Taxable Talk

Let’s assume you talk to your attorney, and he advises you that you should create a reserve fund for taxes. Usually, it’s a good idea to listen to your attorney. If you don’t like his opinion, perhaps get a second opinion.

Of course, there’s also the Bozo method. The Miccosukee Tribe runs a successful casino near Miami, Florida. The tribe is exempt from taxes (it’s a sovereign nation). However, its members must pay taxes. They decided that they knew better than their attorney, and didn’t report distributions to its members or create a reserve fund in case their opinion was wrong. The Miccosukees filed a malpractice suit against their longtime attorney in a Florida court. The attorney had copies of his advice which pretty much (to this layman’s eyes) throws the malpractice case in the trash can.

Taxdood has more. Hint: The Miccosukee Tribe is the first nominee for the Bozo Tax Offender of the Year.

Absolute Poker, the now more-or-less defunct company that included UltimateBet, has been hit with a 180 million Norwegian Kroner tax bill ($29.9 million) by the Norwegian tax agency, Skatteetaten. The tax agency accuses Absolute Poker of running 430 million Kroner of business through a now bankrupt alleged Norwegian subsidiary, Madeira Fjord, and owing Norway’s Value Added Tax.

While this could impact Americans seeking refunds of balances on Absolute, it’s more likely that this is symbolic. Madeira Fjord and Absolute are bankrupt, and given the ongoing negotiations with the US Department of Justice its likely (but not certain) that player balances will receive a higher priority than Skatteetaten VAT claim.

Article in Norwegian
Article in English

The IRS has acquiesced to the decision in Mayo v. Commissioner; this decision will be published in the January 17, 2012 issue of the Internal Revenue Bulliten according to Linda Beale. The Mayo case allows a professional gambler to deduct his business expenses in excess of his net gambling income (to create a loss).

The effects of this are minor. Had the IRS continued to fight this decision, impacted taxpayers could (and presumably would) cite this case and would eventually prevail in court.

Discussion of Decision (January 2011)

I’ve been asked numerous times over the past few weeks one question by poker players: “Can I take a casualty loss on the money I have tied up on Full Tilt Poker?” The answer is a definite maybe, but even if there is a casualty loss it will likely not be a 2011 event.

For those unaware, Full Tilt Poker was one of three business offering online poker to Americans before April 15, 2011. On that date, the US Department of Justice indicted Full Tilt, PokerStars, and Absolute Poker/UltimateBet. The companies were accused of bank fraud and violations of the Unlawful Internet Gambling Enforcement Act (UIGEA) and other statutes. Yesterday, Brent Beckley (one of the founders of Absolute Poker) pleaded guilty to conspiracy to commit bank fraud and wire fraud and conspiracy to violate the UIGEA. His sentencing is scheduled for April 19th.

Of the three businesses, PokerStars has fully repaid its customers. Absolute Poker/UltimateBet announced that the business is closing, with assets being sold in an attempt to repay customers. Full Tilt Poker, after being accused of being a Ponzi scheme, was sold to Group Benard Tapie (GBT). According to reports, GBT will repay non-US customers while the Department of Justice will repay Americans.

So let’s get back to the original question: Can an individual take a casualty loss on his funds at Full Tilt Poker? First, we need to determine whether there has been a casualty loss. A casualty loss is a sudden, unexpected or unusual event where an individual loses something of financial value. There is no doubt that the loss of funds from Full Tilt Poker’s collapse was “sudden and unexpected.” However, there’s a problem with this being a casualty loss. Given that the DOJ and GBT do expect to repay Americans, there’s no loss today. There may be a loss at some future date if funds aren’t fully repaid, but today the most likely possibility for Americans is full repayment sometime in late 2012. That means there is no casualty loss.

This is even true for Absolute Poker/UltimateBet. Given that AP/UB is attempting to sell their assets and repay players, we do not have certainty of what will be lost (or won’t be lost). And certainty of loss is another thing needed to claim a casualty loss. While I doubt that AP/UB will fully repay players, it’s probable players will get something. Until we know what that something is, it’s not yet time to take a casualty loss.

The other question that goes hand-in-hand with this is whether individuals need to claim money “won” on Full Tilt Poker (and Absolute Poker/UltimateBet) that they did not cash out before April 15th. Here we must look at whether individuals constructively received the funds.

The doctrine of constructive receipt governs when income is reported in the United States. If you receive a check on December 29th you can’t hold it until next year to defer the income. You had the funds in your possession (albeit as a check), and there’s no reason you couldn’t have deposited them in December. You constructively received the money and its income in this year.

