Winning the lottery is an exciting event that can change someone’s life in an instant. However, lottery winnings are considered taxable income by both the federal government and the state of Texas. This means that a portion of any lottery prize will be withheld for taxes before the winner ever sees the money.
Federal Tax Withholding on Lottery Winnings
At the federal level, lottery winnings are taxed as ordinary income based on the winner’s tax bracket. This means winnings are subject to federal income tax up to the highest rate of 37%. For prizes over $5,000, an automatic 24% federal tax withholding applies to the gross prize amount before any other reductions or state taxes are taken out. This 24% covers the winner’s federal income tax liability on the prize money. However, it may not cover the entire amount of federal taxes owed on the winnings. Final federal tax liability is determined when the winner files their tax return for the year. Additional taxes could be due if the winnings bump the winner into a higher tax bracket.
For example, if a Texas resident wins a $100,000 lottery prize, 24% of the gross prize or $24,000 would be withheld upfront for federal taxes. However, if the winner’s ordinary income tax bracket is only 22%, they would receive a refund for the extra taxes that were withheld when they file their tax return. On the other hand, if the prize boosted the winner into the 32% bracket for their total taxable income that year, they would owe additional tax when they file.
Texas State Tax Withholding
Texas does not have a state income tax. Therefore no taxes are withheld at the state level on lottery prize winnings by the Texas Lottery Commission. Residents of Texas get to enjoy the entire prize amount less federal withholding when state taxes are not a factor.
Other Texas Lottery Withholdings
While Texas does not tax lottery winnings, the Texas Lottery Commission does make some other withholdings and reductions from claimed prizes over $5,000:
- Prize withholding – The Texas Lottery withholds any delinquent tax debt, child support, student loans, or other state debt from lottery winnings over $5,000. This ranges from 5-25% of the prize amount.
- Assignment withholding – Outstanding spousal or child support can be withheld if a court order requires it. This is also 5-25% of the prize.
- An annual $5,000 reduction – To help with the cost of the annuity prize payments, $5,000 is deducted each year from claimed annuity prizes over 20 years in Texas.
- Unpaid child support – Any delinquent child support owed by the winner will be paid from the lottery winnings to clear the debt.
These mandatory deductions reduce the actual cash payment a Texas lottery winner will receive. But taxes remain the largest deduction. Federal income tax can take up to 25-30% of a large Texas lottery prize depending on the winner’s tax situation.
What About Lottery Annuity Payments in Texas?
For lottery prizes paid over many years through an annuity, taxes work differently. With annuity prizes, taxes are only applied to each annual payment as it is received by the winner. This helps reduce the overall tax bill compared to taxes being taken all at once on the full prize amount.
Federal withholding of 24% applies to each annuity check before the winner receives it. State tax withholding does not apply. The winner is responsible for paying any additional federal or state taxes still owed when they file returns each year. Annual payments may push the winner into higher tax brackets over time compared to receiving a lump sum.
Tax Rates on Lottery Winnings in Texas
While Texas has no state income tax on lottery winnings, here are the federal income tax brackets and rates that determine how much tax is owed based on total taxable income:
| Taxable Income | Federal Tax Rate |
|---|---|
| Up to $10,275 | 10% |
| $10,276 to $41,775 | 12% |
| $41,776 to $89,075 | 22% |
| $89,076 to $170,050 | 24% |
| $170,051 to $215,950 | 32% |
| $215,951 to $539,900 | 35% |
| Over $539,900 | 37% |
As shown in the table, larger lottery prizes can push the winner into higher brackets. A Texas resident’s winnings are added to their other taxable income for the year to determine their final tax rates. After federal withholding, additional tax may be owed if the prize boosts total income into a higher bracket.
Do You Have to Pay Tax on Lottery Winnings Under $5,000 in Texas?
Prizes under $5,000 are generally not subject to automatic federal or Texas state withholding. However, you are still required to claim the winnings on your tax return. Smaller prizes are reported as “Other Income” on your return.
If your total taxable income including the prize remains under certain thresholds, you may owe no tax. For 2022, a single taxpayer with under $12,950 in total income ($25,900 for married joint filers) pays no federal income tax. You may still need to file a return to report the winnings even if no tax is due.
Claiming Lottery Prizes in Texas
To receive lottery winnings in Texas, you must claim the prize within 180 days of the drawing. For prizes over $600, you will need to provide your name, address, and Social Security number to the Texas Lottery Commission for tax reporting.
Prizes up to $5 million can be claimed at any Texas Lottery claim center. Jackpot prizes over $5 million must be claimed in person at the Austin claim center. When you claim the prize, taxes and any other required deductions will be taken out and you will receive a check for the remainder.
Getting a Lump Sum vs. Annuity Payments
For large lottery prizes in Texas, you are faced with choosing between a lump sum cash option or annuity installment payments over 20 or 25 years. The cash value is lower than the annuity – the Texas Lottery only pays 50-60% for the cash option.
There are pros and cons to each approach. Lump sums allow total control of the winnings immediately. But a large cash amount could be mismanaged. Annuities provide predictable income over decades, but reduce flexibility.
Taxes are also a factor. With a lump sum, all taxes are taken out immediately at likely a higher rate. Annuities spread the tax liability over years in potentially lower brackets. But annuities leave ongoing tax filing duties for the winner.
Establishing a Trust for Lottery Winnings
To help manage a large windfall, Texas lottery winners can benefit from establishing a trust to claim the prize. A properly structured trust allows you to distribute funds over time while optimizing taxes.
