national lottery, let’s face it. You might have to share some of that money with taxing authorities, but what’s left over is still money you didn’t have before.