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Ways to reduce tax due on lottery & other gambling winnings

Powerball and money stacks

A single winning ticket for the record $2.04 billion Powerball lottery jackpot was sold in Altadena, California.

The good news for the buyer, or buyers if it's a shared ticket, is that California is one of two states that don't tax lottery winnings. The other is Delaware.

The bad news is that the U.S. Treasury still gets a big chuck of the huge payout when the winner(s) finally collect.

Winnings are ordinary taxable income: Since lottery winnings are considered under the Internal Revenue Code as gambling proceeds, the Internal Revenue Service will get a cut.

When winnings are more than $5,000, the amount is automatically subject to 24 percent federal withholding. The tax comes directly out of the winnings.

If it turns out at tax filing time the amount was too much, you'll have to claim the excess as a refund. Or, conversely, if not enough was withheld to take care of the jackpot plus the winner's other income, tax will be due.

A Lottery is a Taxation,
Upon all the Fools in Creation;
And Heav’n be prais’d,
It is easily rais’d,
Credulity’s always in Fashion;
For, Folly’s a Fund,
Will never lose Ground;
While Fools are so rife in the Nation

John Fielding, the 18th-century English satirist

When jackpots are as large as this Powerball amount, there's generally not a lot the winner can do to reduce taxes. However, for the rest of us who collect much, much smaller lottery and other gambling winnings, here are three ways to reduce the tax take on your good luck.

1. Take the lump sum. When you win a large lottery, you get the option to take the payout as a lump sum or in annuity payments over 30 years. Most people take the one big payment.

That's totally understandable, even though the lump sum generally is a much smaller amount than the actual jackpot. Plus, you end up owing tax on the amount in the year you won.

Still, taking the one payment up front could be the better move from a tax certainty standpoint. No, it won't reduce what you owe. But at least you'll know what you owe.

If you take the annuity, you'll owe tax on the annual payouts, along with whatever income you get in coming years.

All gambling winnings are taxed at ordinary income tax rates, which could be, at least through 2025, as high as 37 percent. If Congress hikes tax rates, especially on the wealthy — which is what you are after winning a big jackpot — the rate you'll face in the future could be higher.

2. Share your new wealth. Admit it. You already know what you'd do with a big lottery win. But if you're willing to share the wealth with the less fortunate, it could help cut your tax bill.

Depending on the size of your winnings, donating some of the jackpot to charity should reduce your tax bill. You'll have to itemize, but if the gifts made possible by your winnings, along with other Schedule A claims, are more than your standard deduction amount, it will lower your eventual tax liability.

Note, though, that there is a limit on tax deductible contributions. You can claim cash gifts that total up to 60 percent of your adjusted gross income (AGI). If you hit the donation deduction limit, you can carry it forward as a claim in a future tax year.

3. Deduct your gambling losses. This move also means itemizing. You can claim all the money you lost on lottery tickets that didn't pay off, as well as other gambling losses, against your winnings.

Obviously, a handful of $10 lotto ducats won't make a big dent on a historic lottery like this week's Powerball. But for relatively smaller winnings, the losses could lower the amount of taxable winnings.

As with all tax claims, you'll need to have good records to prove your losses.

And you can only claim losses up to your winnings. You cannot use excess losses to reduce the rest of your income.

But in non-ginormous gambling winning situations, tallying up your losses should help lower the tax bill on your winnings.

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