Under Chapter 13 of the U.S. Bankruptcy Code, you can get your finances under control by steadily paying off your creditors without the worry of losing major assets such as your house. In the extremely unlikely event that you win the lottery while under such bankruptcy protection, your winnings may give you a chance to escape your financial quagmire. In some cases, you won't have a choice in the matter.
Chapter 13 bankruptcy allows individuals with extensive debts but a steady income to pay off some or all of their debts under a three- to five-year repayment plan. This plan will require you to pay off in full priority debts such as taxes and child support as well as secured debts such as your mortgage and car payments, but you will be able to keep those assets. The courts also will determine a percentage of your unsecured debts -- medical debts, credit card bills and anything else not directly attached to a tangible asset -- for you to pay back, based on your the amount of income you have leftover after your necessary living expenses and debt payments. A court trustee will monitor your finances and payment plan.
Lottery winnings, be they a $1,000 winning scratch-off ticket or a multimillion dollar jackpot, are a form of financial windfall, similar to an inheritance or lawsuit settlement. The effect this has on your debt payments depends on which U.S. federal court district you call home. Federal bankruptcy laws require you to report newly acquired assets only if you acquire them through inheritance, divorce proceedings or as a life insurance death benefit, according to Minnesota bankruptcy attorney Craig Andresen. This would mean you are not required to report lottery winnings. Many districts have their own rules related to windfalls, however. The Western District of Oklahoma, for example, requires you to report any windfall in excess of $500.
Because bankruptcy laws are complex and vary across the country, you should consult a bankruptcy attorney immediately should you hit a lottery jackpot, according to Virgina law firm Boyle Bain Reback & Slayton. The lawyer will let you know whether you need to inform your trustee, who then likely would adjust your payment schedule with your new fortune in mind, perhaps requiring you to pay a larger percent of your unsecured debts. Resist the temptation to keep your winnings a secret. Remember: Your trustee will be watching your finances closely, including looking at your annual tax returns, so you won't be able to keep it hidden for long.
If you win the lottery, your inclination might be simply to pay off the full amount owed in your bankruptcy settlement, but this is not always the best move, according to Pennsylvania bankruptcy attorney Lawrence Rubin. You cannot simply pay off a bankruptcy settlement early like a loan. To exit bankruptcy early, you must pay not only what's owed through your plan, but also your unsecured debts in full and perhaps even the penalties and interest you would have accrued on that debt without bankruptcy protection. An attorney can advise you on whether this is a good course of action.
Michael Baker has worked as a full-time journalist since 2002 and currently serves as editor for several travel-industry trade publications in New York. He previously was a business reporter for "The Press of Atlantic City" in New Jersey and "The [Brazoria County] Facts" in Freeport, Texas. Baker holds a Master of Science in journalism from Quinnipiac University in Hamden, Conn.