Can a lottery winner avoid inheritance tax by placing winnings into trusts and what are the tax consequences?
Executive summary
A trust cannot erase the federal income tax due on lottery winnings: lotteries withhold 24–25% at payout but winners still report the prize as ordinary income and may owe up to the top federal rate (about 37% for 2025 reporting in many sources) when they file [1] [2] [3]. Trusts and entities (LLCs, irrevocable trusts, ILITs) are commonly used to claim prizes for anonymity, split pooled tickets, manage distributions, and to reduce estate or inheritance taxes — but those tools do not eliminate the immediate income tax on the prize itself [4] [5] [6] [7].
1. What trusts can do: privacy, control and estate planning
Winners routinely use trusts—often nominee or “lottery trusts”—to claim prizes so the beneficiary stays private, to centralize management of a big lump-sum, and to control how funds are invested and distributed to heirs; trusts also help avoid probate and can reduce estate-tax exposure when properly designed [5] [4] [6]. Estate planners also recommend irrevocable vehicles such as an ILIT to convert windfalls into estate-planning tools that create liquidity for tax obligations and shelter value from estate tax when successful transfers are completed [7].
2. What trusts cannot do: they don’t eliminate income tax at claim
Federal tax law treats lottery proceeds as ordinary income in the year received, so placing winnings into a trust does not remove that tax liability. State withholding and federal withholding (commonly cited as 24–25% at payout) are taken at the time of distribution, but the winner’s ultimate tax bill is determined on their tax return and can be higher—often pushing winners into the top marginal bracket [1] [2] [3] [8]. Practical guides and tax advisers emphasize that trusts do not negate income tax on the prize [5] [9].
3. Annuity versus lump sum — trust consequences differ
Whether you take a lump sum or annuity changes timing of income and how a trust receives funds. Some trusts can continue to receive installment payments after the winner’s death or be structured to hold annuity receipts, but the present-value of future payments is generally included in estate calculations and income reporting rules still apply [4] [7]. Planners warn that failing to convert or shelter future payments can leave an estate short of funds to pay taxes [7].
4. Using entities (LLCs) or trusts to split pooled wins and allocate tax burdens
When tickets are pooled, claimants sometimes use an LLC or a trust to file and then allocate shares using Form 5754 or similar agreements so income tax liability is spread among actual contributors rather than concentrated on one claimant [6]. That route helps formalize distribution rights and avoid disputes, but it doesn’t change the underlying taxable character of the prize [6] [10].
5. Gift, estate and inheritance tax implications — trust planning matters
After taxes on the prize are paid, large transfers to family can trigger gift tax rules; lifetime exemptions and annual exclusions govern how much can be transferred tax-free (sources note lifetime estate/gift exemptions and annual exclusion amounts that change by year) and trusts can be designed to reduce estate-tax exposure [3] [2] [5]. ILITs and other irrevocable trusts are named in planning literature as ways to preserve value for heirs and create liquidity to meet tax bills [7] [5].
6. Withholding and final tax bill: expect differences
States and sources differ slightly on exact withholding percentages: many cite a 24% federal withholding on large prizes for U.S. residents (with 30% for nonresident aliens), sometimes rounded to 25% in older summaries; final tax due depends on your bracket and total income and can exceed the withholding by a substantial margin [2] [1] [8]. Practical tax guides and filing calculators warn winners that initial withholding rarely covers the total—winners should plan for additional federal and state taxes [8] [2].
7. Conflicting advice and limitations in reporting
Sources agree on the central point—winnings are taxable income and trusts don’t erase that tax—but differ on small technicals (withholding shown as 24% vs. 25% in different write-ups) and on suggested top federal rates (some pieces cite 37% for 2025 while older practitioner notes reference higher historical brackets) [1] [2] [3] [6]. Available sources do not mention a single, uniform method that allows a winner to fully avoid federal income tax by placement into any trust (not found in current reporting).
8. Practical checklist for a winner considering a trust
Assemble a team: tax CPA, estate attorney experienced with lottery claims, financial planner; decide anonymously whether to claim via an entity or trust (state rules vary); choose lump sum vs annuity strategically; use irrevocable trusts (or ILIT) to address estate/inheritance exposure and liquidity for taxes; but budget for substantial federal and state tax bills—the trust is for management and estate planning, not a federal-income-tax dodge [6] [5] [7] [1].
Limitations: this summary draws only on the provided sources; state-specific rules, the winner’s domicile, and up-to-date federal tax law changes can materially change outcomes and are beyond the scope of the cited articles.