Taxable Talk

Question 1.

"Good afternoon Russ,

"I am a regular [poker] player online and I was wondering the policy in the state of California? Is there a certain amount and above that needs to be reported on your taxes? Since the money comes in overseas is there even a policy?"

The US Tax Code is quite explicit about gambling income: it's taxable. And whatever the source--US or foreign--all income is taxable unless Congress explicitly exempts it.

California taxes start with the Adjusted Gross Income from your US tax return. The only gambling income exempted on a California tax return is California lottery winnings.

Either report it or you are committing tax evasion.

Question 2.

"Hello, sir:

I AM 73 YEARS OLD AND WON A $1700.00 $1.00 TRIFECTA. I RECEIVED A W2-G FORM from Churchill Downs Racetrack but i don't know what or where to go with it.

The Form shows that no money has been withdrawn yet from the Winings. i understand that the Law states that in horseracing, a person owes taxes if the winnings are 300 times the wager. Therefore, if I played a $1.00 Trifectsa( I bet $36.00) i am liable. Right?

If so, my friend, what do I do now? I pay NO TAXES currently. The only money taken out of my check is a $93 amount for Medicare.

Can you please tell me how to proceed? I DO appreciate your help."

First, you owe tax on all gambling winnings whether or not you receive a W-2G. Your gambling winnings go on line 21 of Form 1040 (other income). You can deduct losses up to the amount of your winnings as an itemized deduction on Schedule A.

It sounds like your only other income is Social Security. Assuming that the $1700 is your only gambling winnings of 2008, you almost certainly won't have to pay income tax on your winnings--your Social Security won't be taxed and with just $1700 of income you won't owe any income tax. However, if you have other significant gambling winnings your Social Security could be taxed.

Question 3.

"I reside in New York City, and am planning on moving to Thailand at year-end and will be a professional gambler. I understand that if I'm out of the US for 330 days out of 365 I'm eligible for the Earned Income Exclusion."

So far so good....

"My question is how can I avoid New York taxes? How can New York tax me when I'm going to be a resident of Bangkok?"

At this point, cue Murray Head and One Night in Bangkok. Now that we have the appropriate theme in the background, here's the answer: Because they can.

Seriously, every US citizen is considered a resident of a US state or territory. You have a domicile (residency) in that state. Until you establish a domicile in another US state or territory you are considered a resident of whatever state you currently reside in. The toughest states in enforcing this are New York and California; both routinely conduct residency audits.

You may wish to consider first establishing residency in a state with no income tax, such as Texas, Florida, or Nevada, before moving to Thailand. You would need to sever your ties with New York and establish ties with your new state. You should stay in your new state for several months so that you truly become a resident of your new state.

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Just a reminder: This opinion is limited to the one or more Federal tax issues addressed in the opinion. Additional issues may exist that could affect the Federal tax treatment of the transaction or matter that is the subject of this opinion and the opinion does not consider or provide a conclusion with respect to any additional issues. With respect to any significant Federal tax issues outside the limited scope of this opinion, the article was not written, and cannot be used by the taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.

The TaxProf Blog alerted me to an interesting Tax Court case decided earlier this week. Once again the Court looked at whether or not an individual can be a professional gambler when that individual specializes in video poker.

In video poker, you play against a machine and attempt to try to get the best payout possible. Because the payouts are shown on the machine you can calculate your exact expected value by playing any machine.

The petitioners in todays case were a successful New York City physician and his wife. The doctor decided that he wanted to start playing video poker, and he went to the nearby Mohegan Sun casino. He looked at the paytables of various video poker machines and only played progressive machines with big payouts.

To be a professional gambler an individual needs to keep good records. I recommend to everyone they keep a gambling log: a pocket notebook where you record your wins and losses. But the petitioner in today's case decided to rely on the casino for his records:

Petitioners were misguided to assume that Dr. Merkin’s Players Club card would keep a complete business record of his activities at a casino and that this record would absolve them of the duty to maintain business records. See sec. 6001. It is the taxpayer’s duty, and not that of the casino, to maintain such records. Sec. 6001. In short, his lack of records and accountability for his activities illustrates to us that Dr. Merkin did not carry on his video poker playing in a businesslike manner.