The same principle holds in reverse. When there is substantial doubt as to the paying of the funds, you do not have constructive receipt. With Full Tilt Poker and Absolute Poker/UltimateBet, such doubt definitely exists. (Given that the Department of Justice has charged Full Tilt Poker as being a Ponzi scheme, even the US government sees this doubt.) I can’t see constructive receipt existing here. (Note: For anyone who received funds from Full Tilt Poker or Absolute Poker/Ultimate Bet in 2011, there is definitely constructive receipt.) Until the funds are repaid, there likely is no constructive receipt.

Finally, I’ve been asked, “Can’t I just deduct the money I had on Full Tilt Poker (or Absolute Poker/Ultimate Bet) as a gambling loss?” No. You clearly did not lose the funds in a wagering event. This isn’t a gambling loss. This may be a theft or loss of funds on deposit, but today all we know is that the funds are in limbo.

Nine individuals came to Las Vegas this past weekend to compete for the championship at the World Series of Poker. Who would be the lucky winner? And who really got to keep the money?

This year’s World Series of Poker concluded late last night at the Rio Hotel and Casino in Las Vegas. The winner of the main event won $8,715,638 but would he actually end up with all that money?

This year we have the first winner ever from Germany. Congratulation to Pius Heinz of Cologne.

First, Mr. Heinz benefits from the US-Germany Tax Treaty. Under that Tax Treaty, gambling income earned in the US is exempt from US taxation. (Without a tax treaty, he’d lose 30% of his winnings to the IRS.) Next, Germany considers gambling to be a use of after-tax (earned) money so for gamblers it’s tax free. (German casinos, however, are heavily taxed: They pay die Spielbankabgabe and other taxes to the German states.) Thus, Mr. Heinz gets to keep all $8,715,638 of his winnings.

Martin Stazko of Trinec in the Czech Republic placed second for $5,433,086. Mr. Stazko is yet another player who thanks the diplomats of his country; the US-Czech Tax Treaty also exempts gambling winnings so he owes nothing to the IRS. It is unclear if gambling winnings are taxed in the Czech Republic. It appears that they may be taxed if you are a professional gambler but are not taxed if you are an amateur. Mr. Stazko has called himself a professional, so we’ll assume he pays the 15% tax rate and will lose $814,963 in taxes.

Ben Lamb, a professional poker player originally from Tulsa, Oklahoma, finished third. Mr. Lamb was the World Series of Poker Player of the Year. The $4,021,038 he won is on top of the $1,332,832 he won previously at this year’s World Series of Poker. Of Mr. Lamb’s $4.0 million, I estimate he’ll owe $1,524,011 to the IRS and $241,268 to the Oklahoma State Tax Commission. Mr. Lamb will owe 37.9% of his income to taxes.

Edit: I have been informed that Mr. Lamb now resides in Las Vegas and has done so for all of 2011. Thus, he will not owe any tax to Oklahoma.

Matt Giannetti of Las Vegas was the fourth place finisher and earned $3,012,700. As a resident of Las Vegas, he doesn’t have to worry about state income taxes. However, the IRS will take an estimated $1,048,642 of his winnings (35%).

Phil Collins finished fifth. No, not that Phil Collins. Although Mr. Collins was named after the famous singer, this Phil Collins is the only married participant and is a professional gambler residing in Las Vegas. He earned $2,269,599 for his finish and will owe an estimated $852,480 to the IRS (38%).

Eoghan O’Dea of Dublin, Ireland finished sixth. Mr. O’Dea was in position to knock out Ben Lamb on Sunday; Mr. Lamb needed one of three eights left in the deck to fall “on the river” to avoid elimination. Unfortunately for Mr. O’Dea, that’s exactly what happened and Mr. O’Dea was crippled and was soon eliminated. The $1,720,831 will likely assuage some of the bitterness of that final eight.

Mr. O’Dea is also thankful that Irish diplomats did a good job with their tax treaty with the United States; gambling income for Irish citizens is also exempt from US taxation. However, gambling income in Ireland is taxable for professionals (there is no tax for amateurs). Mr. O’Dea, a professional gambler, is subject to a tax rate of 20% on his first €36,400; the tax rate is 41% thereafter. I estimate that Mr. O’Dea will owe $695,018 to the Office of Revenue Commissioners (40.4%). That’s the highest percentage in tax of any participant.

Bob Bounahra of Belize City, Belize finished in seventh place. The native of Chicago earned $1,314,097 for his efforts. The only amateur in the final nine, he wished that Belize diplomats were as good negotiators as those in Germany, the Czech Republic, the Ukraine, or the United Kingdom. He loses 30% of his winnings, $394,229, to the IRS. Normally he’d owe the 15% income tax to Belize. However, he’ll likely get a tax credit from his withholding to the IRS so that he is not double-taxed.

