Acquiring $1 million in a lump sum is no simple matter and figuring out the amount of taxes due on it is also complicated. The answer depends on several factors, including the source of the money, where you live and whether Social Security and other FICA taxes apply. Individual circumstances make all the difference. In fact, the total tax bite on a $1-million windfall can range from none of it to most of it. A financial advisor can help you create a comprehensive financial plan that includes tax planning.
Overview of Taxes on $1 Million
You may owe several types of taxes on $1 million. Federal income taxes typically claim the biggest slice, although this varies depending on how you came by the $1 million. Capital gains taxes, when applicable, will take a smaller share. State income taxes and payroll taxes, if any, usually demand a more modest cut.
Location is all-important for state income taxes. If you live in one of the nine states that have no income tax you’ll owe nothing. The other states levy income taxes at varying rates. A few cities also have local income taxes that may apply.
While where you are is a factor, where the money came from matters more, at least most of the time. Inheritances and withdrawals from a Roth IRA or similar after-tax retirement account may be completely tax-free. If the $1 million comes from profit on selling an asset such as a stock you’ve owned for more than a year, chances are it will be treated as a long-term capital gain and qualify for a significantly lower tax rate.
In the worst case, the biggest tax bites normally apply if you acquire the $1 million as ordinary taxable income, which includes salary and some other types of income. Here are some scenarios outlining possible tax consequences of acquiring $1 million in different circumstances.
$1 Million Tax-Free
You can accept $1 million without owing any taxes in a handful of situations, including inheritance, insurance and withdrawing from a retirement account. This is not a blanket statement, however. Sometimes you may owe taxes on any of these possible sources of $1 million.
For instance, if you inherit $1 million from your spouse, you will owe no federal tax. Six states tax inheritances from spouses. These are Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. In the rest, you can generally inherit $1 million tax-free.
You can also cash a $1 million insurance payout check without owing taxes, at least some of the time. Life insurance settlements generally escape taxation, for instance. Also, you usually owe no tax on a settlement for personal physical injury, although you often do on a settlement covering emotional injury. An insurance payout for property damage typically owes no tax unless it’s for more than the lost property’s discounted tax basis.
A $1-million withdrawal from a Roth retirement account offers another potentially tax-free scenario. Exceptions exist, however. Certain states tax retirement income and early withdrawals of earnings before reaching age 59.5 may owe a 10% penalty in addition to income taxes.
$1 Million In Ordinary Income
The worst case from a tax standpoint occurs when you earn $1 million in salary. Tax rules treat salary, wages and similar sources as ordinary income subject to several taxes.
To start with, you’ll owe federal income tax. For example, if you’re single and earn $1 million in taxable income, you’ll fall into the highest tax bracket, which is currently 37%. This means that you’ll pay 37% in federal income taxes on the portion of your income that exceeds the threshold for the highest tax bracket. You’ll still owe taxes on your income that fall below this threshold, but you’ll pay at a lower rate.
In addition to the federal income tax levy, most states collect income tax on ordinary income. The highest marginal rate is in California, at 13.3%.
If you earn $1 million from wages or self-employment income, you’ll also have to pay Social Security and Medicare taxes. The Social Security tax rate is 6.2% for employees and employers (12.4% for self-employed individuals) and the Medicare tax rate is 1.45% for employees and employers (2.9% for self-employed individuals).
However, there is a cap on the amount of wages subject to Social Security taxes. In 2023, the cap is $142,800. This means that if you earn more than $142,800 in wages or self-employment income, you won’t have to pay Social Security taxes on the amount above the cap. These scenarios assume that $1 million in ordinary income was received in a single year. You can reduce your tax bill by spreading it over several years if that’s possible.
Other Sources of Income
If you win $1 million in the lottery or gaming at a casino, you’ll have to pay federal income taxes on it because gambling winnings are considered taxable income. States also take a share of gambling wins. However, you’ll escape FICA taxes on your winning bet.
If the $1 million is from a long-term capital gain, such as the sale of stocks or real estate, you’ll pay a lower tax rate than if it were ordinary income. The long-term capital gains tax rate is currently 20% for high-income earners. Capital gains and other investment income are also free of FICA tax.
In addition to location and income source, your filing status can affect how much you’ll pay in taxes on $1 million. For example, if you’re married and file a joint tax return with your spouse, your combined income will determine your tax bracket. If you have children or other dependents, you may be eligible for tax credits that can reduce your tax liability.
Tax management strategies can also moderate your tax burden. For example, you may choose to donate to charity, get a tax deduction and reduce the tax you owe. You may also be able to contribute to a retirement account, subject to the annual contribution limits, reducing your taxable income.
Many factors can affect how much you’ll pay in taxes on $1 million. The source of the funds may be most important. You could owe no tax on money from an insurance settlement or spousal insurance, for example. But if it came from salary or wages you were paid, especially if you live in a state with high-income taxes, you may owe most of your windfall to taxes. Your tax filing status and any tax management strategies also can make a sizable difference.
Tips for Tax Planning
- If you want to learn more about tax planning strategies, consider working with a financial advisor. A financial advisor can help you understand your tax situation and provide guidance on how to reduce your tax liability. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s Tax Return Calculator looks at your income, filing status, withholding, deductions and other key elements to provide you with an estimate of what you will owe at tax time.
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