The headlines have spoken! The ‘fiscal cliff’ has fallen (no pun intended) to the back pages and been replaced by talk of the second largest lottery jackpot in U.S. history. Some news organizations have hyped the excitement and rags-to-riches stories that lotteries can bring, even going so far as to make the case that lottery tickets are good investments; others have been distributing information about what winners should do to safely collect their earnings; while others point out that many lottery winners end up in worse financial positions then they were before. There’s also the issue of taxation, which can have major impacts on how much the winners collect and how they should choose to handle their money so as to get the best return.
The last post on this blog showed how most Americans lack basic financial literacy, which should give cause for concern to the friends and family of the two major winners ($192 million each) and 60 + big winners ($1 million or more) of the most recent Powerball drawing. In 2010, researchers at Vanderbuilt University produced a study which found that big winners ($10,000 or more) were more likely to go bankrupt than small winners five-years after-the-fact.. Why? Because they spent it all. Similarly, Business Insider published a feature article that highlighted 10 big “Winners Who Lost It All“, some of whom ended up in jail or on the streets. This includes Juan Rodriquez, a $149 Million MegaMillions winner who last half of his $88 million lump-sum payout through divorce filings and blew the remainder within a few short years. The Atlantic Wire summarized even more gruesome stories of past winners including, but not limited to: public humiliation, suicide, death-threats and dramatic downward spirals leading to a host of even worse outcomes.
Tax policy on lottery winnings is also a nightmare within itself. The city and state a winner lives in, and the city and state they purchased a winning ticket in, all effect to varying degrees the final amount that can be collected. From a federal level, you have to fill out a form W-2G, which automatically deducts 25% of winnings and dulls them out to Uncle Sam. For lottery winnings of this scope, big winners will face the top 35% federal income tax rate. In most states, lottery winnings count as taxable income and are subject to state and local taxes as well. In New York City, for example, the state tax on couples making over $2 million is 8.82%. Add an additional 3.88% for a city levy on individuals making over $500,000 for a top rate of 12.7%, all of which would apply to the most recent Powerball winners. However, if the state and local taxes are itemized and deducted correctly, the total taxes owed is more around 43%, rather than 47.7% (35% + 12.7%). The high rates may be avoidable if the winner chooses to receive their payments in annuities and then move out of the state, although some tax experts say that New York still would have a claim to its cut. It gets even more tricky if a ticket was purchased by a non-resident. If a California resident bought a ticket in NYC, they would only have to pay the New York state tax of 8.82% on a large win, not the city tax. That might be good news if they weren’t also subject to California’s taxation as well – where a recent law made their combined state and local taxes the highest in the country. California doesn’t tax their own local lottery winnings, but out-of-state tickets are not exempt. The rules vary from state to state and city to city, so if you picked the lucky numbers do yourself a favor and hire a team of financial and tax advisors; also, heed the wise words of your parents, “don’t spend it all in one place!”
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