It’s my annual Taxes from A to Z series! This time, it’s Tax Cuts and Jobs Act (TCJA) style. If you’re wondering whether you can claim home office expenses or whether to deduct a capital loss under the new law, you won’t want to miss a single letter.
J is for Jackpot.
The Powerball Jackpot is now $750 million, which makes it the fourth-largest U.S. lottery prize ever. Your odds of hitting the jackpot – and matching all six numbers – are about 1 in 292 million.
If you win, depending on the state, you can opt for a lump sum or an annuity. The annuity option would land you 30 average annual payments of $25 million, while the lump sum option is worth $465.5 million. That is, of course, before taxes: winnings are reportable for federal income tax purposes.
Whether it’s the Powerball Jackpot or just a regular scratch-off ticket, your winnings may be reported to the Internal Revenue Service (IRS) using a federal form W-2G, Certain Gambling Winnings. A form W-2G is issued when gambling winnings other than those from bingo, slot machines, keno, and poker tournaments, are $600 or more and at least 300 times the amount of the wager. A form W-2G will also be issued if winnings are subject to withholding, including backup withholding and regular gambling withholding. For 2019, gambling withholding – including lottery winnings – is equal to the cost of backup withholding: a flat 24% (note that this rate is less than the prior 25% rate).
Your winnings are treated as ordinary income (some limited exceptions apply). So what determines your tax rate? If you take out your money in a lump sum, you’d pay at the rate determined by your tax bracket. Since most Powerball Jackpot winnings are more than the threshold for the top bracket (for 2019, the top rate is 37% for a single taxpayer with income beginning at $510,301), that means that those winnings are almost always taxed at top rates.
If you take your money in a lump sum, you’ll pay at the rate determined by your tax bracket each year. This tends to make sense for prizes worth less. The annuity payment on a $5 million win, for example, would be low enough not to be taxed at the top rate, barring other income considerations. Over time, that could be a money saver; taxpayers like to defer income whenever possible for this reason (that’s probably why you have a retirement account). In the case of the Powerball Jackpot, however, the annuity payment is large enough that the taxpayers would still be taxed at the top rate each year.
Remember that withholding? When you reconcile your taxes, if you withheld too much, you’ll get the difference back in the form of a tax refund. If you withhold held too little, you’ll have to pay the difference. That’s where planning in advance makes sense – and why lottery winners often consult with a tax professional for advice before coming forward.
No matter the amount, you’ll include your winnings as income on line 21 on the new Schedule 1 as part of the not-so-postcard-sized form 1040 (more on the new form here). While all gamblers have to report their winnings, casual gamblers may only deduct losses up to the amount of your winnings as an itemized deduction on Schedule A. That didn’t change under the TCJA. The deduction for gambling losses remains in place; miscellaneous deductions which exceed 2% of your adjusted gross income (AGI) were eliminated, but deductions for miscellaneous expenses not subject to the 2% threshold, like gambling losses, remain.
Other TCJA-related changes may affect your ability, as a casual gambler, to claim losses. Most notably, the increase in the standard deduction, combined with restrictions on home mortgage interest (more on that here) and state and local tax deductions (more on those here), make it less likely that taxpayers will itemize. That means that most taxpayers will claim the standard deduction; if you claim the standard deduction instead of itemizing your deductions, then any casual gambling loss is, well, lost.
When gambling is your trade or business, gambling-related income and expenses are reported on a Schedule C, which means that you do not have to itemize to claim your losses. However, the TCJA modified the definition of “gambling losses” under section 165(d) of the Tax Code to include any deduction otherwise allowable in carrying on any wagering transaction. What that means is that taxpayers whose business is gambling can no longer deduct non-wagering expenses, such as travel to and from a casino, separately from losses. So, for example, a taxpayer with $10,000 in winnings may deduct up to that amount in combined losses and related expenses. This change applies to professional gamblers for the years 2018 through 2025. Before the TCJA, professional gamblers could deduct travel and other costs related to gambling without regard to wins and losses (that was the rule previously confirmed by the Tax Court in Mayo v. Commissioner).
And while this series focuses on federal income tax, don’t forget about state taxes. You’ll pay a tax on your winnings in most states, but you’ll catch a break in California, Delaware, Florida, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Those states either have no income tax, or there’s no state tax on lottery prizes in those states.
For more Taxes From A To ZTM 2019, check out the rest of the series: