Estate Planning for Lottery Winners: What You Need To Know

Michael Davidov

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Estate Planning Attorney

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Posted almost 4 years ago. 6 helpful votes

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1

Who owns the winning ticket?

At times, colleagues, friends or several family members purchase lottery tickets together with pooled funds. In such situations, the potential owners of the winning ticket must determine whether they were in a partnership relationship at the time the winning ticket was purchased. If a partnership existed, the potential owners can memorialize their partnership in a written agreement, even after they discover that they won.

2

Who accepts the prize?

If one person accepts the prize on behalf of a group, only that person (or that person's estate) will receive checks. The New York Lottery Commission requires that when more than one winner exists for the ticket, an entity must accept the winnings on behalf of the group. Therefore, it is important to memorialize the partnership agreement in writing prior to accepting the prize. Alternatively, a single winner may want to establish a revocable trust with its own employer identification number to accept the prize. First, probating of the lottery winnings will be avoided. Second, the lottery winner can amend the trust without the Lottery Commission's approval. Third, no transfer occurs for gift tax purposes when the winner places the ticket in a revocable trust.

3

Lump Sum vs. Installment Payments

Lottery jackpot amounts are based on annuity payments for a fixed period of time. For example, the Mega Million jackpot pays in 26 annual installments. The winner can elect to collect the winnings in a discounted lump sum payment, equal to the amount the Lottery Commission would have to invest now to yield a payment stream equal to the amount jackpot amount. Lottery winners may take the lump sum payment and invest and control the money themselves. For estate tax purposes, the lump sum arrangement will prevent the lottery winner's successors in interest from assuming a potentially large estate tax obligation. The winner's estate will have the money with which to pay the estate tax and liquidity problems can be avoided. Additionally, the winner can have flexibility in accessing funds in case of an emergency or for other reasons. With a lump sum arrangement, the winnings are always within the lottery winner's reach.

4

Income Tax liability

Lottery winnings are taxable income when received. If the lottery winner elects to take a lump sum payment of the present value of the winnings, the entire lump sum payment is reported as income. Conversely, a winner who receives payments in yearly installments, reports the amount received during that year as taxable income.

5

Gift tax liability

A gift by the lottery winner of the ticket or lottery proceeds may be subject to gift taxes. When lottery winners purchase a ticket jointly, it is important for them to create a partnership agreement before accepting the prize. They should accept the prize in the name of the partnership. Every lottery winner may give up to the annual gift tax exclusion amount (currently $13,000) per year to an unlimited number of donees without incurring a gift tax liability. Annual exclusion gifting is an excellent way to spread the wealth and to reduce the taxable estate of the lottery winner. If a lottery winner is married, the winner can join with his or her spouse and the two can combine their annual exclusion amounts and make gift tax free gifts of $26,000 instead of $13,000. All payments that a lottery winner makes for another person's medical or educational expenses are not subject to gift tax. There is no limit on the amount of these gifts or the amount of recipients. There is no

6

Estate tax liability

The lottery winner's estate may be subject to both federal and State estate taxes at his or her death. in 2011, the estate tax rates are as high as 55% of the net estate. The first million is exempt from estate taxes for federal estate tax purposes. A lottery winner can maximize at death deductions such as the marital and charitable deductions by executing an appropriate will or a will substitute such as a trust. By planning ahead, the lottery winner can control the distribution to beneficiaries and may be able to structure marital trusts and bypass trusts to minimize the estate tax burden. The lottery winner may consider incorporating life insurance into his or her plan. Life insurance planning is an effective technique to pay the estate tax on either the lump sum distribution or the present value of future lottery distributions. By purchasing the life insurance policy in a life insurance trust, the proceeds of the policy will not be subject to est. tax in the winner's estate

7

Conclusion

Winning the lottery has the potential of being a blessing and a curse. Every lottery player needs to consider the ramifications of winning before playing the lottery because the option of electing a lump sum distribution is foreclosed once the ticket is purchased. Immediately after winning, but before claiming the prize, the lottery winner must decide the most effective way of claiming the prize. After collecting the lump sum payout or beginning to receive yearly distributions, the winner must be alert to possible tax strategies. By following the steps outlined in this article, lottery players and winners may increase the likelihood that their luck will not trigger complications for surviving family members and friends.

Additional Resources

Michael Davidov is an estate planning attorney in New York City. He advised clients in matters involving trusts and estates, asset protection, estate administration, estate litigation, and tax matters. He can be reached at 718-793-7000 or http://www.davidovlaw.com

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