Posted by The Life and Legacy Planning Group
On February 14, 2023, California state lottery officials named the winner of the largest lottery prize in United States history: Edwin Castro won an eye-popping $2.04 billion in a November 2022 lottery drawing, choosing a lump sum payment of $997.6 million instead of annual payments over three decades.1 A lottery player in Maine recently won the $1.35 billion Mega Millions jackpot—another of the largest prizes ever recorded.2 If you are fortunate enough to have purchased a winning lottery ticket, it is important to carefully consider how you want to handle your unexpected windfall to avoid repeating the unfortunate pattern of many lottery winners who quickly squander their new wealth3, even if your prize is much smaller than those mentioned.
Take your time. Lottery winners typically have a specific length of time to claim their winnings, although the deadlines vary by state. For example, under title 8, section 382 of the Maine Revised Statutes, the Maine Mega Millions winner has one year after the drawing to claim the money. If it is never claimed, it will be transferred to the state’s general fund. In North Carolina, however, the prize must be collected within 90 or 180 days of the end of the game or drawing, depending upon the type of lottery prize you have won4. Although it is not wise to delay too long, you should take time to think carefully about what you would like to do with the cash you have won, preferably even before you claim your prize.
Manage expectations. If your lottery winnings have substantially increased your wealth, you may discover that your popularity has also grown. Some family members, acquaintances, and scammers are likely to want a piece of your winnings. Do not feel pressured to do anything that you do not genuinely feel good about, and be firm about your choices, regardless of attempts to make you feel obligated or guilty. Nevertheless, you may choose to be generous with your winnings, making gifts to family members, loved ones, or charities. However, keep in mind that large gifts may have tax consequences. In 2023, the annual gift tax exclusion amount is $17,000 per recipient. This means that, with a few exceptions, if you give more than $17,000 to someone other than your spouse or a dependent, you will have to file a gift tax return and there will be gift tax consequences to making that gift. There likely will be no gift tax due, but you must file a Form 709 (gift tax return). The amount of the gift exceeding $17,000 can be deducted from your lifetime exemption amount ($12.92 million for 2023).
Keep an eye on income tax consequences. Although the winner of California’s lottery opted to receive a lump sum of $997.6 million, he will not actually receive that amount, which is the amount of his winnings before taxes. Mr. Castro should hold off on buying any private islands until all the taxes on his winnings are paid. Before the state of California gives him any of his winnings, 24 percent—$239.4 million—will be withheld and sent directly to the Internal Revenue Service (IRS)5. In addition, because the highest federal income tax rate is 37 percent, an additional 13 percent—$129.7 million—will be due in April 20236. After these federal tax payments are made, Mr. Castro will be left with a relatively paltry $628.5 million. Depending upon the state and city in which lottery winners live, their prize may also be subject to a state tax.
It is important to file tax returns reporting your winnings and pay taxes owed to avoid interest and penalties. There is a 5 percent per month penalty for each month after the due date up to a maximum of 25 percent for failure to file your tax return on time. If you file your tax return on time, but do not pay all the tax you owe on time, there is a failure-to-pay penalty of one-half of one percent per month up to a maximum of 25 percent of the amount of unpaid taxes. The amount of the penalty will increase if the IRS issues a notice of intent to levy property as a means of collecting the amount due. If your prize winnings are substantial, these penalties could also be sizable.
It is also crucial to make a good faith effort to ensure that your tax return accurately reports your winnings and not take any steps to willfully evade paying taxes owed. In 2021, an Ohio man who won $1 million in the lottery was charged with filing a false tax return to avoid taxes7. According to court documents, the man, who pleaded guilty, had falsely claimed large gambling losses and transferred significant sums of money to foreign bank accounts that were not disclosed to the IRS in an effort to avoid paying taxes on his winnings. The maximum penalty for filing a false tax return is three years in prison and a fine of up to $100,000.
Contact professional advisors. The financial, tax, and legal issues that arise when you win a large prize can be overwhelming if you do not seek help. Before you make any major purchases or gifts, it is important to immediately contact a team of professionals to help you think through how to handle your winnings. If you would like to preserve your new wealth and enable it to grow, it is important to contact a financial advisor who can help you make wise financial decisions that are most appropriate for your unique situation. A tax advisor will also help you make important decisions such as determining whether there are more tax savings from receiving the lottery winnings as a lump-sum or installment payments, as well as make sure you file an accurate and timely tax return and pay taxes owed by the IRS’s due date.
As your estate planning attorneys, we can coordinate with your other advisors to help you make decisions and create or update your estate plan to incorporate strategies that will ensure that your winnings are protected during your lifetime, income and transfer taxes are minimized, and that your wealth is distributed to the people you choose in the way you desire when you pass away. Let us help you avoid hasty decisions that you may later regret. Call us today to set up an appointment so we can help you create a plan that will maximize the benefits from your lottery prize during your lifetime and create a lasting legacy for your loved ones.
1Jordan Mendoza, Winner of Record $2.04 Billion Powerball Finally Revealed, Says They Were ‘Shocked and Ecstatic,’ USA Today (Feb. 15, 2023), https://www.usatoday.com/story/news/nation/2023/02/14/who-won-two-billion-powerball-jackpot/11258329002/.
2Jesus Jimenez, Someone in Maine Won the $1.35 Billion Mega Millions Jackpot, N.Y. Times (Jan. 18, 2023), https://www.nytimes.com/2023/01/14/us/mega-millions-jackpot-winner.html.
3Mark Abadi et al., 20 Lottery Winners Who Lost It All — As Millions Vie for Powerball’s $700 Million Jackpot, Bus. Insider (Jan. 11, 2023), https://www.businessinsider.com/lottery-winners-lost-everything-2017-8.
4Frequently Asked Questions, NC Education Lottery, https://nclottery.com/faq#:~:text=For%20instant%20scratch%2Doff%20games,which%20the%20ticket%20was%20purchased (last visited Mar. 29, 2023).
5Robert W. Wood, $2.04 Billion Powerball Winner Takes Home $628 Million after Taxes, Forbes (Nov. 9, 2022), https://www.forbes.com/sites/robertwood/2022/11/09/204-billion-powerball-winner-takes-home-628-million-after-taxes/?sh=38a5cba87bbe.
7Hilliard Man Lies to Avoid Taxes on $1 Million in Lottery Winnings; Pleads Guilty to Tax Fraud, U.S. Dep’t Just. (Nov. 9, 2021), https://www.justice.gov/usao-sdoh/pr/hilliard-man-lies-avoid-taxes-1-million-lottery-winnings-pleads-guilty-tax-fraud.