The Court didn't like that his Club card was his only record: "In fact, the only credible evidence in the record with respect to Dr. Merkin’s time spent playing video poker in 2003 was a Player’s Club statement generated by Mohegan Sun and provided by petitioners at trial."

That was strike one.

Next, it helps to be profitable. One of the tests to see if an individual is conducting a business or a hobby is whether he makes money. The petitioner was losing money, so did he change his system?

Despite Dr. Merkin’s playing time (whether it was 319 or 1,128 hours), he did not testify that he spent any time honing or adjusting his system when it became clear to him that he was not on track to make a profit playing video poker in 2003. See sec. 1.183-2(b)(2) and (3), Income Tax Regs. Dr. Merkin did testify that he read video poker magazines and kept abreast of the machines and their respective payout histories at the casino, but he did not prove that he used this knowledge to adjust his system in the light of his overall losses. We view Dr. Merkin’s failure to spend any time adjusting and/or improving his system as a factor weighing against his gambling activity’s being a trade or business.

He didn't, and that was strike two.

Next, the petitioners argued that if you included the value of the gifts they received with their Club card they would be profitable. But there's a problem with that, and the Court saw it quite easily:

The items he earned through redemption of his Player’s Club points were items that he essentially paid for with the amounts that he bet. Put another way, if petitioners were to have purchased all of the items they received through the redemption of their Player’s Club points in 2003, it is highly improbable that the value of those items would equal the amount of money wagered by Dr. Merkin in 2003.

Moreover, and with respect to the items for which Dr. Merkin redeemed his Player’s Club points in 2003, we note that petitioners failed to report as income the value of any car, airfare, or travel that they acquired from the casino in 2003...However, if Dr. Merkin received any items of that type in redemption of his Player’s Club points, we could not permit him to have it both ways; that is, by taking the value of those items into account to determine whether his gambling activity was engaged in with the actual intent of making a profit while not including the value of those items in income.

That's three strikes, but the Court found a fourth strike. The test to be a professional gambler includes that you use the income for your livelihood. However, the petitioner in this case is a successful physician who "...had ample disposable income as a result of Dr. Merkin’s practice to cover the expenses associated with two residences as well as Dr. Merkin’s spending while at Mohegan Sun."

It doesn't help when the petitioner admits that his gambling wasn't making money. "Dr. Merkin conceded this reality when he admitted at trial that his system did not work." Indeed, the physician has given up video poker.

But losing this case won't be the end of the story for the doctor. He will soon be hearing from the New York Tax Department. Why? Because once your income reaches a certain level—and given the petitioner's successful medical practice, it's a certainty he's well beyond that level—New York only allows 50% of itemized deductions. Thus, while the petitioner owed $21,000 in additional tax to the IRS, he will face a substantial tax bill from New York on his gambling...and he was an overall loser. At least he gets to deduct 50% of the losses; had he resided in Connecticut he would get none of the losses.

Case: Merkin v. Commissioner, T.C. Memo 2008-146

Nevada's constitution exempts food for human consumption. The Nevada Department of Taxation believed that Use Tax was owed on meals that were given out free of charge (either to employees or as complimentary meals to patrons); the Nugget Hotel in Sparks, Nevada thought that the plain language of the Nevada Constitution exempted such food from tax. The Nevada Supreme Court gave the answer earlier this week.

Use Tax is the equivalent of sales tax on items purchased from out-of-state where no sales tax is charged. For example, if you purchase a book on Amazon.com and are not charged sales tax and live in California, you are supposed to remit Use Tax to the Board of Equalization. The Nevada Department of Taxation believed that there's no such thing as a free lunch, and that the Nugget owed Use Tax on the free food.

The Nevada Supreme Court disagreed.

"...[T]he Nugget’s initial purchases of unprepared food did not “escape” sales tax liability since Nevada’s constitution exempts such purchases from sales and use taxation. Indeed, Nevada’s constitutionally mandated food exemption applies to all “food for human consumption,” unless that food is “prepared food intended for immediate consumption.” Because the food at issue in this case was not “prepared food intended for immediate consumption” at the time it was purchased by the Nugget, the Nugget’s initial purchase was exempt from sales taxation. Furthermore, the Nugget’s later “use” of that food to prepare complimentary meals was not subject to use taxation since the Nugget’s “use” did not follow an otherwise taxable purchase that had “escaped” sales tax liability."

