If You Win $1 Million, Can You Minimize the Taxes?

You may dream of having $1 million, but if you got it what would your tax plan be? One school of thought says just get the money and you can figure out what to do then. I reject that idea and I’ll show you why – the goal should be to keep more of what you make.

Let's start by thinking about professional athletes and entertainers, who often come into large sums of money but find themselves in a different situation regarding taxes. If they are considered independent contractors and not employees, then they would receive their million dollars without any taxes taken out. With even more up-front money in gross income, they could end up spending even more money, only to receive a surprise at tax time when they find out how much they still owe.

I believe this is one of the reasons that we hear about their tax problems. We often hear of the multi-million dollar contracts athletes sign. That is like the offer letter you may have received from your employer. As you know, it does not indicate what you will actually have in the bank after taxes. (For more, see: Don't Listen to Advice Without Considering Taxes.)

Will a Lump Sum or Annuity Payments Lower Taxes?

In the 1980s I met someone whose boyfriend won $4 million in the lottery. He opted to take the payments whereas most people take the lump sum payment. Was that a good idea? Today, if you take the lump sum in a $1 million lottery, your total federal income taxes are estimated at $356,875. Instead, let’s look at what happens if you take the million dollars as 20 payments of $50,000. Your total federal income taxes are estimated at $5,684 (or $113,680 after 20 years assuming that the tax rate doesn't change). You have saved $243,195 over the 20-year period.

Total Winnings

 $1,000,000

 $1,000,000

Payments

1

20

Paid Out in Year 1

 $1,000,000

 $50,000

Taxes in Year 1

$356,875

$5,684

Total Taxes Paid 

$356,875

$113,680

Tax Savings

$0

$243,195

Winnings Received Over

20 Years

$643,125

$886,320

Will Your Behaviors Cancel Out a Good Tax Plan?

I often ask people if you got your entire paycheck on January 1, by which month do you think you would run out of money? Most people chuckle and say somewhere around June or July. If that is true, then investor behavior is the big issue. If you took a million dollars now you wouldn’t have another million dollars coming the next year. This is especially true if you’re an athlete without a guaranteed contract or a lottery winner. Instead, if you did have the benefit of 20 years of payments, you could only spend so much in the first year. Then you would have 19 more years of that same $50,000 payment to adjust your spending behavior based on the lesson you just learned. (For more, see: How to Manage a Cash Windfall.)

 

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.