The tax implications of being a winner

tax implications of being a winner

If you’re lucky enough to be a winner at gambling or the lottery, congratulations! After you celebrate, be ready to deal with the tax consequences of your good fortune.

Winning at gambling

Whether you win at the casino, a bingo hall, or elsewhere, you must report 100 percent of your winnings as taxable income. They’re reported on the “Other income” line on Schedule 1 of your 1040 tax return. To measure your winnings on a particular wager, use the net gain. For example, if a $30 bet at the racetrack turns into a $110 win, you’ve won $80, not $110.

You must separately keep track of losses. They’re deductible, but only as itemized deductions. Therefore, if you don’t itemize and take the standard deduction, you can’t deduct gambling losses. In addition, gambling losses are only deductible up to the amount of gambling winnings. So you can use losses to “wipe out” gambling income but you can’t show a gambling tax loss.

Maintain good records of your losses during the year. Keep a diary in which you indicate the date, place, amount and type of loss, as well as the names of anyone who was with you. Save all documentation, such as checks or credit slips.

Winning the lottery

The chances of winning the lottery are slim. But if you don’t follow the tax rules after winning, the chances of hearing from the IRS are much higher.

Lottery winnings are taxable. This is the case for cash prizes and for the fair market value of any noncash prizes, such as a car or vacation. Depending on your other income and the amount of your winnings, your federal tax rate may be as high as 37 percent. You may also be subject to state income tax.

You report lottery winnings as income in the year, or years, you actually receive them. In the case of noncash prizes, this would be the year the prize is received. With cash, if you take the winnings in annual installments, you only report each year’s installment as income for that year.

If you win more than $5,000 in the lottery or certain types of gambling, 24 percent must be withheld for federal tax purposes. You’ll receive a Form W-2G from the payer showing the amount paid to you and the federal tax withheld. (The payer also sends this information to the IRS.) If state tax withholding is withheld, that amount may also be shown on Form W-2G.

Since your federal tax rate can be up to 37 percent, which is well above the 24 percent withheld, the withholding may not be enough to cover your federal tax bill. Therefore, you may have to make estimated tax payments — and you may be assessed a penalty if you fail to do so. In addition, you may be required to make state and local estimated tax payments.

We can help

If you’re fortunate enough to hit a sizable jackpot, there are other issues to consider, including estate planning. This article only covers the basic tax rules. Different rules apply to people who qualify as professional gamblers. Contact us with questions. We can help you minimize taxes and stay in compliance with all requirements.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

A buy-sell agreement can provide the liquidity to cover estate taxes

buy-sell agreements

If you own an interest in a closely held business, it’s critical to have a well-designed, properly funded buy-sell agreement. Without one, an owner’s death can have a negative effect on the surviving owners.

If one of your co-owners dies, for example, you may be forced to go into business with his or her family or other heirs. And if you die, your family’s financial security may depend on your co-owners’ ability to continue operating the business successfully.

Buy-sell agreement and estate taxes

There’s also the question of estate taxes. With the federal gift and estate tax exemption currently at $11.4 million, estate taxes affect fewer people than they once did. But estate taxes can bring about a forced sale of the business if your estate is large enough and your family lacks liquid assets to satisfy the tax liability.

A buy-sell agreement requires (or permits) the company or the remaining owners to buy the interest of an owner who dies, becomes disabled, retires or otherwise leaves the business. It also establishes a valuation mechanism for setting the price and payment terms. In the case of death, the buyout typically is funded by life insurance, which provides a source of liquid funds to purchase the deceased owner’s shares and cover any estate taxes or other expenses.

3 options

Buy-sell agreements typically are structured as one of the following agreements:

  1. Redemption, which permits or requires the business as a whole to repurchase an owner’s interest,
  2. Cross-purchase, which permits or requires the remaining owners of the company to buy the interest, typically on a pro rata basis, or
  3. Hybrid, which combines the two preceding structures. A hybrid agreement, for example, might require a departing owner to first make a sale offer to the company and, if it declines, sell to the remaining individual owners.

Depending on the structure of your business and other factors, the type of agreement you choose may have significant income tax implications. They’ll differ based on whether your company is a flow-through entity or a C corporation. We can help you design a buy-sell agreement that’s right for your business.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

A divorce necessitates an estate plan review

estate plan review

If you’re divorcing, it’s important to review your estate plan as early as possible, for two reasons: First, you may wish to revise your plan immediately to prevent your spouse from inheriting or gaining control over your assets if you die or become incapacitated before the divorce is final. Second, although a divorce judgment or settlement automatically extinguishes certain of your former spouse’s rights, some documents must be modified to ensure that he or she doesn’t receive unintended benefits.

