State tax planning and the lottery; what does that have to do with me? I buy a ticket, I win, I pay my federal and resident state tax, and I still walk away with a large sum of money, right? Well, yes, but if some states have their way, maybe a little less. If you thought the pandemic was causing odd withholding results, the lottery has been causing problems for some time.
Readers of my blog are well aware of the situation where one can be a dual resident and taxed twice on intangible income. Generally, a nonresident state where you may earn income, taxes you on the income attributable to that state. Your resident state taxes you on worldwide income, which includes the income sourced to the nonresident state and provides a credit for the tax paid to the nonresident state. However, a dual resident with income earned that is not attributable to any state (generally interest and dividends) can end up paying state tax twice since neither “resident” state will provide a credit.
So what does this have to do with lottery winners that are only resident in one state? The state where one buys a lottery ticket may take the position that the income is sourced to us. The state where you are a resident is going to tax you on worldwide income and take the position that the lottery winnings are intangible income and sourced to no jurisdiction. Accordingly, the home state is not necessarily going to provide a credit. Even if a credit is proffered, if the nonresident state of purchase has a higher tax rate than your resident state, you will end up paying more.
The takeaway is to think carefully about where you buy your lottery tickets. Buy in your resident state and you know you will be taxed once. Buy out of state and you will end up sharing more of your winnings with accountants and lawyers. Good luck.
If I have raised questions, contact me at WBerkowitz@BerdonLLP.com or your Berdon advisor.
Wayne Berkowitz, a tax partner and co-leader of the State and Local Tax Group at Berdon LLP, advises on the unique requirements of governments and municipalities across the nation.