So, you’ve won the lottery. Congratulations! Or perhaps you’re still dreaming of winning someday. As exciting as a lottery win could be, though, you’ll be required to pay a portion of your windfall to Uncle Sam, both when you take the payout and at tax time. The first call you should make should be to a financial adviser or lawyer to find out what you need to do to protect your new wealth. Although there are benefits to setting up a trust fund in which to store your winnings, it won’t reduce your tax bill.
Although you can quickly establish a trust fund to store your lottery winnings, this will not exempt you from any tax responsibilities established by state and federal governments.
Taxes on Lottery Winnings
You might not realize it, but if you win the lottery, you won’t be handed a check for the full amount. The IRS takes 25 percent of lottery winnings from the start. So even if you could direct your winnings into a trust fund to avoid paying taxes, that 25 percent would be withheld. The rest of your tax bill comes when you file your next tax return.
What you owe depends on your tax bracket. Under the new tax laws, though, you’ll be in the top income tax bracket if you earn more than $500,000 in a given year – or $600,000 if you’re married filing jointly. That means you’ll owe taxes of 37 percent on the amount you take home. If you live somewhere with state income tax, you’ll also owe for that. In New York, you’ll likely be hit with a tax bill for 12.7 percent of your winnings. There are several states that don’t tax lottery winnings, including California and Delaware, but you’ll still owe federal tax.
Trusts and Taxes
Trusts are designed to protect assets, often in the event of a person’s death. Trust funds are often used when referring to money set aside for a minor to enjoy once they reach a certain age. You won’t escape taxes through a trust, but having your money set aside that way could allow you to distribute it tax-free in the form of a gift to a loved one in the event of your death. You can give up to $11.18 million tax-free in this type of situation.
If you’re just trying to shift the funds into a trust to avoid paying taxes, though, you’ll be disappointed. The IRS doesn’t allow taxpayers to assign their income to another party, so if you shift your tax winnings into a trust, you will owe taxes on that income in the year in which you shift it.
Why Create a Trust Fund?
There are legitimate reasons to shift your lottery winnings into a trust fund. If you won the lottery as part of a group, such as a workplace lottery pool, you can save on taxes by shifting the lump sum into a trust. The funds can then be distributed to the individual winners by the trust, which also eliminates the pressure of having one person manage it.
But most lottery winners turn to a trust fund for privacy reasons. When the winnings are claimed by a trust, the thinking is that the actual winner’s identity will be shielded. This prevents the problem of random relatives showing up at your doorstep, asking for money. You simply set up a trust, claim the ticket in the name of that trust, and continue to live your life as a secret millionaire.
- Kiplinger: How Much Tax You Will Pay on Your Lottery Winnings
- Time: The Next Powerball Winner Could Keep an Extra $7 Million Thanks to the New Tax Law
- CNN: What tax reform means for the next big lottery winner
- LegalBeagle: How to Create a Trust to Claim Lottery Winnings
- IRS: What's New - Estate and Gift Tax
- IRS: Abusive Trust Tax Evasion Schemes - Questions and Answers
- Today: Mega Millions, Powerball top $300 million each: Here's how to stay anonymous if you win
- IRS. "Instructions for Forms W-2G and 5754 (2020)." Accessed March 27, 2020.
- IRS. "IRS Provides Tax Inflation Adjustments for Tax Year 2020." Accessed March 27, 2020.
- Tax Foundation. "Taxes in New York." Accessed March 27, 2020.
- The Tax Foundation. "State Individual Income Tax Rates and Brackets for 2020." Accessed March 27, 2020.
- Oregon Secretary of State. "Government Finance: Taxes." Accessed March 27, 2020.
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- IRS. "Topic No. 419 Gambling Income and Losses." Accessed March 27, 2020.
- IRS. "Topic No. 503 Deductible Taxes." Accessed March 27, 2020.
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.