Anton Makiievskyi of Dnipropetrovsk, Ukraine earned $1,010,015 for finishing eighth. Another professional gambler, Mr. Makiievskyi doesn’t have to deal with the IRS; the US-Ukraine tax treaty exempts gambling. Unfortunately, gambling income is taxable in the Ukraine. The Ukraine tax rate is based on monthly income: 15% on the first ₴9,410 (the “₴” stands for the hryvnya, the Ukrainian currency), and 17% thereafter. Mr. Makiievskyi will owe an estimated equivalent of $171,656 to the State Tax Service of the Ukraine.

Sam Holden of Sussex in the United Kingdom finished ninth and earned $782,115. The US-UK tax treaty exempts gambling so he loses nothing to the IRS. And like Germany, the United Kingdom currently does not tax gambling winnings of players so he loses nothing to HM Revenue & Customs. (As an aside, I like the old name, Inland Revenue, much more than the current name.)

Here’s a table summarizing the tax bite:

That’s a total tax bite of 19.45%. Interestingly, last year’s tax bite was much higher (42.99%). That’s because last year every participant at the final table was subject to taxation; this year, two individuals are exempt.

Here’s a second table with the winners sorted by their estimated take-home winnings:

Thanks to tax treaties and how Germany and the United Kingdom treat gambling winnings, this year the taxman wasn’t the big winner at the World Series (the IRS finished second). Still, consider that if Mr. Lamb won he would have finished second to Mr. Heinz in net winnings: Mr. Lamb would have kept only $5,412,349 of the $8,715,638 the winner received.

So congratulations to the winners. Just remember that a winner—perhaps the biggest winner of all—is the taxman. As we all know the house always wins.

PokerFuse is reporting that Full Tilt Poker has been sold to Group Bernard Tapie. The deal is conditional on factors including a favorable resolution with the US Department of Justice. PokerFuse reports that the deal calls for repayment of all players…eventually.

As I noted last week, Full Tilt Poker allegedly paid their owners $440 million, much of that money supposedly coming from player deposits. One question I’ve been asked is, where did that money go?

Well, I don’t know where all of it went, but I do know where a large percentage of it went: The IRS and California’s Franchise Tax Board.

Full Tilt Poker has a complicated structure (to say the least) but it appears that the main vehicle for ownership was Tiltware LLC. That’s a California LLC, still active, with one Raymond Bitar listed as the agent for service. (You can look it up here.) There’s also a Tiltware Merchandise Services, LLC (another California LLC) whose agent for service is one Chris Ferguson. Mr. Bitar is under indictment in the original Black Friday (April 15th) accusations against Full Tilt; Mr. Bitar and Mr. Ferguson are among the accused in last week’s expansion of the civil claims against Full Tilt.

In any case, there were approximately 19 owners of Full Tilt. Assuming that the payments went through Tiltware, California income tax would be owed on the entire amounts of the payments. A California LLC must withhold state income tax on foreign (non-California) members (owners) of the LLC. The withholding rate is 7%. (Some of the members are Californians, and would likely owe up to 10.55% on their income. But I’ll be conservative and use 7%.) That’s a little more than $31 million into the California treasury.

Next is federal income tax. Unless the members had incredibly bozo tax professionals, they’ve paid federal income tax on all of the income they’ve received from Full Tilt. Interestingly, there were no tax charges filed with the original Black Friday indictments. Given that it is routine in allegations of financial crimes for the US Attorney’s Office to check with IRS Criminal Investigations, it’s fairly certain that Ray Bitar paid his taxes.

Using an average federal tax rate of 33%, that’s over $146 million collected in US income tax.

I assume Full Tilt is being taxed as a partnership. An LLC can elect to be taxed as either a C-Corporation or an S-Corporation. Given that Full Tilt has foreign owners, it cannot elect S-Corporation status. While it could be taxed as a C-Corp, it’s more likely that it’s being taxed as the default option, as a partnership.

That leaves self-employment tax. General partners in a partnership (those involved in the business) pay self-employment tax on their income from the partnership. Self-employment tax is at 15.3% on the first $106,800 and 2.9% thereafter. Now, not all of the Full Tilt owners would pay this, but it’s likely that the majority who received distributions did pay this. I’ll use 2% rather than 2.9% as an overall estimated rate for the effect of the limited partners. Still, that’s nearly $9 million more to the Treasury.

The total is $186 million, but that’s an understatement. And that’s probably a significant understatement. Still, even this figure represents 42% of the money distributed.

The problem with this analysis is that for federal tax purposes, tax is owed on the full amount earned, no matter what the distributions were! Suppose you have an LLC that earns $1 million, but you don’t take any withdrawals. You still owe tax on the $1 million!

