Winning even a small lottery prize has income tax implications. You must report lottery winnings to the Internal Revenue Service, although it won't necessarily change how you file your tax returns. You may have to prepare tax forms that you haven't used in the past, however, 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. You won't find a specific line on your tax form to report lottery winnings, however. 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. In other words, if you purchased $500 worth of lottery tickets and won $750, you must report $750, not the difference – even though you technically only reaped $250 when calculating in how much it cost you to win.
Read More: How to Create a Trust to Claim Lottery Winnings
When to Report
Most filers are cash basis taxpayers, meaning that their returns report income in the tax year it's received, not when it's 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, you might have won $1,000 on a scratch ticket in December 2018 but you didn't cash it until January 2019. In this scenario, the lottery winnings are taxable for the 2019 tax year, which you'd file in 2020.
If you cashed the ticket in December, the prize is taxable in the 2018 tax year, which you would file for in 2019. If your lottery prize is paid out in installments over a number of years, you would only report the installment payments you receive each year, not the total prize amount.
Deducting Your Gambling Losses
You may still be able to claim a deduction for what it cost you to buy those tickets, but you'll have to itemize. You can claim a deduction for gambling losses up to the amount of taxable winnings reported on your return. In other words, you must report at least $100 of gambling winnings as income on your tax return to deduct the $100 you spent on losing scratch-off tickets. Taxpayers often find that they're better off taking the standard deduction rather than itemizing, however. If you claim the standard deduction, you lose the deduction.
Keep Accurate Records
If you intend to deduct gambling losses to reduce the tax on your lottery winnings, you have an obligation to maintain accurate records to 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.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.