Estate planners working with clients who have hit the jackpot in Atlantic City or Las Vegas, or have won the lottery, can assist in the formation of an irrevocable life insurance trust (ILIT) to enhance liquidity and pay assigned federal and state estate taxes before the event of their death. The federal Internal Revenue Service (“IRS”) restricts the transfer of lottery future payments, and some state laws also prohibit assignment of cash transfers of winnings without proper estate or gift planning in place. Creation of an ILIT allows for a decedent to protect family members from unexpected gift and estate taxation of winnings, and plan for distribution of any future payment streams resulting from one of these special assets.
Tax implications of a “win”
Federal estate tax rules for gaming and lottery assets are relatively straightforward. The IRS applies a 25% tax rate to all gaming, gambling, lottery or sweepstakes winnings above $5,000. Winnings less than that amount are exempt from federal taxation. An estate that holds a lottery or other gaming win as an asset is valued on basis of fair market value, but also the winner’s original interest in the asset at time of death.
Annual gift tax rules also apply to gaming and lottery distributions to named beneficiaries prior to the death of an estate’s decedent. The annual federal tax exemption per gift in 2018 is $15,000 per recipient. Spousal gifts of gaming or lottery winnings are separate from this rule. The IRS allows for tax-free distribution of estate property to spouses, including unlimited gift amounts for citizens; and to the annual limit of $152,000 for non-citizens. Some states also apply an additional gift tax to amounts over a designated limit.
The future value of a “win”
Lottery jackpots are special in that the win is typically distributed in annual payments. Payments will continue after the death of the winner. The IRS and state tax boards account for the present value of a lottery asset, plus the full amount of total future lottery payments for purposes of inheritance taxation. If a gaming or lottery winner has not transferred the annual payments from the win to an ILIT or other tax-exempt trust, and there are outstanding payments owed, the estate may lack sufficient funds to pay taxes due.
If a lottery claimant has not reinvested jackpot funds in transferable assets, there is a higher probability that an estate comprised exclusively of lottery payments will be an inheritance tax hassle in the future. By not converting winnings into tax-exempt assets, inheritance tax will greatly reduce the full amount of an estate, and distributions to heirs and beneficiaries. The standard annuity tables published by the IRS provide an index for calculating the future value of payments from a lottery win.
Planning an ILIT
In the United States, a gaming or lottery claimant can form a general partnership, limited partnership, limited liability company, corporation, revocable trust, or irrevocable trust to transfer the cash flows from a prize. A licensed attorney at law specializing in estate law can advise a client in the planning of a ILIT to protect gaming or lottery assets from future loss.
NY Law Firm
Ettinger Law Firm is a licensed New York attorney practice specializing in estate planning and estate probate litigation. Contact Ettinger Law Firm to schedule a consultation about an estate law or trust related matter.
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