In this, the fourth of five parts of my series on taxes and online gambling, I'll examine state income taxes, withholding requirements, and some legal issues, including the
Silver Platter Doctrine.
State Income Taxes
Americans not only pay federal income tax, we pay income tax to the state we live in. If you're lucky enough to live in Alaska, Florida, Nevada, South Dakota, Texas, Washington or Wyoming, there is no state income tax. Additionally, New Hampshire and Tennessee tax only dividend and interest income.
Every state with a state income tax taxes gambling income. The tax rate will depend on what bracket you fall into. Unfortunately, many states do
not allow deductions for gambling losses. Some of the states that don't allow gambling losses are Connecticut, Massachusetts, and Ohio. Professionals can deduct their losses because they will file Schedule C (or the state equivalent).
And some cities have city income taxes. Some cities tax everything, including gambling; some only tax specific items (usually wages, interest, dividends, and self-employment income). As each city's ordinance is different, you should check with a professional to determine what, if anything, is taxable and what, if anything, can be deducted.
Withholding Requirements
Adding to the filing burden is that many gamblers must make estimated tax payments. The government expects to receive its tax receipts during the year. If you're a wage earner, a portion of your wages are withheld and paid as federal (and state) income tax. If you gamble, and you are successful, you may have to make additional estimated payments. These are done by filing
Form 1040-ES. If you also have wage income, you can increase your withholding to pay your additional tax. If you elect
not to make these additional payments, you may be subject to penalties for underpayment of tax (not enough tax withheld).
I strongly advise gamblers to consult with a professional tax advisor. He or she can look at your tax situation in totality, determine what payments (if any) need to be made and to whom, and give advice to your specific situation.
Deducting More Than You Lose
For the amateur, deductions are limited to the amount of winnings.
This rule also holds for the professional gambler. The professional gambler is in the only profession where losses are not allowed (for tax purposes).
Personally, I believe that this violates the US Consitution's
Due Process Clause. (The "Equal Protection Clause" only applies to states, not the federal government. See
this discussion.) The Tax Court, and Courts of Appeals, have ruled that the prohibition against deducting gambling losses outweighs the professional gambler's right to be treated like any other occupation. To fight this, a gambler would have to show that he's normally a winner, had a bad year, and win in both a Court of Appeals and potentially the US Supreme Court. That's an expensive fight, and unlikely to happen. Thus, don't expect any change in the law soon.
Legal Issues
I am
not an attorney. The remainder of this article is not meant as legal advice. Rather, I'm examining some legal issues from a tax perspective.
I. Nelson Rose, a professor of law at Whittier University,
wrote, “The State Gaming Division acknowledged that a tip from an outside source started their investigation. Jeff says he thinks it was the IRS. This is unlikely, because the IRS is bound by the "silver platter" doctrine, which prevent the IRS from turning over a gambler, and his required tax returns, on a silver platter to local law enforcement.” However, the references that I’ve seen to the Silver Platter doctrine are a bit different.
[This next section gives the history of the "Silver Platter Doctrine." It's not exciting reading, and is in the hidden text below.]
Indeed, the Silver Platter doctrine allowed federal courts to permit the introduction of evidence seized by state officers which had they been seized by federal officers would have been inadmissible, Weeks v. United States, 232 U.S. 383, 398 (1914), so long as no federal officer participated in the search, Byars v. United States, 273 U.S. 28 (1927), or the search was not made on behalf of federal law enforcement purposes. Gambino v. United States, 275 U.S. 310 (1927). This rule became known as the ''silver platter doctrine'' after the phrase coined by Justice Frankfurter in Lustig v. United States, 338 U.S. 74, 78-79 (1949): ''The crux of that doctrine is that a search is a search by a federal official if he had a hand in it; it is not a search by a federal official if evidence secured by state authorities is turned over to the federal authorities on a silver platter.'' In Elkins v. United States, 364 U.S. 206 (1960), the doctrine was discarded by a five-to-four majority which held that inasmuch as Wolf v. Colorado, 338 U.S. 25 (1949), had made state searches and seizures subject to federal constitutional restrictions through the Fourteenth Amendment's due process clause, the ''silver platter doctrine'' was no longer constitutionally viable. During this same period, since state courts were free to admit any evidence no matter how obtained, evidence illegally seized by federal officers could be used in state courts, Wilson v. Schnettler, 365 U.S. 381 (1961), although the Supreme Court ruled out such a course if the evidence had first been offered in a federal trial and had been suppressed. Rea v. United States, 350 U.S. 214 (1956).
The
IRS’ Criminal Investigation Handbook notes, “Evidence obtained by state officers under circumstances which would constitute unreasonable search and seizure under the Fourth Amendment if obtained by Federal officers is equally inadmissible in a Federal criminal trial. This repudiates the former so-called silver platter doctrine which had allowed Federal courts to admit evidence illegally obtained by state officers if there had been no collusion by Federal officials. The Federal court must decide for itself if there has been unreasonable search and seizure by state officers, even though the state court has already considered the question and irrespective of the state court's findings.” (Admissibility of Evidence, Handbook 9.4, Chapter 9.15.4)
So let's examine online gambling.
Chuck Humphrey has concluded that online poker is technically illegal in California. His website has both a summary of his conclusions on the legality of gambling in each state and each state's law. For example, all gambling is illegal in Tennessee and Utah. Of course, the 2003
World Series of Poker champion won his entry via online gambling and hails from Tennessee and, to my knowledge, hasn't been prosecuted. But that doesn't mean you won't be, unfortunately. Until the situation is clarified (and this may take some number of years), the legality of being a professional online gambler is unknown.
On every federal tax return you must include your occupation. This is a statutory requirement. However, you do not have to incriminate yourself (
the Fifth Amendment). There is nothing wrong with an online gambler (filing as a professional) calling himself a professional gambler. That's a correct description of what he or she does. Be forewarned that if you are stupid enough to put down on your tax return that you are in an illegal occupation (e.g. "illegal drug dealer"), you can have your name forwarded by the IRS to other law enforcement.
Today the government isn't attempting to prosecute online gamblers. However, the government might be looking to prosecute owners of online gambling sites and people who work for online gambling sites. Online gamblers are far better off declaring their gambling income on their tax returns and paying their taxes than facing fines, penalties and possible imprisonment for ignoring the law.
In Part 5 (coming next week) I'll conclude this series by examining poker tournaments and taxes.
