Taxable Lottery Winnings

• The federal tax law that determines which types of income you receive are taxable is broad and covers almost every payment you receive that is not specifically tax-exempt or an inheritance or gift. There is no exemption for lottery winnings, so the Internal Revenue Service expects to see your lottery prizes on your tax return at the end of the year. Depending on how much you win, the payment may even be subject to federal tax withholding. When you fill out your federal tax return at the end of the year, report the lottery winnings as "other income."
  
  

State Tax Implications

• If you are lucky enough to win the lottery and live in a state that doesn't impose income tax, then you won't have to pay a second tax on the winnings. However, if you live in one of the 41 states (as of this article's date of publication) that do impose an income tax, your state taxing authority will also require you to pay tax on the winnings. Your lottery payments that exceed the particular threshold in your state will also be subject to a state income tax withholding. If you do pay a state income tax and itemize deductions on your federal return, you can at least claim a deduction for the state tax payments.
  
  

Deducting Lottery Losses

• Unless this is your first time playing the lottery, you can reduce the amount of your winnings that are taxable by deducting your other lottery and gambling losses. In order to claim this deduction, you must first report all of your gambling winnings, not just your lottery winnings. Your deduction, however, cannot exceed the amount of winnings you report. The IRS will require you to retain some documentary proof of your losses to claim the deduction. And although you don't submit the proof with your tax return, in the event of an audit, the IRS expects you to have it available for review. In regard to losing lottery tickets, the best form of proof is to keep every losing ticket you purchase during the year. For other gambling losses, such as from a racetrack or casino, at a minimum, maintain a diary of the location where you gamble, the dates, the wagers you place, wins and losses and the names of people who accompany you.
  
  

Must Itemize Deductions

• Not everyone can reduce taxable lottery winnings with gambling losses. In order to claim the deduction, you must itemize your deductions in lieu of claiming a standard deduction. To determine which is more beneficial, compare the total of all itemized expenses, including gambling losses, with the standard deduction and choose the larger of the two.