My friend won $5 million on the Mega Million. We have a partnership and I get 1% of the prize money. Can you explain the tax situation for both of us? Thanks.

In general, the federal government taxes prizes, awards, raffle and lottery winnings, and other similar types of income as ordinary income, no matter the amount. This is true even if you did not make any effort to enter in to the running for the prize. Your state will tax the winnings too, unless you live in a state that does not impose a state-level income tax.
The tax rate will be determined by your income;
As he wins and gives shares to you, he has made gift of a significant amount of money and can expect to file form 709 with the IRS for the gift . and you donot need to pay tax on the gift of 1% of the $5M mega mil.
You could certainly set up an LLC and claim through that, but it won't protect you. If ownership isn't established before a ticket becomes a winner, then you've still got the IRS' assumption that there is only one owner who made gifts after they won. An LLC won't protect your assets, either. An LLC only protects the members against personal liability for the actions of the LLC.