So many Nevada casinos may be requesting tax refunds from the Nevada Department of Taxation. Nevada, too, has a state budget crisis. This ruling may exacerbate that a bit, but it does prove that sometimes there really is such a thing as a free lunch.

Hat Tip: TaxProf Blog

We get mail. Now, I don't answer all of it, but this weekend I got quite a bit of interesting email. A reader asks,

"I caught your appearance on the Ante Up podcast last week, so I thought I'd take a look at your blog and subscribe to your feed. Both the blog and your appearance on the show was very helpful.

"I had a question. I remember when Jamie Gold won the WSOP main event in 2006 he waited to collect his funds for several weeks. Now, I don't care to discuss the whole legal battle he had. I recall the reasoning for him waiting to collect his money had something to do with positioning himself for taxes and potentially creating some sort of corporation around this.

"We all dream of winning the big one. If one was to win the big one, what type of options around taxes and collection of your winnings would be smart to look into? I am curious if you could claim professional at that time or if you could have your corporation collect the funds."

Good questions. First, the timing of income for most taxpayers is guided by the doctrine of constructive receipt. When you can access the money it's income. In the case of 2006 World Series of Poker winner Jamie Gold, it didn't matter if he waited to pick up his winnings until 2007—he could have picked it up in 2006. Thus, he clearly had 2006 income.

He of course had legal issues which as you noted delayed his receipt of the money. And he may well have wanted to get some advice from an accountant regarding the tax implications. Had I been advising him I would have told to make sure to put at least 40% of the money aside to pay California and federal taxes.

The question of whether an individual gambler is a professional or an amateur is one governed by the facts and circumstances of each case. For example, today Joe Hachem (the 2005 winner of the World Series of Poker) is a professional player. However, he wanted to be considered an amateur when he won because of Australian tax issues. Mr. Hachem won his case. Returning to your question, there is no one right answer.

You also ask whether you could assign your winnings to your corporation. This is an issue I'm often asked: Can an individual incorporate and be a professional gambling corporation and are there any tax advantages to doing that? I have significant doubts whether the IRS would accept a professional gambler without ancillary sources of income as a corporation. Gambling is a personal service, and this poses another problem. The Tax Code has a special type of corporation for personal service corporations; they are taxed at a flat 35%. And a 35% tax rate defeats the purpose. Most corporations are formed for liability reasons; that's a non-issue for professional gamblers.

You could elect to be an S-Corporation. But an owner of an S-Corporation must pay himself a "reasonable" salary, so the savings is limited to the self-employment tax differential between a reasonable salary and $102,000. That's if the IRS accepts it.

And there's one last hurdle. Last year Harrah's (the owner of the World Series of Poker) refused to honor correctly submitted Form 5754s and told anyone who submitted a Form 5754, "You have to deal with the tax problems," and issued W-2Gs solely to the winner. That policy violated IRS regulations, but until the IRS stops Harrah's I'm sure their illegal policy will continue.

An intriguing question, and one that I hope you have to ponder this summer.

I've been asked by some of my gambling clients about ePassporte, an e-wallet that's now in widespread use. The question that has arisen is whether ePassporte is a foreign bank account like Neteller was.

It's hard to figure this out from ePassporte's web site. Their official name is "ePassporte, N.V." which certainly doesn't sound like an American entity. The whois for their domain returns an address in Curacao. ePassporte offers banking services, so if they're a foreign company they would meet the requirements of a foreign bank under Treasury Department regulations.

So where is ePassporte headquarted? They're headquartered in St. Kitts, part of the Federation of Saint Kitts and Nevis, the smallest independent nation in the Caribbean. So if you have an account at ePassporte it is a foreign bank account. If you're a US citizen and your high balances in any foreign bank accounts when added together add up to $10,000 or more, you must file Form TD F 90-22.1 and check the box on Schedule B. If you willfully don't file Form TD F 90-22.1 the minimum fine is $100,000.

So if you have foreign bank accounts and meet the threshold of reporting make sure you comply. You have until June 30th for your report to make its way to the Department of the Treasury (this form is file with the Treasury, not the IRS).

