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Home » Estate Planning » California Estate Tax and Lottery Winnings

California Estate Tax and Lottery Winnings

September 12, 2016Estate Planning

estate planningIf you are one of many who shares the misconception that there is an estate tax exception for lottery winnings, you may be disappointed. With the enticingly large multi-state Powerball payouts lately, the potential estate tax consequences for lottery winnings can be significant. Although there is no California estate tax on the state level, the IRS will be sure to take its share of your winnings. Here is what you need to know.

California Estate Tax has been eliminated

As of January 1, 2005, California no longer imposes a separate estate tax at the state level. Therefore, the only estate tax liability California residents need to be concerned with is on the federal level. Currently there are 17 states who still impose estate tax on the state level. However, gift taxes are still imposed. A gift is property you receive from someone while that person is still alive. Generally, the person giving the gift is the one who will be responsible for paying gift taxes and reporting that gift to the IRS. The person receiving the gift does not have immediate tax liability. However, there may be future tax consequences, such as when the gift is sold.

The federal estate tax exemption

The federal estate tax exemption allows an estate with a value below the exemption amount to be passed on tax-free. As of 2016, the exemption amount is $5.45 million. The tax exemption is “portable,” meaning that the surviving spouse of a decedent can take advantage of any unused portion of their deceased spouse’s exemption. .

Sharing your lottery winnings with family

It is very common for lottery winners to make arrangements for sharing those huge winnings with their family members. Some even have plans in place for sharing their lottery loot even before they buy their lottery tickets. These arrangements can work as long as they are bona fide, binding arrangements to share the proceeds, which actually allow for the transfer of the winnings to a special account to be shared directly by family members.

However, if the arrangement isn’t made properly, the sharing of lottery proceeds will result in simple gifts to family. The misconception is that there is a federal exception to gift or estate taxes when lottery winnings are shared amongst family.

The IRS will still get its share of lottery winnings

What you need to know is that there is no lottery exception to the imposition of gift or estate taxes. A lottery winner’s estate will include his or her interest in the lottery winnings as of his or her date of death, at fair market value. The regular gift tax rules also apply to lottery winners.

Lottery winners may make tax-free gifts to any number of individuals as long as the total amount given to each beneficiary in a year does not exceed the annual exclusion from the gift tax ($14,000 per recipient in 2016).

The use of a lottery trust

When a transfer is made prior to claiming the lottery winnings, the gift tax issue becomes a little trickier. Certainly, the wisest thing is to make a gift of an interest in the lottery ticket before the winning numbers are selected. That way, the value of the gift is insignificant. If you regularly play the lottery, it would be a good idea to have a sharing agreement in place ahead of time, just in case. In this way, you may be able to avoid gift taxes.

An oral agreement might suffice

There have been a few cases where oral agreements to share lottery winnings have been sufficient to avoid adverse gift tax consequences. For example, in once case a family established that the two parents and five adult children contributed money jointly toward the purchase of lottery tickets each week by contributing dollar bills to a goldfish bowl. Subsequently, the winning ticket was purchased with the pooled funds so the shares allocated to the children were not considered to be gifts.

Because there was no written partnership agreement documenting the sharing arrangement, however, the Internal Revenue Service ruled that state law regarding oral partnerships applied, meaning that all seven family members were deemed to own equal shares of the partnership (and not the unequal shares they wanted to use).

Issues with transferring lottery proceeds to an entity

In one particular case, a lottery winner created a corporation after winning so that the entity could claim the lottery proceeds. She and her spouse owned 49% of the stock in the company and other family members owned the remaining 51%. In that situation, the court determined that the 51% owned by the family actually constituted a gift. In doing so, the court rejected the argument that there was an enforceable contract for a number of reasons. Primarily, there was no written agreement and the family members involved had no obligation to buy or contribute to buying the tickets. In fact, it was not clear from the arrangement how many family members were actually a party to the agreement.

Join us for a FREE seminar! If you have questions regarding California estate tax, or any other estate planning issues, please contact the Schomer Law Group for a consultation, either online or by calling us at (310) 337-7696.

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Scott Schomer, Estate Planning Attorney
Scott Schomer, Estate Planning Attorney
A graduate of Boston University School of Law, Scott P. Schomer is a frequent lecturer on estate planning and elder law issues, having discussed these important issues on local and national television. A seasoned courtroom advocate, Scott has obtained combined judgments and verdicts in excess of twenty-five million dollars for his clients. Scott has served as a member of the Los Angeles Superior Court Probate Volunteer Panel (PVP Attorney), Probate Settlement Panel and a Judge Pro Tempore. Scott's expertise has been recognized by his peers with such accolades as a life-time membership in the Multi-Million Dollar Advocates Forum, the Five Star Wealth Manager designation, and repeated nominations as California Super Lawyer.
Scott Schomer, Estate Planning Attorney
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