Consider revising your will and any revocable trusts to exclude your spouse. Note that, in many states, your spouse will retain elective share or community property rights to a portion of your estate until the marriage ends.

But revising your will or trust will limit your spouse to the legal minimum if you die before the divorce is final. If you have irrevocable trusts, determine whether they provide for your spouse’s interest to terminate automatically upon divorce.

Other actions to consider include:

  • Changing beneficiary designations in IRAs, life insurance policies, annuities or retirement plans (note that federal law prevents you from removing your spouse as beneficiary of a retirement plan, without his or her consent, until the divorce is final),
  • Revising payable on death (POD) or transfer on death (TOD) designations in bank or brokerage accounts,
  • Revoking powers of attorney or health care directives naming your spouse as agent, and
  • Establishing trusts for your minor children. (If they inherit assets from you outright, a court will likely appoint your former spouse as conservator.)

Finally, bear in mind that, under the Tax Cuts and Jobs Act, any alimony paid is no longer deductible by the payer or taxable to the payee.

In light of this major life event, don’t hesitate to turn to us. We can review your estate plan and recommend any revisions necessary because of the divorce.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Charitable lead trusts offer philanthropic and family benefits

Charitable lead trusts

Affluent families who wish to give to charity while minimizing gift and estate taxes should consider a charitable lead trust (CLT). These trusts are most effective in a low-interest-rate environment, so conditions for taking advantage of a CLT currently are favorable. Although interest rates have crept up a bit in recent years, they remain quite low.

CLTs come in two flavors

A CLT provides a regular income stream to one or more charities during the trust term, after which the remaining assets pass to your children or other noncharitable beneficiaries.

There are two types of CLTs: 1) a charitable lead annuity trust (CLAT), which makes annual payments to charity equal to a fixed dollar amount or a fixed percentage of the trust assets’ initial value, and 2) a charitable lead unitrust (CLUT), which pays out a set percentage of the trust assets’ value, recalculated annually. Most people prefer CLATs because they provide a better opportunity to maximize the amount received by the noncharitable beneficiaries.

Typically, people establish CLATs during their lives because it allows them to lock in a favorable interest rate. Another option is a testamentary CLAT, or “T-CLAT,” which is established at death by your will or living trust.

Interest matters

Why are CLATs so effective when interest rates are low? When you fund a CLAT, you make a taxable gift equal to the initial value of the assets you contribute to the trust, less the value of all charitable interests. A charity’s interest is equal to the total payments it will receive over the trust term, discounted to present value using the Section 7520 rate, a conservative interest rate set monthly by the IRS. As of this writing, the Sec. 7520 rate has fluctuated between 2.8% and 3.4% this year.

If trust assets outperform the applicable Sec. 7520 rate (that is, the rate published in the month the trust is established), the trust will produce wealth transfer benefits. For example, if the applicable Sec. 7520 rate is 2.5% and the trust assets actually grow at a 7% rate, your noncharitable beneficiaries will receive assets well in excess of the taxable gift you report when the trust is established.

Act now

If a CLAT appeals to you, the sooner you act, the better. In a low-interest-rate environment, outperforming the Sec. 7520 rate is relatively easy, so the prospects of transferring a significant amount of wealth tax-free are good. Contact us with questions.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Your succession plan may benefit from a separation of business and real estate

Your succession plan

Like most businesses, yours probably has a variety of physical assets, such as production equipment, office furnishings and a plethora of technological devices. But the largest physical asset in your portfolio may be your real estate holdings — that is, the building and the land it sits on.

Under such circumstances, many business owners choose to separate ownership of the real estate from the company itself. A typical purpose of this strategy is to shield these assets from claims by creditors if the business ever files for bankruptcy (assuming the property isn’t pledged as loan collateral). In addition, the property is better protected against claims that may arise if a customer is injured on the property and sues the business.

But there’s another reason to consider separating your business interests from your real estate holdings: to benefit your succession plan.

Ownership transition

A common and generally effective way to separate the ownership of real estate from a company is to form a distinct entity, such as a limited liability company (LLC) or a limited liability partnership (LLP), to hold legal title to the property. Your business will then rent the property from the entity in a tenant-landlord relationship.

Using this strategy can help you transition ownership of your company to one or more chosen successors, or to reward employees for strong performance. By holding real estate in a separate entity, you can sell shares in the company to the successors or employees without transferring ownership of the real estate.

In addition, retaining title to the property will allow you to collect rent from the new owners. Doing so can be a valuable source of cash flow during retirement.

You could also realize estate planning benefits. When real estate is held in a separate legal entity, you can gift business interests to your heirs without giving up interest in the property.

Complex strategy

The details involved in separating the title to your real estate from your business can be complex. Our firm can help you determine whether this strategy would suit your company and succession plan, including a close examination of the potential tax benefits or risks.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.