Poker Tournaments Takes a Hit

Back in 2005, I speculated that the IRS would write a regulation requiring withholding from poker tournaments. The IRS will, on Tuesday, announce Revenue Procedure 2007-57, requiring withholding from any winner of a poker tournament who has received more than $5000 in winnings from the tournament.

First, this is a Revenue Procedure; this is the lowest form of IRS regulation. (The Tax Code is statutory law; it’s the highest form of regulation. Next are IRS regulations. Those are promulgated under the Tax Code. Then come from Revenue Rulings and then, finally, Revenue Procedures.)

Entities do not have to follow a Revenue Procedure. But Revenue Procedures are written so that entities usually follow them. They include verbiage that reads (this is taken from Revenue Procedure 2007-57), “The IRS will not assert any liability for additional tax or additions to tax for violations of any withholding obligation with respect to amounts paid to winners of poker tournaments under section 3402, provided that the poker tournament sponsor meets all of the requirements for information reporting under section 3402(q) and the regulations thereunder.” Of course, this implies the IRS may assert violations to entities that don’t follow the Procedure. Effectively, all casinos will likely follow the Procedure.

So what does Revenue Procedure 2007-57 say? In Section 3.01, it classifies poker tournaments as a “wagering pool.” It does so by referencing United States v. Berent, 523 F.2d 1360, 1361 (9th Cir. 1975). And IRS regulation §31.3402(q)-1(b)(2) requires withholding on wagers in a wagering pool if the proceeds from the wager exceed $5,000.

Interestingly, the Revenue Procedure states that withholding will be required: “A poker tournament sponsor is required to withhold and report on payments of more than $5,000 made to a winning payee in a taxable year….” Per the regulations, the required withholding rate is 25%.

This has two impacts. First, anyone who wins more than $5,000 will receive 75% of his winnings (unless subject to a higher withholding rate). Second, many casinos will again start issuing W-2Gs to everyone who wins in a poker tournament. Once casinos have to start issuing W-2Gs to a few people, casinos will come to the conclusion it’s easier to issue them to everyone.

As to the Revenue Procedure itself, I think it’s a poor application of the law. As I reported back in 2005, I don’t believe poker tournaments are a wagering pool. Wagering pools are when you wager on something else, such as a horse race. Indeed, the IRS came to that same conclusion as I did in a private letter ruling in 2005. The reality is, though, that I don’t think a casino or cardroom is going to challenge the IRS on this. Their attorneys and tax counsels will say that the easiest thing to do is to go along with the IRS Revenue Procedure. Entities that don’t will potentially be subject to additional IRS scrutiny, so following the Procedure is the course of least resistance.

What will the impact be to tournament poker? First, there will be additional compliance with the Tax Code. Given that more W-2Gs will be issued, and withholding will occur, the IRS will see additional collections (which is their goal). The other major impact of this ruling is that money will be taken out of the poker economy. Once this Revenue Procedure goes into effect (March 4, 2008), about 25% of the prize pool of major poker tournaments will vanish. Of course, the IRS will correctly note that this money should have been paid in taxes at some point. However, given that gambling losses are deductible against wins, some of the withheld funds would never have been owed in taxes because of gambling losses.

Will this impact the number of players in major poker tournaments? Possibly. Where it may have the biggest effect is in a series of major tournaments. Suppose John Doe wins $10,000 on day 1 of a tournament. Under the new Revenue Procedure, he will only keep $7,500. There’s a higher chance of him not entering additional events so that the funds don’t reenter the poker economy.

Link to Revenue Procedure 2007-57

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