Mega Migraines: The IRS and the Lottery by Corporate Tax Network Staff

Mega Migraines: The IRS and the Lottery

Many of us have bought a ticket or two, especially when the jackpot is hitting upwards of hundreds of millions. But whether you're in it to win millions in the state lottery or double your money at the local casino, your earnings will likely have tax implications.

by Corporate Tax Network Staff
updated January 15, 2021 · 3 min read

Now that we've all put away our “What I'd like to do with $656 million” lists, it's time to get back to the grind. But just in case the Mega Millions lottery prize climbs sky high again, you should reduce the number at the top of that list since the IRS will be expecting a portion of the payout, too.

Gambling winnings are always taxable, whether they are from the historic $656 million or just a few bucks from a slot machine. That doesn't mean taxpayers always report it, especially when it's just a nominal chunk of change.

Casinos and racetracks are required to report winnings that pass a certain threshold. With slot machines and bingo, casinos must report any single payout of $1,200 or more on W-2G. Noncash prizes, such as a car or a vacation, are reported at their fair market value. In the lottery, winnings of $600 or more are reported if they are 300 times the original bet. But remember, each lottery ticket you buy is considered an individual bet. 

Reporting Wins and Losses

If you get lucky and win more than the threshold, you will be asked to provide your personal information, including your social security number, to report the winnings to the IRS.

Gambling winnings of more than $5,000 from sweepstakes, wagering pools, lottery, poker tournaments, and a few others are subject to a 25% income tax withholding. Winnings from bingo, slot machines, and keno are usually not subject to withholding.

Remember that even if withholding is not required, you may need to make estimated tax payments to avoid the underpayment penalty. If you refuse to provide your Social Security number, the house can withhold up to 28% of your winnings for taxes—this applies to bingo, slot machines, and keno as well. We'll have to assume this is how James Bond claims his money.

If you do win some money in a casino, chances are you also lost some at the same casino. As they say, “the house always wins.” If you find yourself in this situation, know that the IRS allows you to deduct gambling losses to the extent of the winnings as “miscellaneous expenses” on Schedule A where itemized deductions are reported.

If no winnings are reported, the losses are not deductible. You can make sure you keep all this information by keeping a rewards card with one casino or keeping track of your wins and losses with a gambling log. If you itemize your deductions, then you can count any money you spend on lotto tickets as a gambling loss.

Professional gamblers have slightly different filing requirements. If you gamble regularly for your livelihood and perform the activity in a businesslike manner, the winnings and losses would be reported as ordinary income/loss on schedule C.

Taking an Annuity or Lump Sum?

For big lottery winners, the situation gets a little more complicated. They can choose to receive less of their money in a lump sum or receive the whole amount over a number of years as an annuity.

If you take the annuity, then how much the IRS ends up taking can be affected by future tax laws, making the IRS rates unpredictable. But at least you'd get the whole amount—in this case, $656 million.

If you take a lump sum from the March 2012 jackpot, the actual jackpot you would receive is $474 million after accounting for future cashflows. The IRS will then automatically withhold the maximum allowable rate of 25% for federal taxes on that new amount.

It doesn't always end there—depending on your tax rate in the state in which you live, another chunk of up to 12% may be withheld. For those of you who live in California, New Hampshire, Pennsylvania, Tennessee, Texas, South Dakota, and Washington, that's the end of the story. Your states do not have income tax on lotteries. However, for those who live outside of those states, your winnings would be further taxed at the state level.

While some of this might sound confusing, especially with changes in laws on both federal and state levels—take heart—if you end up a big lottery winner, you can always pay someone else, such as a tax attorney or accountant, to stay on top of the laws and do the math for you.

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