Don't Mess With Taxes

Yes, I bought a ticket for the Jan. 29 Powerball. I always do when the jackpot of that and the other national lottery, Mega Millions, gets into the, well, mega million-dollar range.

No, I didn't win. Again.

Last night's Powerball payout, which had climbed to $396.9 million, is going to the lucky person who bought the winning ticket in Florida. Yes, I am contacting my Sunshine State friends and relatives!

In addition to the one big winner, three other Powerball tickets worth $1 million each went to ticket holders in Ohio, Virginia and, again, Florida.

If you're one of the four new suddenly rich Americans, congratulations on your lucky numbers.

Here are 5 quick tax tips for them and other lottery and prize and/or gambling winners on how to deal with unexpected new wealth.

1. Hire or at least consult a tax professional.
By now, everyone is well aware that lottery jackpots mean big winnings for the tax man, too. A tax pro will be able to give you an overview of the myriad tax issues you'll face at the federal and your state and local levels.

Regardless of how you receive your winnings (more on this in tip #2), Uncle Sam will get his cut up front. At the federal level, taxes on lottery winnings of more than $5,000 are withheld automatically at the 24 percent rate.

The two Florida Powerball winners are lucky in that their state doesn't have an income tax. The winners in Ohio and Virginia, however, will have to deal with withholding on their winnings also going to their state tax collectors.

Even if you do usually pay state taxes, some states have special tax rules for lottery winnings, ranging from lower rates to no taxes on resident winners.

Your tax adviser, and you should hire/consult him or her before you go collect your winnings, can help you maneuver these immediate tax matters, as well as advise you on the next tax steps a sudden millionaire must think about.

2. Decide how you want your money.
The smart-ass answer to the question as to when to collect your cash is "as soon as possible." But that's not necessarily the smart answer.

Depending on where you live, you'll have time, possibly months, to decide whether to get your winnings at once in a lump sum or as 30 annuity payments over 29 years (the first payment is immediate).

For this latest nearly $397 million jackpot, the lump sum payment before taxes would be about $274.6 million. 

Your tax pro can help you break out the tax costs of the choices.

The advantage of taking a lump sum is you get all the money at once. The disadvantage of taking a lump sum is that you must pay tax on the entire amount in one tax year.

The advantage of an annuity is that you're taxed only as you receive the payments. The disadvantage of an annuity is you only get a few million a year. OK, not really a disadvantage, but you know what I mean.

You also don't have any control with an annuity over how the winnings might grow. Compare the effective yield of the annuity with what you could earn by taking the money at once, paying the taxes and then investing the proceeds on your own.

You also need to do a little economic and political prognosticating.

The current top federal individual ordinary income tax rate is, thanks to the Tax Cuts and Jobs Act (TCJA) is 37 percent. Plus, if you do take the cash now and invest it, note that there's the added 3.8 percent net investment income tax that's tacked on to earnings by wealthy taxpayers, of which you'll be a part.

The current federal top individual tax is in effect through tax year 2025. After that, it could go back up to the previous high of 39.6 percent. Or depending on the outcomes of intervening elections, it could hold steady or be cut some more.

Similarly, you need to think about what your current state tax liability is and might be in the future.

That's a lot to consider, which brings us to tip #3.

3. Pick a team of financial and legal advisers.
Regardless of how you take the winnings, you're probably going to be in the highest tax bracket for a while. Your tax pro, as well as an investment adviser, accountant and attorney can help you sort through the financial and legal intricacies of dealing with such a large amount of money.

There are ways to legally shelter your income, but typically they are complex. That's why the rich hire the best and brightest advisers to maneuver through the financial and tax rules and regulations.

You're part of that wealthy club now, so use some of your winnings to hire experienced financial professionals to help safeguard your membership.

4. Carefully consider gifts.
With all that new disposable income, you'll probably want to share the wealth. Good for you.

The gifts likely will include funds for charities as well as to friends and family. (Speaking of which, none of mine in Florida are answering their phones. Hmmm.)

If you want to give to your favorite IRS-approved nonprofit, talk with the charity first. While it will definitely be grateful for the financial help, getting a huge gift also could pose some planning issues for the organization.

Charitable gifts survived the TCJA changes. They are still tax deductible if you itemize and the new tax law even allows donors to give up to 60 percent of their adjusted gross income (AGI). Previously, the limit for gifts to public charities was 50 percent of the philanthropist's AGI.

But don't just show up with a big check. Work with the group, again through your financial advice team, to set up a giving strategy that helps the charity and does your financial and tax plan some good, too.

Again, your tax adviser can suggest options, such as establishing an endowment for your favorite nonprofit or a donor advised fund, that work best for your new tax and financial situation, as well as the charities with which you want to share your new wealth.

As for your family and friends, make sure you know what effect such a gift could have on them and you. True, gifts are never taxable to the recipient, but when you give more than the annual gift exclusion amount — which is $15,000 this year — then you have some tax paperwork to complete.

Also, note that an extravagant gift, however well-intentioned, could have additional financial obligations that the recipient isn't prepared to meet.

An expensive car means higher auto insurance costs. A high-dollar home also will have more operating and maintenance costs, as well as an equally high property tax rate that the new homeowner might not be able to meet year after year.

And don't forget the ultimate gift, bequests to heirs. Again, your financial dream team can help you work through the considerations of what will happen to your money once you're gone.

The TCJA has greatly increased the federal estate tax exemption. Currently, heirs can leave a tax-free estate of up to $11.58 million, twice that for a married couple. It's also adjusted annually for inflation, so by the time this is a consideration, more of your estate could be free from the 40 percent federal estate tax.

This larger exemption is in place through 2025, unless political changes on Capitol Hill produce other tax changes. Again, another good reason to have a tax pro to help you track expected adjustments as well as any large-scale revisions.

A handful of states also collect an estate tax. A couple have inheritance taxes, too, so include that possibility in your bequests.

5. Add up your gambling losses.
OK, 2020 has just begun, so unless you have a major gambling problem, you probably don't have many gambling losses yet.

And realistically, with the amount of winnings from this latest Powerball drawing you'll never accumulate enough in losing bets to make a dent in your taxes due on the jackpot.

Some of my old, losing Powerball tickets. Yes, I've been a sucker for big jackpots years!

But for the rest of us casual gamblers who occasionally drop a few dollars on lottery tickets or other games of chance, our relatively meager winnings — one of my $2 slips this week paid out a big $4 — might be offset by our more common gambling losses.

While the TCJA made a lot of changes to the Internal Revenue Code, one tax break of interest to bettors remains. You still can deduct your gambling losses against any winnings as an itemized deduction on Schedule A.

The key, as with all things tax, is to keep track of your gambling wins and losses throughout the year. Your losses can offset your winnings, but not create a gambling loss.

For most of who occasionally waste a few bucks on Powerball or Mega Millions when the pots get too big to resist taking a chance, our lottery tickets will go into our gambling loss folder.

But you never know. Good luck on your future lottery dreams. And bookmark this post, just in case!

You also might find these items of interest:

• Don't get into lottery tax trouble
• Super Bowl tax tips for the big game's prop bets
• How to report your gambling winnings to the IRS

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