How to Calculate Tax on Prizes Won

by Stephanie Faris ; Updated September 07, 2018
How to Calculate Tax on Prizes Won

You win the multimillion-dollar Powerball drawing, or maybe you dominate your favorite TV game show, earning the top prize. You can already imagine exactly what you’ll do first, whether it’s quitting your job or taking your dream vacation. But your daydreams likely don’t include paying taxes on your windfall. Unfortunately, taxes are an all-too-realistic part of winning prize money, but there is some good news. If you know what to expect in advance, you’ll avoid an unpleasant surprise when your dreams do come true.

Prize Tax Rate Calculator for Cash

If you win cash, calculating how much you’ll take home is fairly easy. The U.S. government requires 25 percent to be taken off the top of any prize over $5,000. For those who don’t have a Social Security number, that amount is even higher, with the IRS taking 28 percent in addition to the amount owed at tax time. Non-U.S. residents will be taxed at 30 percent on any lottery winnings, in addition to the amount due in mid-April. If you win the lottery jackpot, you’ll see 39.6 percent taken out of your check before it hits your bank account.

In addition to these obligations, you’ll also be required to report your winnings to the IRS at tax time if you won more than $600. Those who meet the filing requirements will be issued Form W-2G, which details the amount won, as well as the income tax that was withheld from the payment. This makes it easier to report the earnings, but it can help to know exactly how much you’ll be taxed before the time for filing.

Taxes on Winnings

By the time you’re really enjoying your lottery winnings, you’ll have to start worrying about filing your taxes. The good news is that the government has already taken 25 percent of your winnings and this counts toward the taxes you’ll owe in April. But if you took the full payout, you’ll be responsible for paying the remaining percentage. With the new tax brackets, that means you’ll owe 37 percent on your winnings, minus the 25 percent you’ve already paid, for a total of 12 percent.

If you live in a state where lottery prizes are taxed, you’ll owe an additional tax of 2.9 percent to 8.82 percent, depending on the laws where you live. Additionally, you may need to pay local taxes if applicable. Those who likely will see the highest tax bill will be New York City residents since they pay local, state and federal taxes on their lottery winnings. You’ll fare much better in states like Florida and Washington since there are no state taxes on lottery winnings there. If you buy your ticket in a state where you don’t live, you’ll be required to pay the tax rate of whichever of the two states has the highest taxes.

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Lump Sum Versus Annuity

When you win a large sum of money in the lottery, you’re given two options for collecting your funds. One is a lump-sum payment, which issues the full amount at once. If you win $500 million, in this case, you’d receive all $500 million at once, minus 39.6 taken by Uncle Sam. The alternative to a lump-sum payment is to take the money as an annuity. This method has your money issued in 30 annual payments over 29 years. Each check will have the 25 percent withheld and you’ll need to claim the income on your taxes.

There are pros and cons to each option, so it’s important to research carefully before making a decision. For tax purposes, though, an annuity could keep you in a lower tax bracket each year, resulting in lower taxes. For instance, for the current tax year, the top tax bracket is 37 percent, which means a multimillion-dollar lottery winner taking the lump sum payout will pay 37 percent on income in that tax bracket during the tax year in which the money is taken. However, a winner who chooses a $200,000 annuity paid over 29 years would fall in the 32 percent tax bracket for the current year.

Tax Rate Calculator for Gambling Winnings

Most often when discussing U.S. prize tax, it applies specifically to gambling winnings. Nearly two-thirds of Americans admit to gambling, so they face this question more often than Powerball winners or "The Price Is Right contestants. The tax reporting requirements for gambling winnings can be a bit complicated, though, since it varies based on the type of game you were playing when you won. If you win either $600 or 300 times your wager at the horse track, for instance, they’ll be required to report it. But if you win big at your local bingo hall, it won’t be reported unless it exceeds $1,200.

As with lottery and game show winnings, you’ll see 25 percent taken off the top when you claim your prize. You’ll also receive Form W2-G for your gambling winnings and be required to pay the amount you owe in taxes based on your income bracket, minus the 25 percent you paid when you won. This information will be included on Form 1040 on the line for “Other Income.”

