The winner of last night’s Mega Millions jackpot just became an instant billionaire. Well, before taxes.
The more than $1.5 billion prize—the second largest lottery prize in U.S. history—comes with a historic tax bill.
If you are holding the winning ticket, there are a few things to sort out before you can go buy a private island.
The first choice is between a lump sum or an annual payout. The lump sum is $878 million, while the annual annuity option totals $1.537 billion, according to Mega Millions.
No matter what you choose, the federal government automatically withholds 24 percent of lottery winnings, which would be about $211 million of that lump sum.
“This federal withholding actually applies to all gambling winnings over $5,000,” Hayes Holderness, an associate professor of law at the University of Richmond, told Bloomberg Tax. “So even if you’re playing craps in Las Vegas and win a $6,000 bet, the federal withholding affects you.”
Holderness said the winner is then on the hook for the remaining 13 percent of federal tax owed in the same year, which brings the total to 37 percent—the top tax bracket. If you choose the annual payment option, you would likely pay the top federal tax rate for all three decades.
South Carolina, where the winning ticket was sold, will also take its cut of the prize: the state’s highest income tax bracket pays 7 percent. That means if you won the more than $1.5 billion prize and opted for the lump sum, you will end up with just under $500 million.
Lump Sum or Payments?
Is there a tax advantage to taking the lump sum or the annual payments?
“Whether or not you would benefit from a lump sum vs annuity depends on whether or not you think taxes will go up or down from where they currently stand,” Jennifer Weidler Karpchuk, a tax attorney with Chamberlain, Hrdlicka, White, Williams & Aughtry in Philadelphia, told Bloomberg Tax in an email. “From a federal perspective, tax rates were cut slightly” with the 2017 federal tax law.
“What we have today could be a historically low tax rate, in which case the lump sum also makes sense from a tax perspective,” Karpchuk said.
Holderness said a smart taxpayer would take the lump sum and immediately invest it.
“If you take the lump sum payout and invest it, you’d only have to pay a capital gains tax when you eventually cash out your investment. This rate currently sits at 20 percent, but it could change in the future,” he said. “In the end, if someone is unhappy with lottery tax rates, they don’t have to play it.”