Winning even a small lottery prize has income tax implications. You must report lottery winnings to the Internal Revenue Service, though a lotto prize doesn't necessarily change how you file tax returns. You may, however, need to prepare tax forms that you haven't used in the past -- especially if you plan on deducting some of your lottery losses.
All Lottery Winnings Are Taxable
The federal government taxes all gambling winnings, including lottery prizes, at the same rates as most types of other income you earn, such as wages and bank interest. However, you won't find a specific line on your tax form to report lottery winnings on. Instead, your total gambling winnings for the year are reported on the “other income” line of your return. The IRS requires that you enter the gross amount of your winnings without any reduction for gambling losses.
When To Report
Most filers are cash basis taxpayers, meaning their returns only report income that's received during the tax year rather than when it is earned. If you prepare your taxes on the cash basis, you'll only include the lottery prizes that are paid out during the year. For example, suppose you won $1,000 on a scratch ticket in December 2013 but you didn't cash it until January 2014. In this scenario, the lottery winnings are taxable for the 2014 tax year, which you'll file in 2015. If you cashed the ticket in December, the prize is taxable for the 2013 tax year, which you will file in 2014. If your lottery prize is paid out in installments over a number of years, you still only report the installment payments you receive each year -- not the total prize amount.
Deduct Your Gambling Losses
The good news is that in years you have lottery winnings, you can claim a deduction for gambling losses up to the amount of taxable winnings reported on your return. But you have to itemize to take the deduction. In other words, to deduct the $100 you spent on losing scratch-off tickets, at least $100 of gambling winnings must be reported as income on your tax return. If you are better off taking the standard deduction instead of itemizing, your $100 of lotto winnings are still taxable even though the losses aren't deductible because you chose not to itemize.
Keep Accurate Records
If you intend to deduct gambling losses to reduce the tax on your lottery winnings, you have an obligation to maintain records that support the deduction amount. The IRS suggests keeping a diary of all gambling activity that includes information such as the dates you play the lottery or gamble, the cost of tickets and other wagers placed, and how much you win and lose. To support a gambling loss deduction that's attributed mainly to playing the lottery, the agency also suggests holding on to all those losing tickets as well.