Tax Rate Calculator for Noncash Prizes

For those who win noncash prizes, things get a little more complicated. Taxpayers often ask, “If you win a car how much are the taxes?” As it turns out, the amount they’ll owe is a percentage of the fair market value for the item. The entity issuing the prize is the one responsible for figuring that out and issuing you a Form 1099 that details the amount in Box 3, which is designated as “Other.” Here, they state the value of any prize issued to you, as well as federal income tax that was withheld from those winnings.

The problem with winning merchandise, though, is that you may not have the cash on hand to pay taxes on the item. The federal government still wants its 25 percent when you are issued the prize, and if you won a $50,000 car, that’s a full $12,500, and that doesn’t include the cost of registering and insuring your new vehicle. If the prize issuer offers cash to take care of the taxes, you’ll be taxed on that gift, as well.

Winning a House

Perhaps the biggest tax bill will come if you win a house as part of a contest or sweepstakes. These houses are usually on the higher-priced end of things, which means they bring a hefty tax bill. You’ll owe 25 percent up front to take the house, plus income tax on the amount when you file your taxes. This is in addition to the property tax you’ll be required to pay and the higher cost of utilities and other expenses. You may also inherit an HOA fee in the hundreds of dollars each month. All of this can put you well above what you’re currently paying in rent or on a mortgage.

If you win a house, you may be lucky enough to sell your existing home and pay all of the tax costs. You may also be able to take out a home equity loan to pay all of the ancillary costs until you can get into the house and start managing all of the extras that come with owning a dream home.

Claiming Expenses

Although you will certainly pay plenty in taxes, you can get some relief in the form of itemizing your gambling expenses. You’ll do this on Form 1040 Schedule A, under “Miscellaneous Deductions.” You can claim your gambling losses for the tax year until they exceed the amount you reported that you won on line 21. You also will need to have documentation of the amount you lost, including detailed records of the date you lost, the type of activity, the name and address of the place where you lost the money and witnesses to your loss.

You can also claim losses against any lottery payout you receive. If you have receipts and documentation of the money you spent on lottery tickets for that tax year, you can claim them on your taxes until they reach the amount of money you won. But don’t dare try to defraud the IRS by claiming tickets you didn’t buy. You may find you trigger an audit by reporting an extremely high expense on lottery tickets, so you’ll need the paperwork to back up every dollar you claim.

Deducting Local Expenses

If you’re responsible for local taxes on your gambling winnings, it might be worth checking with tax authorities to see if you can claim expenditures, as well. The New York Department of Finance and Taxation, for instance, allows you to itemize expenses on Form IT-201, as long as they don’t exceed the amount of winnings you reported under other income.

Before you claim any gambling expenses, make sure you have approved documentation to back it up. In New York, you may be asked to forward proof of the expense. These can be in the form of a digital copy scanned by a scanner or your phone or an online services account.

Tax-Exempt Winnings

You can toss the taxes on prize winnings calculator out if you can prove that the prize qualified for tax-exempt status. That service award you receive in appreciation of 20 years of service with your employer, for instance, falls under the category of achievement recognition and is therefore not subject to taxation. These prizes don’t have to be counted as gross income as long as the cost of the award is less than the deduction allowed to the employer for that award.

Awards and prizes also aren’t taxable if they were given as recognition of religious, charitable, scientific, educational, artistic, literary or civic achievement. However, in order to qualify as tax-exempt, you’ll need to be able to demonstrate that the prize was given to you without any action on your part to qualify and there are no promises that you’ll provide future services in exchange for receiving the prize.

Affording Prize Taxes

The prize tax on winning a car may seem daunting, but it shouldn’t stop you from entering contests. If you win a $50,000 car and owe $12,500 in taxes, plus other costs, when you pick it up, you can simply sell that $50,000 car and pocket the money you have left over after you’ve paid it all off. Don’t forget to set money aside to pay the remainder you owe in mid-April when you file your taxes. You’ll still be better off than if you hadn’t won at all.

If you’ve won merchandise and are concerned about the prizes, a cash alternative may be a better option. Some contests offer this for the winners who aren’t interested in the particular prize they won. This will save you the trouble of trying to sell the item and filing the taxes since you can simply pay your tax bill and start enjoying your cash winnings.

About the Author

Stephanie Faris is a novelist and finance writer whose work has appeared on The Motley Fool, MoneyGeek, and Ecommerce Insiders.

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