Welcome!
If you're reading this, you've probably won something on a game show. First off, congrats! Secondly, you've probably been warned a large tax bill is coming. How do you prepare for this? That's what this post is about.
Avoiding an underpayment penalty
The first thing you want to do is adjust your withholding at work to avoid an underpayment penalty. Details about how to that are here:
How much will you owe?
You've set your withholding to avoid a penalty and you know a large tax bill is coming early next year. You may be wondering exactly how much larger your tax bill will be due to your game show winnings. Unfortunately, it depends on too many factors to give a generic answer to that. However, we can calculate an upper bound. The maximum federal tax rate is, as I type this in early 2025, 37%. Most people aren't in that tax bracket, but we'll use that to calculate our upper bound. Simply multiply your winnings by 37% and that will be your maximum possible federal tax.
Example: You won $50,000. Your maximum federal tax liability on those winnings is 37%*$50,000 = $18,500
What do you do with the money you will owe the IRS?
What you do with the money you know you're going to owe the IRS depends on how good you are at saving money.
If you can't help spending money
First off, I'm not judging you! This is mathematically worse than the method below, but if you're the type who knows you're going to spend money if you have it, then pay the tax amount calculated above to the IRS as an estimated tax payment as soon as you receive your winnings. Then, if 37% ended up being more than you actually owed, you'll get the overage back as a refund when you file your taxes next year. You can make an estimated tax payment here:
Note: If you make an estimated tax payment, you still need to adjust your withholding as described in the previous post!
If you can save money
If you are the type who's able to put money in an account and not spend it, then take the maximum tax amount calculated above and put it in a high yield savings account (HYSA) as soon as you receive your winnings; not only are HYSAs risk-free, as of early 2025, they'll give you somewhere around 3.5-4% interest on your money while you're waiting to give it to the IRS. If you already have an HYSA, see if your bank lets you open a separate account so the tax money stays separate from your other HYSA money. Keep the money in that account until you fill out your taxes next year and find out how much you owe. Then pay the IRS the amount due, move the rest of the money into your "normal" accounts, and put it towards life.
Example: You put $18,500 from the example above into an HYSA account earmarked for taxes. Due to interest, it has risen to $18,870 when you file your taxes next year. After filing, you discover you owe "only" $9,463 in taxes. Pay that $9,463 to the IRS and take the remaining $9,407 and do whatever you like with it.
Note: Do not invest this money! Individual stocks, ETFs, mutual funds, cryptocurrency, etc. all have the risk of going down in the short term, which you don't want to happen to money you know you're going to need to pay the government next April.
Don't forget about state taxes!
This article is only about federal taxes, but you may have a tax bill that you have to pay to your state as well. The math is similar to before: find the maximum tax rate for the state you live in and multiply it by your winnings to determine the maximum amount you'll have to pay your state. Then save that until early next year.
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