Winning the lottery can be a dream come true for many, but it can also trigger a number of tax-related complexities. This includes everything from income tax on the sale of lottery payments to substantiating lottery costs and losses. The IRS frequently challenges these issues on audit.
One of these complexities arises when it comes to small lottery winnings and whether or not withholding tax is needed. A recent Private Letter Ruling (“PLR”) from the IRS, PLR 2007130002, sheds light on this issue and provides important insights into the nuances of Section 3402(q) and related regulations governing the withholding of taxes on gambling winnings.
The PLR addresses the question as to whether a state lottery has to withhold tax from lotto winnings if a single taxpayer wins more than one lottery prize from the same lotto ticket where the total winnings exceed $5,000, but the individual winnings do not exceed $5,000.
Section 3402(q) Withholding
Section 3402(q) deals with the withholding of taxes on certain types of non-wage compensation, such as gambling winnings.
Specifically, Section 3402(q)(1) requires persons making payments of winnings subject to withholding to deduct and withhold 25% of such payments. Section 3402(q)(3)(B) defines “winnings subject to withholding” as proceeds of more than $5,000 from a wager placed in a lottery conducted by an agency of a state acting under the authority of state law.
There are special rules and definitions for determining the amount of proceeds from a wager. As relevant here, these rules address the treatment of identical wagers as a single wager for purposes of calculating the amount of proceeds. The “identical wager” provisions were adopted pursuant to Treasury Decision 7919. The regulations also address these concepts.
What is an “Identical Wager”
To determine the amount of proceeds from a wager, Section 31.3402(q)-1(c)(1) of the regulations provides definitions and special rules. For example, Section 31.3402(q)-1(c)(1)(ii) provides that identical wagers are treated as paid with respect to a single wager for purposes of calculating the amount of proceeds from a wager. This means that if a person places multiple identical bets, the winnings from those bets are aggregated and treated as a single wager for tax purposes.
Wagers containing different elements, such as an “exacta” and a “trifecta,” are not identical, and the winning amounts do not need to be aggregated under the identical wagers provisions of Section 3402(q). This means that different types of bets are treated differently for tax purposes.
This brings us back to the PLR at issue in this article and the question as to whether multiple wins on one lotto ticket trigger withholding. In PLR 200713002, the IRS held that the state would not have to withhold the tax as long as the lotto numbers were different. The IRS reasoned that lotto tickets that have different winning numbers are not “identical wagers.” Identical wagers are treated as single wagers.
The IRS provides the following example: Placing two bets on the same horse in a horse race would be an “identical wager” and it would be treated as only one wager. But, there would be no “identical wager” where one bet was placed with the track and the other bet was placed with an off-track betting establishment. Similarly, there would be no “identical wager” if the bets were placed with the same establishment but one bet was for a trifecta and the other an exacta.
Thus, in this case, the IRS said that the lottery numbers would have to be identical for the bet to be an “identical wager.” The state lotto would only have to withhold tax if the winning lottery ticket had the same numbers, because the winnings were treated as different wagers and the individual winnings did not exceed the $5,000 withholding requirement limit. No withholding is required.
The state generally has to withhold taxes on lotting winnings in excess of $5,000. In the case of a state lottery, this PLR shows that withholding is not required if a single taxpayer wins more than one lottery prize from the same lotto ticket where the total winnings exceed $5,000, but the individual winnings do not exceed $5,000, as long as the lotto numbers are different. This ruling highlights the importance of understanding the nuances of Section 3402(q) and related regulations in order to ensure compliance with federal tax laws.