Does Anyone Really Win the Lottery?

The Prebola v. Commissioner case serves as a reminder that winning the lottery requires significant tax planning. It also serves as a reminder that absent advanced tax planning, the federal and state governments are the only true lottery winners.

Lottery winnings are treated as income from gambling. As noted in the Prebola case, lottery winnings are accorded ordinary tax treatment, rather than capital gains tax treatment. This means that the federal government can impose a 38%+ tax on significant lottery winnings at the time that the taxpayer receives the winnings. The state and city governments where the taxpayer resides may also impose taxes on the lottery winnings at the time that the taxpayer receives the winnings. These taxes could approach 10%+, as is the case for taxpayers in some cities in Colorado.

If that is not bad enough, both the federal and local governments may impose capital gains taxes on proceeds derived from invested lottery winnings. These taxes could exceed 20%+ of the gains. In addition, the federal and local governments may collect excise and other taxes on items purchased with lottery winnings. These taxes could exceed 10%+ of the cost of the items purchased.

And still, the federal and state governments may impose a tax on gifted or unspent lottery winnings. These taxes could exceed 50%+ of the unspent lottery winnings.

For those keeping tabs, the total tax liability can exceed 100% of the lotto winnings — which shows who really wins the lottery.

It appears that Prebola did not present any real claims by bringing suit against the IRS, but, given the amount of taxes that she, and other lottery winners, have to pay, one can understand her frustration. Of course, hiring a tax attorney to help restructure her lottery winnings might be a more productive way to vent her frustrations.