Some states are more lenient with lottery winners than others. When it comes to taxing lottery winnings, the federal government will want a piece of that prize, and it’s likely that the state taxing authority will want a share as well. However, there are some states that are more lenient than others regarding the taxation of lottery winnings.
Federal Taxes on Lottery Winnings
FICA taxes – Social Security and Medicare – are imposed on earned income, so here’s the good news: Lottery winnings are exempt from FICA taxes because they are not earned.
However, the IRS requires that lottery officials withhold income taxes from your winnings. They must do this if you won $5,000 or more after deducting the cost of the ticket. The withholding rate is 25%. The IRS treats the 25% withholding in the same manner it would treat if an employer withheld from your paychecks. You will receive a refund if you do not owe that amount when you file your tax return.
Note: You will need to benefit from those winnings a little more to pay the additional taxes if you owe more than 25%. This can happen due to the tax bracket that will apply to the large prize.
Other Lottery Taxes Vary by State
States that impose the highest upper income tax rates can also create a hefty tax burden. New York is one example, especially if you live in New York City, where they will also want a share of your winnings.
The highest tax rate in New York is 8.82% as of 2022, but you have to add an additional 3.867% for the local tax if you live in New York City. This can total nearly 12.7% of your winnings. Your tax bill will be about $127,000 if you win a million dollars. It would be around $12.7 million if you win $100 million.
The Worst States for Lottery Taxes
New Jersey is considered the worst state for lottery taxes, with a top tax rate of 10.75% as of 2021. Oregon comes in second at 9.90%, followed by Minnesota at 9.85%. The District of Columbia ranks fourth at 8.95%. New York comes in fifth at 8.82%.
Here’s a list of the 10 states with the highest tax rates: Vermont: 8.75%; Iowa: 8.53%; Arizona: 8.00%; Wisconsin: 7.65%; Maine: 7.15%.
The taxes you will pay depend on the exact threshold at which these top tax rates kick in and on the amount you won. For example, you will pay only 9.9% in Oregon if you win over $125,000, and you will pay that percentage only on the excess portion of your winnings. You will pay 9% if you win $124,999 or less.
All of this assumes that your state participates in the national lottery and that it taxes lottery winnings. For example, Hawaii has a top tax rate of 11%, but you cannot play Powerball there. It is one of six states that does not participate in the lottery. It’s a very long swim to the mainland to buy a lottery ticket.
Note: Other states that do not participate in Powerball are Alabama, Alaska, Idaho, Nevada, and Utah.
Nicest States Regarding Lottery Taxes
The best option to avoid lottery taxes is to live in a state that has no income tax at all as of 2022: Florida, South Dakota, Texas, Washington, Tennessee, and Wyoming. Alaska and Nevada also do not impose an income tax, but they do not participate in the national lottery.
Then
There are two additional states that graciously refrain from imposing taxes on lottery winnings: California, Utah, South Dakota, Mississippi, Tennessee, Alabama, New Hampshire, and Delaware will allow you to keep your winnings tax-free. This is particularly convenient in California, where the top tax rate is worse than what you would pay in New York City: 13.30% as of 2021.
These states remain with the lowest top tax rates as of 2021: North Dakota: 2.90%; Pennsylvania: 3.07%; Indiana: 3.23%; Colorado: 4.55%; Ohio: 4.79%; Illinois: 4.95%; Oklahoma: 5.00%; Kentucky: 5.00%; Massachusetts: 5.00%; Missouri: 5.40%.
State Lottery vs. Other Games
Remember that these rankings pertain to national lottery winnings. Generally, other types of winnings are considered income, but they are not always subject to withholding rules. You may not be subject to FICA taxes. However, you may have to pay income tax on the money.
Some Small Tax Privileges
You can deduct gambling losses if you itemize, and if you spent more money trying to win than you actually earned, but only up to the value of your winnings. In other words, you won’t have to pay tax on your prize money, but you won’t be able to use your loss credit to offset other income.
You can also deduct state income taxes you would have to pay on your winnings on your federal return to try to reduce your tax bill. Unfortunately, the Tax Cuts and Jobs Act limits this itemized deduction to $10,000 for tax years 2018 to 2025, and to only $5,000 if you are married and filing separately. This is just a drop in the bucket if your winnings are substantial.
Frequently Asked Questions (FAQs)
How can I avoid paying taxes on lottery winnings?
You cannot legally avoid paying taxes on lottery winnings. The IRS will typically require the lottery company to withhold taxes from your winnings before you even receive a check. However, you can reduce your tax liability by taking your lottery winnings in installments, donating a portion to charity, and deducting any gambling losses.
How often do I have to pay taxes on lottery winnings?
That will depend on how you choose to receive your winnings. You will only pay taxes on your lottery winnings in the year you receive them if you take the lump sum payment. You will pay taxes on the lottery payments you receive each year if you distribute your winnings over several years.
How long can you wait to pay taxes on lottery winnings?
The IRS and state tax agencies treat your lottery winnings as income in the year you receive them. Just like earned income, some taxes will likely be withheld from the outset, and then you will report everything on your tax return for the year in which you receive the money. You may also be required to pay estimated taxes in advance. The only way to delay paying some of the taxes is to take the money in installments.
Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and maintain the accuracy and reliability of our content.
IRS. “Instructions for Forms W-2G and 5754 (2020).”
IRS. “IRS Issues 2022 Inflation-Adjusted Tax Changes.”
New York State Department of Taxation and Finance. “2021 Instructions for Form IT-2105,” page 8.
Tax Foundation. “Taxes in New York.”
Tax Foundation. “Individual Income Tax Rates and Brackets by State for 2021.”
World Population Review. “Powerball States 2021.”
Office of Financial Management. “How Much Does Winning the Lottery Cost?”
IRS.
Federal Taxes. “Topic No. 419 Gambling Income and Losses.”
Internal Revenue Service. “Topic No. 503 Qualified Taxable Distributions.”
Source: https://www.thebalancemoney.com/best-and-worst-states-to-pay-lottery-taxes-4176944
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