Secret Poor Tax: The Lottery

For every $10 of your earnings, as little as $2.00 to 2.50 might ever reach the pocket of a lottery winner

Often, only 60-65% of lottery ticket sales are paid out as winnings

States often receive money three ways when you buy lottery tickets

Most everyone enjoys dreaming of winning it big in the lottery. News media outlets publicize the large unclaimed pots of money on the evening news and they put a spotlight on the lucky multi-million dollar winners. Little do most people realize that the Federal and State Governments are quietly using this gambling device to double and triple tax those who can least afford it: the poor and lower middle class.

The Lottery Wage Drain

Why do we tolerate this?

A single lottery ticket does not cost a lot. The lucky winner is the one who pays the extra tax on everyone’s behalf, but they don’t care because the pot is so large. So by taxing us in small stages and by shifting who pays the tax on lottery winnings, a wonderful re-taxing formula has quietly emerged for state and federal taxing authorities. Put another way, if you were told to voluntarily pay 75% of your wages to government-sponsored programs for the rare chance of getting everyone else’s remaining 25% would you do it?

What to do?

If you think the funds being scooped up by the government is ethically wrong what can you do about it?

Checkmark Stop buying tickets. If the lottery no longer generates sales, the programs would be discontinued.
Checkmark Pressure legislatures. Why aren’t lottery winnings taxed at a lower rate? Shouldn’t the government acknowledge they’ve already received tax on this income? We have lower tax rates on dividends and capital gains so why not on lottery winnings? If you agree, send a letter to your representative asking that lottery winnings be capped at the lowest income tax rate or a special rate for lottery winnings.
Checkmark Tell everyone you know. If you think the double and triple taxing of income through lotteries is not right, make everyone you know aware of this tax trick. The more that know, the more likely something will change.
Checkmark Tax planning. If you win the lottery, consider taking the annuity option and then move to a no income tax state. You won’t save in Federal taxes, but it should save on some of the ongoing state tax obligation.

Playing the lottery is fun. Dreaming of being rich is nice. Having our government promote these things as an opportunity to re-tax its everyday citizens is at best a questionable practice.

Year-end Tax Moves

More important than ever
Costco recently announces a special $7 per share dividend payable in DecemberLegendary basketball coach Bob Knight sells his NCAA championship rings
These are just two examples of moves that are occurring because of imminent changes in the tax code that will occur at the end of this month. While Congress wrestles with what they will do, the rest of us are running out of time to take action prior to yearend. While the tax code changes are vast, a few of them require immediate planning.1. Dividends are getting a tax increase.A big tax increase. They will go from capital gains tax rates (0 to 15%) to ordinary income tax rates (10% to 39.6%). Plus there is a potential bonus Medicare tax of 3.8% if your income exceeds $200,000 single and $250,000 married.Action to take: 401K fee disclosures delayed
Important If you are a shareholder in a small C corporation, consider taking dividends now. It could save a tremendous amount of federal tax versus 2013 and beyond.

2. Capital Gains tax rates are increasing as well. The maximum long-term capital gains tax rates are scheduled to increase 33% from 15% to 20% unless Congress acts.

Action to take:

Important Review your portfolio and consider the appropriateness of taking long-term gains now versus holding the investment. Remember in 2013, these gains might be subject to the 3.8% Medicare surtax as well.
Important Consider the possibility of delaying capital losses. These losses can offset capital gains. If capital gains tax rates go up, then the value of these loses next month improves when netted against higher taxed gains.

3. Last minute charitable donations. Now is the time to finalize your charitable donations. Remember you must always have a receipt (cash donations are no longer deductible without one) and only donate non-cash items in good or better condition. Donations of $250 or more also require an acknowledgement from the charitable organization. Also important, in 2013 these same charitable contributions could be subject to itemized deduction phase-out rules for higher income earners.

Action to take:

Important Make any last minute donations and collect all applicable receipts.
Important Consider making donations this year versus next if your itemized deductions were ever phased out in the past.

4. Don’t forget the year-end “basics.” Just because there is tremendous uncertainty in the tax code, don’t forego the normal discipline of review prior to December 31st. Spend a minute going over the following list.

Action to take now

Important Take your Required Minimum Distribution from retirement accounts if over the age of 70 ½.
Important Rebalance your investment portfolios as necessary
Important Review any medical and dependent care spending accounts to ensure you do not lose any unspent funds
Important Make contributions to your retirement savings accounts, especially if you are self-employed
Important Consider last minute retirement conversions if appropriate
Important Consider donating appreciated stock versus writing a check to a favorite charity
Important Estimate your tax liability and make any required estimated tax payments
Important Make any final gift payments while being aware of the annual gift giving limits
Important Start collecting and organizing your tax records

While there are many scheduled changes and much uncertainty, none of us has a crystal ball. Hopefully, Congress will act to help provide clarity sooner versus later. In the meantime, should you have any questions or concerns please feel free to call.