The odds against winning the Powerball lottery are about one in 292 million, and Mega Millions is even worse: one in about 303 million. And yet someone will eventually manage to do it, and they'll have to pay taxes on their winnings. The federal government will want a piece of the prize, and the state taxing authority will likely have its hand out for a share as well. However, some states are much kinder than others when it comes to taxing lottery winnings.
You’re not going to receive that whole walloping amount if you take the money in a lump sum. The full advertised jackpot is the most you can win—it’s reserved for those who accept their winnings as annuities, so the money is paid out over a span of years. Either way, a significant percentage of your lottery winnings might go to taxes.
Federal Taxes on Lottery Winnings
FICA taxes—Social Security and Medicare—are employment taxes. They’re imposed on earned income, so here’s the good news: Lottery winnings are exempt from FICA taxes because they’re not earned income.
The IRS does require that lottery officials withhold income taxes from your winnings, however, if you win $5,000 or more after subtracting the cost of your ticket. The withholding rate is 24%. The IRS treats that 24% withholding just the same as it would if your employer withheld taxes from your paychecks. It will send you a refund if you don’t end up owing that much when you file your tax return.
You’ll have to dig into those winnings a little more to pay additional taxes if you end up owing more than 24%—and that's probable, given the tax brackets that a significant jackpot would push you into.
The top federal tax rate in tax year 2020 is 37% on incomes over $518,400 for single taxpayers, or $622,050 if you’re married and filing a joint return. In tax year 2021, these incomes increased to $523,600 and $628,300, respectively.
This means you’ll pay 37% income tax on the portion of your winnings that exceeds these amounts.
Other Lottery Taxes Vary by State
States with the highest top income tax rates pose a tough tax burden as well. New York is one example, particularly if you live in New York City, which will also want a cut of your winnings. New York’s top state tax rate is 8.82% as of 2020, but then you’ll have to add another 3.867% for the local tax. That can work out to a hefty nearly 12.7% of your winnings. Your tax bill would come to almost $127,000 if you won $1 million, and about $12.7 million if you won $100 million. But if you live elsewhere in New York and don't have to pay local income taxes, the state actually falls to fifth place overall.
The Worst States for Lottery Taxes
New Jersey comes in as the worst state for lottery taxes, with a 10.75% top tax rate as of 2020. Oregon takes second place at 9.9%. Minnesota comes in third at 9.85%, followed by the District of Columbia at 8.95% and New York at 8.82%.
Rounding out the list of the 10 states with high tax rates are:
- Vermont: 8.7%
- Iowa: 8.53%
- Wisconsin: 7.65%
- Maine: 7.15%
- South Carolina: 7.0%
The hit you'll take depends on the exact threshold where these top tax rates kick in and on how much you've won. For example, you'd only have to pay 9.9% in Oregon if you won more than $125 million, and you’d pay this rate only on the portion of your winnings that exceeds this amount. You'd pay 9% if you won $124,999,999 or less.
All this assumes that your state participates in a national lottery and that it taxes lottery winnings. For example, Hawaii’s top income tax rate is a hefty 11%, but you can’t play Powerball there. 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. Other states that don’t participate in Powerball are Alabama, Alaska, Idaho, Nevada, and Utah.
The Kindest States for Lottery Taxes
Obviously, your best bet for avoiding lottery taxes is to live in one of the states that doesn't have an income tax at all as of 2020: 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 couple of states that kindly refrain from taxing lottery winnings: California and Delaware will generously let you keep your jackpot tax-free. This is particularly convenient in California, where the top tax rate is even worse than what you’d pay in New York City: 13.30% as of 2020.
That leaves us with the states with the lowest top tax rates as of 2020:
- Tennessee: 1%
- North Dakota: 2.90%
- Pennsylvania: 3.07%
- Indiana: 3.23%
- Michigan: 4.25%
- Arizona: 4.50%
- Colorado: 4.63%
- New Mexico: 4.90%
- Illinois and Utah: 4.95%
- Ohio: 4.797%
Tennessee and New Hampshire tax only interest and dividend income, and Tennessee is repealing even that tax beginning in the 2021 tax year.
State Lotteries vs. Other Winnings
Keep in mind that these rankings are for national lottery winnings. As a general rule, other types of winnings are considered income, but they’re not always subject to the withholding rule, and they might not be subject to FICA taxes. However, you might still have to pay income tax on the money.
Some Small Tax Perks
You can deduct gambling losses if you itemize and if you spend more money trying to win than you actually end up winning, but only up to the amount of your winnings. In other words, you wouldn’t have to pay a tax on your prize money, but you couldn’t use the balance of your losses to offset your other income.
Another deduction you can take on your federal return to try to nip away at your tax bill is for the income taxes you must pay to your state on your winnings. Unfortunately, the Tax Cuts and Jobs Act limits this itemized deduction to $10,000 for tax years 2018 through 2025, and to just $5,000 if you're married and filing a separate return. This is just a drop in the bucket if your winnings are significant.
Frequently Asked Questions (FAQs)
How can I avoid paying taxes on lottery winnings?
You cannot legally avoid paying taxes on your lottery winnings, and the IRS will usually require that the lottery company withhold taxes from your winnings before you even receive a check. However, you can reduce your tax liability by taking your lottery winnings in installments, donating a portion of it to charity, and deducting any gambling losses,
How many times do you pay taxes on lottery winnings?
This will depend on how you choose to receive your winnings. If you take the payment in a lump sum, you'll pay taxes on your lottery winnings only in the year you receive them. If you spread your payment out over a period of years, you'll pay taxes on the lottery payments you receive each year.
How long can you wait to pay taxes on lottery winnings?
The IRS and state tax agencies treat your lottery winnings as income in the year you receive them. Just as with employment income, you'll likely have a portion withheld from the beginning, then you'll report everything on your tax return for the year in which you receive the money. You might also be required to pay estimated taxes ahead of time. The only way to partially delay paying taxes is to take your money in installments.