When the Powerball prize pot reaches epic proportions (currently, it’s sitting at $1.5 billion), we all start to dream big. Whether you go to the convenience store and buy a ticket, or whether you shake your head at those who do, the reality is that you’ve probably thought about what you’d do if you won all that money.
Before you get too far into your fantasy of winning the Powerball jackpot, though, you need a bit of a reality check. Whenever you end up with money, Uncle Sam wants his cut, and you need to be prepared to pay your taxes. Here’s what you need to know:
Lottery Winnings = Ordinary Income at the Federal Level
When you win the lottery, the amount is added to your regular yearly income. If you take 30 payments over the course of 29 years, your income will be increased by that amount going forward (that’s $50 million for each payment). If tax rates go up over time, you’ll end up paying more each year.
If you take one lump sum, you actually won’t receive the entire jackpot. That $1.5 billion only applies if you take payments. In reality, a $1.5 billion Powerball jackpot is “only” worth $930 million when you take the lump sum. But that’s still not bad. However, you will be paying your tax bill on that, with your marginal rate at 39.6%, for April 2017. (Realize, though, that the government automatically takes 25% of large winnings, so part of your tax will already be paid.)
Don’t Forget About State Taxes
Does your state collect income tax? If so, you’ll have to pay that bill as well. Many of us forget about state income taxes, but your state won’t forget about it. You’ll need to budget for your state income tax as well as federal income tax. Only states that don’t collect income taxes will save you money.
Tax Deductions and Gifts
You can also reduce your income by making charitable contributions. This will reduce your income to some degree, and you can do good with your winnings.
Be careful of non-charitable gifts, though. Don’t forget that there is a gift tax when you give more than $14,000 (currently) per person, per year. Gift tax is paid by the giver, so keep that in mind. Plus, there is a lifetime exemption of $5.45 million. So once you reach that threshold, you’ll be looking at a flat tax of 40% on your non-charitable gifts.
Interest Earnings and Capital Gains Tax Down the Road
One of the smartest things you can do with your money is invest it. However, don’t forget that you will be taxed on the money your money makes. If you put it in a savings account, any interest you earn during the year will be taxed as ordinary income. Stick $100 million of your winnings in a savings account paying 1% simple interest a year, and you’re still looking at an annual income of $1 million in interest — and you’ll have to pay federal and state taxes on that money.
If you invest in stocks, and you see capital gains, you’ll be taxed at a more favorable rate, but you’ll still be taxed. You can use tax-advantaged retirement accounts to get around some of the tax consequences, though.
If you do beat the rather long odds and win the Powerball jackpot, one of the best things you can do is consult with financial and tax professionals to decide what to do with your money ahead of time. While there’s no getting around the tax bill, there are ways to make manageable when you’re a billionaire.