$1.6 Billion Lottery Winner Will Face Huge Taxes, Possible Lawsuits
With no lotto winner, the combined Mega Millions and Powerball jackpots stand at an astounding $2.2 billion. Yes, billions. The Mega Millions jackpot has reached $1.6 billion while the Powerball pot is up to $620 million.
These world record astonishing numbers seem even more likely to brew big potential liabilities. Of course, everyone should know that taxes on winning tickets are an unavoidable downside. But who wouldn’t want this tax problem? Even after taxes, there’s lots left over, right? First there is the cash v. annuity question, but taxes will come out of either one. Lottery winnings are taxed, with the IRS taking taxes up to 37%. Yet the tax withholding rate on lottery winnings is only 24%. Given that big spread, some lottery winners do not plan ahead, and can have trouble paying their taxes when they file their tax returns the year after they win. Depending on whether your state taxes lottery winnings, you may have to add state taxes too.
(AP Photo/John Minchillo)
Even if the tax withholding doesn’t cover it all, most people still assume they will end up with a lot. But apart from paying the taxman, what if friends, family or co-workers claim a share of the loot? Office pools, informal understandings, and casual deals to split winnings can all bring trouble. It happens more frequently than you might think. It might start with an innocent comment that someone says was an oral agreement. Remarks about splitting winnings can be misinterpreted. Some winners face lawyer fees for defending against the claims.
Most such cases settle, yet taxes can hit on such legal settlements in surprising ways too. The jackpots do not need to be in the hundreds of millions for winners to be targets. Take the 53-year-old California woman who won $1 million, but who faced a lawsuit by the liquor store owner who sold her the winning ticket. Eva Reyes was a winner, but the owner of the liquor Store where she bought the ticket sued her . The store owner claim ed she promised to split the money—$350,000 each after taxes—for fronting the money to buy the tickets. The plaintiff claimed there was a signed note guaranteeing him half the winnings.
The fallout from lottery lawsuits can be especially devastating. For one thing, the shadow of claims by co-workers, former spouses and others who say they deserve a share can tie up the money for years. So be careful what you say and to whom. One case upheld a 20-year-old oral agreement to split lottery winnings. The stakes and tax problems can grow larger on bigger lottery prizes. With $1.6 billion at stake, one can only imagine the creative claims that could arise. And the usual tax problems on winnings can get even more complex. Unless there is a tax partnership, a winner may be taxed on it all, yet only be allowed a partial write-off for the damages paid to those claiming a share.
The tax rules for litigants are complex, made more so by recent tax changes. Here is how legal settlement awards are taxed after the big tax reform law passed in December of 2017. Even if you win a lawsuit, you may have to pay the IRS, even on your attorney’s fees paid directly to your lawyer . The tax rules have gotten worse under the Trump Tax Law, with no deduction for legal fees! Some s uits over lottery winnings are with co-workers and (former) friends. Some disputes are with family members or with the IRS. In Dickerson v. Commissioner, an Alabama Waffle House waitress won a $10 million lottery jackpot on a ticket given to her by a customer.
The trouble started when she tried to benefit her family and to spread the wealth. The IRS said she was liable for gift taxes when she transferred the winning ticket to a family company of which she owned 49%. The waitress fought the tax bill, and eventually landed in Tax Court. But the court agreed with the IRS, so she lost. Some tax advice before the plan might have avoided the extra tax dollars, generated because her tax plan was half-baked. In short, she shouldn’t have assigned her claim in a waffle house . Time and again, lottery winners have trouble paying their taxes and resolving disputes. But cheer up, what are your odds of winning the combined $1.6 billion? They are said to be 1 in 302.6 million.
An earlier version of this story incorrectly stated the combined jackpots totaled $1.6 billion. The combined Mega Millions and Powerball jackpots total $2.2 billlion.The lotto winner could have a big payday, but taxes and lawsuits might not be far behind.
Planning on Sharing your Lottery Winnings with your Family: Write it Down Now!
MegaMillions mania is sweeping the nation. With the grand prize over $500 million, people are dreaming of what they would do with the money, and how they would share it with their families and friends. One one hand, the odds of winning – 1 in 175 million – are infinitesimal. But hey, someone has to win, and it might as well be you. There is however, one guaranteed winner in the lottery–the IRS. Not only are the lottery winnings taxable income to the winner, which will be taxed at a marginal rate of 35%, if the winner tries to share them with his family, there could be substantial gift taxes imposed also.
When someone wins the lottery, what is often done is their family will claim the prize through a partnership or other business entity that is comprised of family members. With a partnership the family could have varying interests. The theory is that the family all decided before the lottery to invest in the ticket together. Mom and Dad contributed 50 cents to the investment cost of the ticket, Uncle Bob contributed 25 cents, and Cousin Rita contributed 25 cents. The family will either claim that the partnership purchased the ticket, or the ticket is then contributed to a partnership in exchange for proportionate interests in the partnership.
If this works, this helps to solve two significant tax issues -the income tax and the gift tax. Because of the marginal nature of the income tax, and because a partnership in itself does not pay taxes, but passes the taxes on to its partners, splitting the income among multiple partners saves on income taxes, because each individual partner has the opportunity to be taxed at the lower bracket rate before reaching their highest marginal rate. Of course, with a a jackpot this size, the difference might seem de minimis.
The other issue is the gift tax. As I’ve written about before, there is wealth transfer tax comprised of the gift tax and the estate tax. Each person can give away, during life or at death, a certain amount of property before the tax kicks in. Currently, that amount is about $5 million a person. Any property given away over that is taxed at the rate of 35%.
So by claiming the lottery winnings as a family partnership, a winner can claim that they are not making a taxable gift, because it was a family investment. This could save millions in gift taxes.
The problem is that in most cases, the IRS knows that it’s baloney. While it’s certainly possible to have agreements among family members (or friends, or co-workers) to enter into a lottery pool, the IRS will not look to kindly on post winning shams. If audited, they will ask for the partnership agreement that existed prior to ticket buying. They will ask when the family members contributed the money. They will ask your history of buying tickets as a family, etc.
Lesson? If you are planning on sharing the lottery with other people, make sure that there is some sort of agreement beforehand.
Or, take the winnings for yourself and flee to Tahiti.
About David Shulman
David is a Fort Lauderdale attorney with a law practice focused on estate planning, probate and trust administration, guardianships, and tax. Among other things he is a Mac nerd, BBQ lover, and blogger.
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