If I win the lottery and start a 501(c)(3) nonprofit, how much can I donate and how much can I reduce my federal and the state income taxes? Can I deduct office space and expenses to start the nonprofit?
We continue to get a lot of questions about giving lottery winnings to charity. The key to avoiding income taxes is to give the ticket, or an interest in the ticket, to the charity before the drawing and before you are entitled to the winnings. As soon as you have won the drawing and have the right to the winnings, you have income that is subject to tax. You can offset that to some extent by giving to charity, but you may not be able to offset it entirely.
How much you can donate depends on your other income and the type of charity to which you make the gift. If you win in 2020 and give the winnings to a public charity, you can claim a deduction for 100% of what is basically your adjusted gross income. This is a special COVID tax break for this year only. The deduction is normally limited to 60% of such income. If you are giving a really large sum, so that you won’t be able to raise enough money from other sources to avoid being classified as a private foundation, your federal deduction will be limited to only 30% of your adjusted gross income. You can carry the excess in either case over for five years, but depending on how much you give and how much other income you have, you may never be able to use it all.
If you can legitimately call it an “unusual grant,” you may be able to avoid private foundation status, but you may still have to raise enough funds from enough other sources to sufficiently offset the investment income on your gift to meet the public support calculation requirements. (See Ready Reference Page: “Calculating Public Support Percentage”) If you are going to provide funds for other expenses on an ongoing basis, you won’t be able to claim that it is an unusual grant. You also won’t be able to claim a charitable contribution deduction for giving the nonprofit the use of office space, since gifts of the use of facilities are not deductible.
How you deal with state income taxes will differ from state to state. Assuming your state has a state income tax, you may have the same ability to deduct if the state follows the federal rules entirely. But some states, such as Pennsylvania, do not permit any deduction for charitable contributions, and so there will be no offset of any type to take against the state tax on your lottery winnings. You will have to check your state law to answer this one.