A trustee oversees the assets and distributions so winners maintain control without endangering their financial security. Trusts also avoid publicity issues since the trustee can claim the prize anonymously in states where that is allowed.
Payment Options for Lottery Winnings in Texas
For lump sum cash prizes in Texas, the Lottery offers two payment options:
- Cash withdrawal – You can withdraw the cash balance of the prize after tax withholding. The lump sum is deposited into your bank account or paid out in a check within 2-4 weeks after claiming.
- Rollover – Prizes $10,000 or larger can be rolled over into a Texas Lottery Prize Annuity account rather than taken as a lump sum. This allows you to collect your net prize winnings over a minimum 5 years or longer period you choose.
Annuity prizes make annual payments on an established schedule over 20 or 25 years. You cannot accelerate annuity payments, but can use the future cash flows to obtain lump sum financing.
Do Non-residents Have to Pay Texas Taxes on Lottery Winnings?
Out-of-state winners of Texas Lottery prizes only have to pay federal taxes, not state taxes. For non-residents, Texas waives state tax withholding on lottery winnings.
However, your state of residency may tax lottery winnings earned in other states. Check your home state’s rules. You may need to make a state tax payment where you live in addition to the 24% federal withholding taken by the Texas Lottery.
Special Rules for Undocumented Immigrants Claiming the Lottery in Texas
Undocumented immigrants are eligible to play and claim lottery prizes in Texas. Winnings are still subject to 24% federal withholding if over $5,000. To claim a prize, acceptable forms of ID include an unexpired passport, Mexican consular ID card, or foreign ID with identifying information and photo.
The Texas Lottery is required to withhold any legally required back taxes and child support owed by undocumented immigrant winners. Tax identification numbers are accepted in lieu of Social Security numbers for tax reporting purposes.
Can You Remain Anonymous When Claiming Large Lottery Prizes in Texas?
Texas does not allow lottery winners to remain anonymous when claiming large prizes. State law requires the Texas Lottery to release the name, city, and amount won for any prize over $1 million.
To discourage frivolous lawsuits, Texas law protects the Lottery from liability for releasing winner information. However, a trust can be used to keep the winner’s identity private and transfer winnings securely.
Lottery Tax Withholding vs. Your Actual Tax Bill
It’s important to understand that tax withholding on lottery winnings is not necessarily your final tax obligation. Withholding only covers part of what you will ultimately owe in taxes on the income.
Your actual final tax bill on lottery winnings is determined when you file your federal and state tax return for the year. Depending on your overall taxable income and deductions, you may owe additional tax if the withholding did not cover your full liability. Or you may get a refund if too much was withheld.
Do You Have to Pay Estimated Taxes on Lottery Winnings?
For very large lottery prizes, the winner may need to pay estimated taxes during the year to avoid penalties. Federal estimated tax payments are required in your current tax year if you expect to owe at least $1,000 in taxes above any withholding.
After claiming a jackpot, estimated payments help cover your tax liability on the windfall as you receive income. You can make quarterly estimated payments to the IRS and applicable state agencies based on income projections.
How Much are Lottery Winnings Taxed in Texas vs. Other States?
Texas is one of eight states with no personal income tax on lottery winnings or other income. Therefore, Texas residents enjoy a more favorable tax treatment than most states. Here is a comparison of top state income tax rates on lottery winnings:
| State | Top Income Tax Rate |
|---|---|
| Texas | 0% |
| Florida | 0% |
| Tennessee | 0% |
| Alaska | 0% |
| Nevada | 0% |
| Washington | 0% |
| Wyoming | 0% |
| South Dakota | 0% |
| California | 13.3% |
| Oregon | 9.9% |
| Minnesota | 9.85% |
| New Jersey | 10.75% |
| New York | 8.82% |
While state taxes do not apply in Texas, large lottery winners can still face a significant tax bill from federal income taxes. Proper planning is essential to minimize taxes and leverage your windfall.
Can You Reduce Taxes on Lottery Winnings in Texas?
Although mandatory withholding takes a chunk of Texas lottery winnings off the top, some strategies can help reduce your overall tax bill:
- Claim prizes anonymously through a trust to avoid publicity about your winnings.
- Choose the annuity prize option and pay taxes annually at likely lower rates.
- Contribute to tax-advantaged retirement accounts to lower your taxable income.
- Offset winnings with deductible charitable contributions.
- Use losses from other investments to offset the taxable income from your prize.
- Invest in opportunity zones or tax-exempt bonds to generate tax-free income.
Consulting a tax professional can help you navigate policies in your specific situation to minimize taxes owed.
What About Federal Gift and Estate Taxes on Lottery Winnings?
If you give away part of your lottery winnings, federal gift tax may apply. In 2023, you can give up to $17,000 per year, per recipient without triggering gift taxes. Larger gifts reduce your lifetime estate tax exclusion. Estate taxes may be owed if your total estate exceeds $12.92 million at death.
Proper estate planning, including trusts and asset transfers, helps minimize these taxes when distributing lottery wealth.
Conclusion
Texas lottery winners face some of the lowest taxes in the nation due to having no state income tax. However, federal taxes still make a substantial dent in large prizes. With proper planning, you can reduce taxes and maximize your windfall through appropriate withholdings, estimated payments, deductions, and tax-advantaged investing. Consult a tax professional to develop the best strategy for your specific lottery winnings and financial situation.