Groups That Hit Lottery Jackpot Should Take Steps to Protect Big Winnings

QUESTION: It’s obvious from the recent big wins in the California lottery that pooling cash among a group of people to purchase lotto tickets has become very popular. I’m wondering how these pools operate and how they handle any winnings. Who should administer the payout? Does the lottery allow more than one individual to claim a portion of the prize, or would the group have to set up a trust or corporation? How are taxes computed, and how are they paid? Do members of the pool have any legal remedies available to them in case the “keeper of the tickets” changes his mind about who owns what?--J. P.

ANSWER: You’re right; group pools are a popular way to play the lottery. No doubt they will become even more popular in the wake of all the publicity heaped on the two groups that each won more than $20 million last month. However, there are virtually no laws or regulations to guide pool members in the event they win.

Lottery officials say the state handles all winnings the same way, regardless of whether a group or an individual has struck it rich. They say the lottery will make the payments to only one person: the individual who signed the back of the ticket. This person is responsible for making sure the pot is distributed appropriately.

In reality, of course, a big win by a group is quite different from an individual win. And lottery officials have some valuable--but non-binding--advice for these winners. They recommend that pool winners retain a lawyer to draft a formal agreement specifying how the winnings are to be distributed. They further suggest that the pool members designate a bank or other trust official to handle the distribution among all the players for the entire duration of the lottery payoff. Lottery officials say there’s more than enough time to draft the appropriate papers between the time the winning numbers are chosen and the first checks are distributed.

Although a lawyer’s formal disbursement agreement isn’t needed unless the group wins, it probably makes sense for pool members to sign some sort of document when the group is formed to officially recognize the players and their appropriate shares of potential winnings. The group members might also want to have the document stamped by a notary public to ensure that the ticket signer doesn’t feel any temptation to deny the existence of his partners.

Not surprisingly, the state helps the winners handle their tax obligations to the federal government. (California lottery winnings are not taxed by the state.) The state withholds a full 20% of all winnings for federal taxes. The remainder is paid to the winner. Group winners divide the credit for the withheld tax just as they divide the winnings.

Let’s say a group of four players is entitled to an annual total payment of $1 million, the equivalent of $250,000 each. The state will deduct 20%--or $200,000--for taxes, and the remaining $800,000 will be divided equally among the players. Credit for making the $200,000 tax payment is divided equally among the players, with each capable of claiming a withholding credit of $50,000.

When it comes to filing tax forms, each player would report lottery winnings of $250,000 in addition to any other earnings. They would also claim credit for tax withholding of $50,000, in addition to any other withheld taxes. At this point, the tax obligations of each player will vary according to his total annual income and deductions.

In addition to the standard 1040 tax form, lottery winners must file a Form 5754, “Statement by Person(s) Receiving Gambling Winnings,” with the Internal Revenue Service.

By the way, in any given year, lottery players may deduct their annual lottery losses from any winnings. However, credit is not allowed for losses in excess of winnings. So hang on to those losing tickets. They may come in handy if you ever score the big win.

Q: Last January, I sold my house for $200,000 and carried back a second deed of trust for $35,000. What happens if the buyer does not keep current on the payments to the holder of the $145,000 first deed of trust--a local bank--but does continue the payments to me on the second trust deed?--M. M.

A: We’re going to assume that your buyer is not already in default on his payments to the bank and that you’re just making a hypothetical inquiry. (If our assumptions are wrong, you should consult your lawyer as soon as you finish reading this.)

The best way to protect your interests as a holder of a second trust deed is to file a special “notice of default” form when you record your trust deed in the county recorder’s office. This form, which is recorded along with your trust deed, alerts the primary lender that you are to be notified if the borrower defaults on the first trust deed. This filing should assure that you are, at the very least, told of the default.

Now, if the borrower should default, you have an opportunity to protect your interests. According to Michael Cichon, senior vice president for residential lending at Great Western Savings, you should contact the primary lender as soon as you learn of the default. Ask for the loan service division and give the representative the loan identification number of the mortgage. Once you’ve learned the lender’s procedures for handling the situation and what your various alternatives are, you would be wise to consult a qualified lawyer for assistance.

One of the most common ways of handling defaults is for the holder of the second trust deed to take over payments on the first trust deed and then file default and foreclosure action against the buyer. This method allows the holder of the secondary note to protect his position, a financial interest that could be wiped out if the holder of the primary note handles the default alone. Again, you are well advised to seek legal counsel.