A New Jersey couple frequented Atlantic City, and enjoyed playing the slot machines. In 2004, they were "lucky" enough to win $208,420 in jackpots for which they received W-2Gs. The couple, though, didn't include that income on their tax return as they had lost overall while gambling in 2004 and they used simple logic to determine that overall losers don't have to include gambling income on their tax returns.

Unfortunately, that's not the case. The couple's return was examined (audited) and the IRS added the $208,420 as gambling income (and did allow an itemized deduction of the same amount). However, because their adjusted gross income (AGI) changed several deductions were disallowed or negatively impacted. They ended up having a tax deficiency of $4,190. They appealed to the U.S. Tax Court.

Unfortunately for the New Jersey couple, gambling income must be included as part of your income even if you're an overall loser for the year. As the Court noted,

"The jackpots that petitioners received constitute gambling income. A taxpayer in the trade or business of gambling may deduct wagering losses to the extent allowable in computing adjusted gross income. A taxpayer who was not in the trade or business of gambling may deduct wagering losses only to the extent allowable as an itemized deduction to compute taxable income."

The couple were not professional gamblers (they both had full-time employment) so the IRS was correct—the $208,420 must be included as income (though they do get an itemized deduction for their losses up to the amount of their wins, $208,420).

The IRS also attempted to impose a negligence penalty under §6662(a). The petitioners explained that they had been preparing their returns in this manner for years without any problems and that they felt that logically losers wouldn't have any income. Luckily, the Court saw the logic in their remarks (though the couple is incorrect on the law).

So the New Jersey couple will have to pay the $4,190 but do not have to pay an additional $838 for negligence. This case shows the unfairness of the US Tax Code toward gamblers—the couple lost and their taxes went up. The wages of sin, I suppose.

Case: Dawson v. Commissioner, T.C. Summary 2008-17

And that's not a good thing.

Assume you're an amateur gambler. You add up your winning and losing sessions for the year, and find that you have $150,000 of wins and $100,000 of losses. You get to deduct the $100,000 of losses on your federal income tax.

But if you're a resident of Louisiana, you can't do that on your state return. Louisiana penalizes anyone who takes itemized deductions. The formula for calculating the LA itemized deductions is:

57.5% * [(Fed. Itemized ded'ns) - (Fed. Standard ded'n)]

This is especially bad for amateur gamblers, because gamblers must include all of their wins as part of their Adjusted Gross Income but none of their losses. At least Louisiana gives a deduction from income of the amount of federal income tax you pay...

So Louisiana joins my list of states where a gambler shouldn't reside. Here's the complete list:

Connecticut
Illinois
Indiana
Louisiana
Massachusetts
Michigan
Minnesota (because of its AMT)
Mississippi (Only MS gambling deductions are allowed)
New York
Ohio
West Virginia
Wisconsin

The Swedish tax agency, Skatteverket, is targeting online poker players and affiliates. Skatteverket uses an online "spider," or web crawler, to find web sites that appear to be income producing. They then investigate to see if they've reported income and/or paid their Swedish income tax. A report in Poker News says that Sweden has found 47 cases of unreported income totaling €44.5; poker players, according to Poker News, represented €5 million of this.

Sweden apparently, like the United States, taxes all gambling income. I've reported on spiders before, and noted that the IRS won't confirm or deny whether they use such software. However, the IRS doesn't need that sophisticated software to make some headway into determining who has and hasn't reported their online gambling income. Neteller is cooperating with the US Department of Justice. What agency in the United States might want information about gambling income besides the Department of Justice? As I've said before, not reporting your online gambling income is not only a violation of US law, you're now likely to get caught given Neteller's cooperation.

Today the Tax Court looked at the case of a "pathological gambler." This isn't a problem gambler. As the Court noted,

"A pathological gambling disorder is a type of impulse control disorder and mental illness, not an “addiction”. This disorder is accepted by the scientific community and is in a category with kleptomania (the impulse to steal stemming from emotional disturbance rather than economic need) and trichotillomania (pulling hair). Dr. Pike concluded that Mr. Gagliardi suffered “from the almost delusional belief that if he gambled long enough, he’d win everything back or break even.”"

