Tax considerations

When you\'re learning about something new, it\'s easy to feel overwhelmed by the sheer amount of relevant information available. This informative article should help you focus on the central points.

 

If you base what you do on inaccurate information, you might be unpleasantly surprised by the consequences. Make sure you get the whole Lottery story from informed sources.

For some taxpayers, the dream of a sudden windfall can turn into a awful tax headache. Winning a major lottery prize requires an immediate examination of the winner\'s situation, often including a choice of whether to take the award in a lump sum or as an annuity, determining if there was a preexisting agreement to share costs and winnings, deciding on whether to make gifts—charitable or otherwise—and calculating the impact on the winner\'s potential gross estate.

Every day, in 37 states and the District of Columbia, lottery contestants take a chance on becoming instant millionaires. If they win, their lives will forever be changed by new social, family, and financial pressures. Among the issues they must immediately confront are the tax implications.

INCOME TAX ISSUES

From an income tax perspective, the issues include the timing of income recognition, application of the constructive receipt and economic benefit doctrines, withholding, the ability to offset losses, and the potential to assign or sell the lottery proceeds.

Inclusion in Income
There no longer is any question (if ever there was) but that winnings from lotteries and raffles are gambling winnings included in gross income under Section 61.1 In addition, Section 74(a) states that "gross income includes amounts received as prizes and awards."2 Section 102(a) provides an exclusion from income for gifts, but a lottery prize is received in exchange for the purchase of a lottery ticket and not from the "detached and disinterested generosity" of the lottery.3

In some instances, when a lottery prize is payable in installments, the lottery may purchase a bond or an annuity, and a portion of each annual installment may be designated as interest on the unpaid balance. Section 103(a) provides that "gross income does not include interest on any State or local bond." Given the fact that a portion of each annual installment of a lottery prize is designated as interest, there is at least a color able argument that the interest being paid falls within the scope of Section 103(a). Nevertheless, Rev. Rul. 78-140, 1978-1 CB 27, states that amounts designated as interest to be paid on the unpaid annual installments of the grand prize of a state lottery, with the interest and the installments totaling the stated amount of the prize, will not be excludable from gross income of the winner under Section 103(a).
 

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