Spreading Out the Taxes on Lottery Winnings

By Cliff Ennico

March 12, 2019 6 min read

"I have an unusual question for you. If I win a large prize in the lottery, should/could I establish a nonprofit corporation to receive the prize? I asked a financial adviser about this, and he said I could do it and also keep the identity of the manager (me) hidden from the public.

"There are two reasons I have for wanting to do this. The first is to keep my identity secret so that no one will know that I won the money. The second is to spread the winnings out over several years, thus possibly lowering the tax rate. According to him, the money will not be taxed when it is paid to the organization by the lottery commission but only when it is dispersed by the organization.

"I am not so much worried about paying the taxes, but keeping my identity secret is very important. I have read about and seen too many instances where families have been torn apart because there is no fair way to share the money. Someone will always feel they did not get as much as they should have. Do you have any thoughts on this?"

First of all, this is a WONDERFUL problem to have. Congratulations!

Let's start with the basics. Lottery winnings are considered "income" and you must pay federal and state income taxes on them.

At the federal level, if you win more than $5,000 in the lottery, 25 percent must be withheld from your winnings for federal income tax purposes. You will receive a federal W-2G form from the lottery commission showing the amount of lottery winnings paid to you during the year and the amount of federal and state income tax withheld.

You report your lottery winnings as income in the year (or years) you actually or constructively receive those winnings. If you're required to take the winnings in annual installments, you only report each year's installment as income for that year. Most states require you to choose between lump sum and installment payments when you buy your ticket, while others will allow you to make the choice after you've won. But the choice usually must be made within a specified time period.

I think your financial adviser is recommending you set up a private foundation to claim the winnings. For a concise summary of the IRS rules on private foundations, see "The Life Cycle of a Private Foundation" page on the IRS website.

It isn't easy — or quick — to set up one of these. First, you must create the corporation, which will take a week or two. Then, the corporation will have to apply for exemption from federal and state income taxes under Section 501(c)(3). The IRS does not rush to grant these exemptions. In fact, they are currently cracking down on nonprofit abuses, and if they even suspect that your corporation does not have a bona fide charitable purpose, they will delay and delay and delay.

Your financial adviser is correct that most states will not require you to disclose your identity when setting up the corporation, as long as you use a registered agent service such as Cogency Global Inc. This will cost between $100 and $200 a year. You should also plan to pay $5,000 to $10,000 a year (to your financial adviser, I suspect) to file the required legal and tax paperwork for your private foundation.

A cheaper and quicker way to preserve your secrecy and anonymity is simply for you (and your spouse) not to say anything to family members about your winnings: no law requires you to do so. And if word leaks out and creates divisions within your family, all I can say is, "Welcome to the upper class." These are issues that all wealthy people face, wherever their money came from. This is why all wealthy people (even "nouveau riche" like yourself) need to hire top-notch estate planning attorneys to ensure that the division of wealth upon one's death is as fair as possible. Frankly, if it were me, I would spend my money on that rather than on a private foundation.

If the fear that your sudden wealth will destroy your family is simply unbearable, consider doing what Microsoft Corp. founder Bill Gates has said he plans to do: Create separate trust funds for all of your kids (allotting the same amount of money for each) with enough money to get each one through college and graduate school ($300,000 apiece should do it).

Then, donate the rest of your winnings to a bona fide public charity (to find out if a charity is bona fide, search online at https://www.irs.gov/charities-non-profits/tax-exempt-organization-search). You will get a huge charitable deduction, receive tons of positive publicity, be seen as a hero in your community, and your kids probably won't hate you too much since they were treated equally.

As for your other family members, buy them lottery tickets ...

Cliff Ennico ([email protected]) is a syndicated columnist, author and former host of the PBS television series "Money Hunt." This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our webpage at www.creators.com.

Photo credit: at Pixabay

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