The IRS claimed that this pathological gambler didn't have any back-up to claim his gambling losses from 1999-2001. The taxpayer disagreed. Which side did the Court believe?

The preferred method of keeping a record of gambling wins and losses is through a gambling log. The gambler in question, Mr. Gagliardi, didn't do that. He had won the lottery in the early 1990s and began, in the late 1990s, to use the proceeds to gamble on slot machines at local Indian casinos. He didn't keep a log; however, he did keep all of his W-2Gs (issued when he won a jackpot of $1200 or more) and his ATM receipts. Mr. Gagliardi testified during the trial Mr. Gagliardi opined that he “could wallpaper my
bathrooms with just the ATM receipts for millions of dollars.” His ex-girlfriend also testified to his gambling.

But this wasn't good enough for the IRS. They didn't believe Mr. Gagliardi, and believed that the only method to substantiate losses was through a gambling log. The Court noted that this isn't the case.

"At trial respondent’s counsel had great difficulty explaining exactly what a “gambling log” is and what petitioner should have recorded in a gambling log. Respondent’s counsel stated that it was not realistic for someone to keep track of every bet and that the revenue procedure does not require taxpayers to keep track of every bet (i.e., the revenue procedure does not require a taxpayer to list how much he/she bet for each slot machine “pull”). Respondent’s counsel contended that to keep a log for slot machine play, per the revenue procedure, a taxpayer must know how much was wagered and how much was lost and record it contemporaneously. But see id.

"We also note that the revenue procedure provides that “Verifiable documentation for gambling transactions includes but is not limited to” Forms W-2G, wagering tickets, canceled checks, credit records, and bank withdrawals--all of which are present here. Id. sec. 3, 1977-2 C.B. at 538. Additionally, the revenue procedure provides a method, keeping a gambling log, that the IRS will consider as acceptable evidence for substantiation of wagering winnings and losses. Id. It does not contain the exclusive method for substantiating gambling losses. Id. sec. 1, 1977-2 C.B. at 538 (“The purpose of this revenue procedure is to provide guidelines to taxpayers concerning the treatment of wagering gains and losses for Federal income tax purposes and the related responsibility for maintaining adequate records in support of winnings and losses.”)."

Mr. Gagliardi also had two expert witnesses who testified on his behalf. Dr. Suzanne Pike (noted above) testified that Mr. Gagliardi was a pathological gambler, and as the Court noted, "Dr. Pike stated that a pathological gambler, such as Mr. Gagliardi, who walks away from a casino with money will, with an extremely high probability, go back to a casino the next day with the money." In fact, the outlook for Mr. Gagliardi is bleak if he continues gambling. The Court stated in a footnote,

"We note that Dr. Pike testified that, unlike recreational and problem gamblers, pathological gamblers take the “gambler’s fallacy” to a delusional level--they believe if they gamble long enough, they will win back all their losses and even more. Dr. Pike also opined that, unless treated for his illness, Mr. Gagliardi will gamble until he dies or loses all his money."

Also testifying for Mr. Gagliardi was Mark Nicely, a casino gaming expert who currently works at International Game Technology, a leading manufacturer of slot machines. Mr. Nicely testified that at the Class 2 machines that Mr. Gagliardi gambled, his chance of breaking even was worse than one in one trillion. At the casinos Mr. Gagliardi gambled the 'payback' on slot machines is probably worse than 90 percent (likely either 83% or 70%).

The IRS had no counter to the testimony which showed fairly conclusively that Mr. Gagliardi gambled and lost. His gambling losses were upheld.

There are two other important points to this case. First, Mr. Gagliardi had to go to Tax Court, hire two attorneys, have expert testimony, and then he won his case. Had he kept a gambling log it's likely he wouldn't have needed to go through the effort. And second, the IRS has a lot of problems dealing with gamblers. Most of the personnel within the IRS doesn't have experience with gambling, and even an IRS attorney had trouble explaining an IRS-suggested procedure on gambling (a gambling log).

Case: Gagliardi v. Commissioner, T.C. Memo 2008-10

The Tax Court looked at another gambler's attempt to write off substantial gambling losses. She claimed a losing year, but the IRS felt otherwise. Did she really have gambling losses, or were they a mirage?

