The good news is that you received a cash windfall. The bad news – or at least information that tempers your exuberance – is that you will probably have to pay taxes on that amount. Exactly how much you pay depends on the nature of that lucky windfall.
Gambling Winnings Are Taxable
If you’ve won the lottery or had a big win at the racetrack or casino, you’ll owe tax at your ordinary income rate for that amount. The downside is that a big win can put you into another tax bracket. Figure out what you’ll owe the IRS by calculating your income for the year, based on earned and unearned income. Add your winnings to the amount of earnings to see if the tax bracket moved upward. For example, if you were in the 15 percent tax bracket, but your windfall put you in the 25 percent bracket, you’ll have to pay taxes on all your income at that rate, not just the winnings. Keep in mind that your state will probably want a piece of your winnings for tax purposes, too. Contact your state’s department of revenue or that of the state in which you won the money for more information.
Parental and Other Gifts
You don’t have to pay taxes on parental cash gifts as long as the parent claims you as a dependent on their tax return. Once you are no longer a dependent, your parents must pay taxes on amounts over $14,000 annually, as of tax year 2017. Each of your parents can give you up to $14,000 annually without incurring a gift tax, so you could reap a $28,000 windfall, and no one pays taxes on those amounts. The $14,000 exclusion doesn’t apply just to parents; anyone can give you up to that much money per year without owing gift taxes.
If the gift goes toward paying educational or medical expenses, there is no limit. However, the person making the gift must pay it directly to the education institution or medical facility, rather than giving the money to the student or patient and having them pay the tuition or medical bill. If you’re married, there is no limit to the amount of cash or other gifts spouses can give each other.
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Inheritances May Be Taxed
Whether you must pay tax on an inheritance depends on who left you the money, the amount inherited, the type of asset and the state. For tax year 2017, the federal estate tax exemption is $5.49 million for an individual. Not many states impose an estate tax, and some that do use the federal exemption as a basis. Just a few states impose an inheritance tax, and the exemption is often much lower. The exemptions are usually very low for those who are not lineal descendants of the deceased. That’s anyone who isn’t a child, grandchild or great-grandchild. Contact the department of revenue in the state in which the deceased person lived to find out if they impose an inheritance tax. If they do, you can calculate how much tax you will owe, if any, by your relationship to the deceased and the amount left to you.
Legal Settlements and Court Judgments
If your windfall results from a legal settlement or court judgment, you’re likely to owe taxes on it. The exception is for damages for personal injury or illness, including emotional stress or mental anguish. Any type of punitive damage award is considered taxable and is reported as other income on Line 21 of Form 1040. There are many variations in legal settlements and judgments, as well as exceptions, so it is crucial to receive professional tax advice, especially if the court judgment is substantial.
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