Powerball. It’s offering a record-breaking $1.5 billion payday if you (and you alone) win. (Of course, to get the $1.5 billion, you have to take it over 30 years; otherwise, you can choose a $930 million lump-sum payment.)
I don’t plan on talking about the futility of winning, or whether you should play. I’d rather talk about the taxes that the lucky winner will end up paying.
Upfront I should note two things. First, Congress, the IRS, and the courts have tended historically to be skeptical of gambling, and rarely provide beneficial tax treatment to winners. But second, there’s a really, really nice provision for lottery winners.
Also, the tax consequences will vary depending on whether the winner is a U.S. citizen or resident, or a non-resident alien (and, if a non-resident alien, the tax consequences will vary depending on her country of residence). With that, let’s go.
You know what would be really bad? Owing taxes on the full $1.5 billion prize in 2016, even if the prize was going to be paid over 30 years. Because if a U.S. taxpayer wins, that taxpayer is going to pay a lot in taxes. Lottery winnings are treated as ordinary income. The win will push her into the highest tax bracket, so in 2016 she’ll pay taxes at rate of 39.6% of her income in excess of $466,951 if she’s married filing jointly ($415,050 if she’s unmarried). If she had to pay all of the taxes on that prize in year one, she’d owe a little less than $590 million in taxes, while she’d be receiving about $50 million a year.
Sure, you say, but that would never happen. That’s crazy.
You’re right that it won’t happen, but it’s not as crazy as it sounds. The tax law has a concept called “constructive receipt.” Simplified, it says that if you have the right to income, but you choose to defer receiving, you have to pay taxes as if you’d received it. And the option to receive the lump sum payment sure makes it look like you had the right to receive your Powerball prize (or, at least, $930 million of it, for a tax bill of $368 million) immediately.
But in 1998, Congress took pity on lottery winners, enacting section 451(h) of the Code. That provision eliminates constructive receipt for lump-sum lottery payments as long as (a) the prize is payable over a period of at least 10 years, and (b) the winner must elect to take the lump-sum payment within 60 days of winning. As long as the Powerball prize meets those criteria (and I have no reason to believe it doesn’t), someone who chooses to take the prize over 30 years won’t pay taxes on any portion of the prize until she receives it.
What if the winner is a foreign person? Generally speaking, lottery winnings by a foreign person are subject to a 30% tax, which is withheld by Powerball. That is, if the foreign person were to elect the lump-sum payment, Powerball would pay $651 million to the winner, and would pay the other $279 million to the IRS.
Certain treaties change this result. Under their respective tax treaties, a winner who was a resident of Austria, Belgium, Bulgaria, Czech Republic, Denmark, Finland, France, Germany, Hungary, Iceland, Ireland, Italy, Japan, Latvia, Lithuania, Luxembourg, Netherlands, Russia, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Tunisia, Turkey, Ukraine, or the United Kingdom would pay no U.S. taxes, and a winner who was a resident of Malta would pay 10% rather than 30%.[fn1]
Unless you live in a handful of countries, you’ll owe U.S. taxes on your Powerball winnings (and I suspect that even in those countries, most winners will owe income taxes to their own government). And, while the tax bite could be worse, the winner will still pay a whole lot of taxes to the federal (and, in all likelihood, her state) government.
But there’s good news: you probably won’t be paying the hundreds of millions in taxes. Because you probably won’t win.[fn2]
[fn1] Technically, the treaties don’t speak to gambling income. But most, if not all, treaties have a provision dealing with types of income not otherwise addressed in the rest of the treaty. In the 27 countries where winners wouldn’t pay any U.S. taxes, the treaty provides that only the country of residence can tax this “other income.” In the rest, both the residence country and the source country can tax it.
[fn2] Sorry, I know I promised not to talk about the futility of winning. But it seemed like a good way to end the post.