Gamblers, both professional or amateur, must keep a contemporaneous written log. If you do keep such a log, you'll be able to substantiate your wins and losses. In today's case, however, the gambler didn't keep a log. She claimed $244,744 in losses, but the IRS only allowed $127,165 (after the gambler found casino ATM receipts, canceled checks made payable to casinos, carbon copies of checks made payable to casinos, and credit card statements stating that cash was advanced at the casinos). What about the remaining $117,579?

The court summarized the problem most ably:

"In order to establish entitlement to a deduction for gambling losses in this Court, the taxpayer must prove the losses sustained during the taxable year...Petitioner failed to present credible evidence of gambling losses beyond those respondent conceded. Petitioner did not maintain a diary or any other contemporaneous record reflecting either her winnings or her losses from gambling during 2002. Further, petitioner’s gambling income of $265,795 for 2002 was established only by an examination of her Forms W-2G, Certain Gambling Winnings, and petitioner appeared unaware of the specific figure until confronted by respondent. At trial, petitioner submitted no evidence to validate her claimed gambling losses, relying only on the theory that her losses must have equaled her earnings because she found herself in debt at the end of the year. We conclude that petitioner has failed to satisfy her burden of substantiating her losses."

There are two problems. First, the Court is very suspicious of a gambler whose only winnings are those reported on the W-2Gs. It's almost certain that the petitioner had other slot winnings which didn't result in the issuance of a Form W-2G.

Second, and most importantly, she had no documentation to prove her losses. Telling the Court, "I'm broke, so I must have lost," may be logical (and may indeed by factual), but it doesn't show proof of the facts. She had no proof, and the petitioner got three lemons for her decision.

Case: Jackson v. Commissioner, T.C. Memo 2007-373

I have had several individuals request that I repost an article that originally appeared on TwoPlusTwo.com's Internet Magazine. Without further ado, here is the article that first appeared in the February 2007 TwoPlusTwo Internet Magazine.

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TAX MYTHS FOR THE POKER PLAYER
By Russell Fox, E.A.

Note: This opinion is limited to the one or more Federal tax issues addressed in the opinion. Additional issues may exist that could affect the Federal tax treatment of the transaction or matter that is the subject of this opinion and the opinion does not consider or provide a conclusion with respect to any additional issues. With respect to any significant Federal tax issues outside the limited scope of this opinion, the article was not written, and cannot be used by the taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.

When I read a post on a poker site such as Two Plus Two or rec.gambling.poker that deals with U.S. taxes, it’s usually with fear and trepidation. Much of the time, the information presented is either wrong or only partially correct. In this article I will examine some of the major tax myths that I’ve seen and hopefully steer you in the right direction.

Myth #1. I’m a U.S. citizen, but I now live in Costa Rica. I don’t have to pay U.S. income tax. The United States taxes citizens on their worldwide income. If you’re a U.S. citizen, you must pay income tax on your income no matter where you reside, be it Moscow, Idaho or Moscow, Russia. You do, though, generally receive an extra two months (until June 15th) to both file and pay your income taxes if you’re outside of the U.S. on April 15th, but you will owe interest on the tax due.

Myth #2. I can renounce my U.S. citizenship, and then I won’t owe any tax. Well, that may be true, or it might not be. The United States has an Expatriation Tax (Section 877 of the Internal Revenue Code). From the ten years following your expatriation, you must file information returns. If you are in the U.S. for thirty days you will owe U.S. income tax for that year. Additionally, if you are considered a high-income individual under this section of the Code, you can owe tax. There are notification rules under this section of the Code, too. Warning: This is a complex area and you absolutely need to consult a tax professional and an attorney before renouncing your U.S. citizenship.

Myth #3. Online poker winnings aren’t taxable because the sites are overseas and/or it’s illegal and illegal income isn’t taxed. Not only does the United States impose an income tax on your worldwide legal income, illegal income is also taxable (see James v. United States, 366 U.S. 213, 218 (1961)). Early in 2006, a woman in Tullahoma, Tennessee pled guilty to four counts of tax evasion for not paying tax on $500,000 she embezzled. She will likely receive 18 to 24 months in prison. Internet gambling winnings are taxable income.