At this point it’s impossible to know what this excess income was. This would be money plowed back into Full Tilt for development, etc. The estimates I’ve seen state that Full Tilt made on average $150 million a year during this time frame; that would equate to $600 million during the four-year period of 2007 – 2010. That might mean another $52 million in federal income tax and $3 million in self-employment tax have been paid. (There would also be some additional California income tax paid, by the California resident members of Full Tilt. I’ll ignore that for this analysis, but this could mean that I’m still understating the total.)

That gives a high estimate of $238 million in taxes paid, or 54% of the total of money distributed. That would leave just over $200 million for the Full Tilt owners to have actually received after taxes.

I was asked why didn’t the Full Tilt owners just loan the company money back so that they could pay the American players after Black Friday? (The Department of Justice estimates that the amount owed to US players is $150 million.) It’s simple: They don’t have the money. Much of the money has been spent or invested; it’s likely that only a small portion of the $200 million was actually sitting in cash or like funds.

What does this mean for the future? For Full Tilt, lots of legal problems and difficulties in selling the business. Yet there is a rumor that a French firm is looking at acquiring Full Tilt and contributing enough capital to pay all current customers (an estimated $300 million); Americans can only hope that this is true. It’s far more likely that Full Tilt will end up in receivership with the pieces being doled out to high bidders, and all customers receiving pennies on the dollar for whatever they had on deposit at Full Tilt.

The United States Attorney for the Southern District of New York this morning alleged that Full Tilt Poker is a “massive Ponzi scheme.” Back in April, the Department of Justice seized the domain names of the three largest US-facing online poker sites (PokerStars, Full Tilt Poker, and Absolute Poker/Ultimate Bet). Since then, PokerStars has refunded all money on deposit to US players, while Absolute Poker/Ultimate Bet has said basically nothing.

Full Tilt Poker continued to operate for just over two months, until the Aldernay Gambling Control Commission shut them down on June 29th. Full Tilt and the AGCC are having closed door hearings in London today regarding a re-start of Full Tilt Poker. It now appears likely that Full Tilt Poker will never restart.

In a statement, US Attorney Preet Bharara said,

Full Tilt was not a legitimate poker company, but a global Ponzi scheme. Full Tilt insiders lined their own pockets with funds picked from the pockets of their most loyal customers while blithely lying to both players and the public alike about the safety and security of the money deposited.

The owners of Full Tilt Poker are accused of pocketing $440 million since 2007.

Where does this leave players? Assuming the charges are true, its clear that players will not have any of the $150 million (the amount owed to US players; an estimated $300 million is owed to players worldwide) refunded to them voluntarily. The most likely case is that a receiver will wind down Full Tilt Poker’s business, and players will eventually receive pennies on the dollar (after filing claims).

From a tax perspective, this will likely become a casualty loss for players. There are special rules regarding Ponzi schemes and casualty losses (developed after the Madoff case in 2009) that may apply. The problem is that while these losses are definitely related to a Ponzi scheme, are they investment losses?

However, given the US Attorney’s description of the losses, it is possible that Revenue Procedure 2009-20 will apply. There are other possible methods of dealing with this (theft of money on deposit); impacted individuals should consult with their own tax professional as to the best method of treating this loss.

There is time to determine the best tax treatment, though. The losses clearly are 2011 events to be reported (probably) on 2011 tax returns filed in 2012.

One obvious remark: Buyer beware. When you are dealing with an offshore entity, you are going on faith and trust. Sometimes that trust is misplaced.

Illinois Governor Pat Quinn is not happy about proposed legislation that would add five casinos in Illinois. One of these would be in Chicago.

Among his complaints are that it would harm education, increase corruption, lower oversight, and add to organized crime. Included in the legislation would be a lowering of tax rates (the current tax on casinos is between 15 and 50 percent) to a maximum of 20, 30 or 40 percent.

Meanwhile, Illinois politicians and the governor (all Democrats) are playing a game of political chicken. While proponents trumpet the possible new revenues (potentially $1 billion from a Chicago casino) it looks as if this legislation may never get out of the Illinois legislature.

As I’ve said in the past, there are several states where being an amateur gambler is not a great thing. Wisconsin is one of those states. Yet another amateur gambler found that out the hard way.

Carol Kubsch reported $473,075 of gambling winnings and losses as an amateur, and discovered that on her Wisconsin tax return that led to $30,000 of taxes on phantom income. So she amended her returns, and tried to be considered a professional. As Taxdood reported, that didn’t work out well: “Unfortunately, a taxpayer can’t simply categorize oneself the type of gambler that produces the lesser tax bill. The professional versus amateur gambler status is a facts and circumstances determination.”

She might have gotten away with this if she hadn’t filed amended returns. Every amended return is looked at by a human.

Taxdood has more.