Myth #4. I won $2,000 at the Grand Casino in Tunica, MS. They withheld $500. I can claim that $500 in tax on my state tax return. This is only a partial myth. Generally, you can only pay tax to one state for any specific income. On your state income tax return, you can receive a credit for tax paid to other states. For example, you’re a resident of California, and you get a W-2G from a casino in Mississippi for $500. You will have to file a Mississippi tax return, attach a copy of that return to your California return, and you can claim a credit for the tax paid on line 28 of Form 540. Warning: The treatment of credits for other states’ taxes varies depending on the states involved. Sometimes the credit will be taken on the other state’s tax return. Consult a professional tax advisor for the correct treatment in your situation.

Myth #5. I work in a salaried, full-time position. I can also file as a professional gambler. This is almost certainly not true. In Commissioner v. Groetzinger (480 U.S. 23), the Supreme Court noted, “…[W]e conclude that if one's gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business within the meaning of the statutes with which we are here concerned.” The key terms herein are full time, good faith, regularity, and livelihood. If you have a full-time job, it’s unlikely you can file as a professional gambler.

Myth #6. I can net my wins and my losses. Unless you’re a professional, the sum of your winning sessions are Other Income (line 21, Form 1040); your losing sessions, up to the amount of your winning sessions, are an itemized deduction taken on Schedule A. Professionals do get to net their results and file using Schedule C (Profit or Loss From Business). Professionals, though, must pay self-employment tax on their net income, at 15.3% of the first $94,000 of net income, and 2.9% above this (2006 numbers). While half of the self-employment tax is a deduction (line 27 of Form 1040), unless the professional earns a substantial six-figure income, he can pay more in tax.

Myth #7. I can lump my play on the Internet for a full day (or week, month, or year) as a session. Unless there are specific rules stating otherwise, the tax treatment of the virtual world is the same as the brick and mortar world. I have previously written on the definition of a session. There’s no way that play for a year, month, or week will pass the IRS’ smell test. Indeed, I do not believe that defining a session as a day will be accepted unless you’re playing for a full, continual 24-hour period.

Myth #8. All states treat gamblers identically. This is definitely not the case. Some states don’t have an income tax or only tax interest and dividends (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming). However, some states do not allow gambling losses as an itemized deduction. (Professionals can still take losses, as they would net their wins and losses on Schedule C or the state equivalent.) The states that gamblers should avoid residing in are Connecticut, Illinois, Indiana, Massachusetts, Michigan, Minnesota, Mississippi, New York, Ohio, West Virginia, and Wisconsin. Two states are today at the top of the “Don’t reside here list”: Washington and Ohio. I’m sure everyone is aware that Washington state made Internet gambling a felony. What you may not know is that Washington also has a Business & Occupation tax that a sole proprietorship, including a professional gambler, must pay. Ohio has a law that makes being a professional gambler a crime (Section 2915.02(A)(4), Ohio Revised Code). I’m not an attorney, and have no idea if this law is being enforced, but given how Ohio treats gamblers, I’d consider relocating if I were an Ohioan.

Myth #9. The IRS doesn’t share information with state tax agencies. Absolutely false. The IRS and state tax agencies actively share information. As far as I know the only state that does not share information with the IRS is Nevada. You can find a description of the information sharing program here.

Myth #10. I just won’t file. I’ll do everything with cash, and the IRS will never know. If you spend $10,000 or more, a currency transaction report is required to be generated and is sent to the IRS. Banking transactions of $10,000 or more in cash must be reported. So just keep everything small, right? Wrong. If you deliberately attempt to evade transaction reporting by engaging in a series of smaller transactions, you may be found guilty of the crime of “structuring,” which is a felony. Finally, banks and other financial institutions (casinos are considered a financial institution) are encouraged to report smaller transactions—anything that makes them suspicious.

Myth #11. The IRS can never catch me. On the contrary, they can, and probably will if you’re not paying your taxes and you owe an appreciable amount. First, the IRS has a reward program. The IRS’ largest source of tips are ex-spouses and girlfriends/boyfriends, so make sure your significant other is happy. Second, if you use a Neteller debit/credit card to avoid IRS scrutiny, think again. Neteller has cooperated with US government investigations in the past and undoubtedly will in the future. Indeed, Neteller obeys a Maryland state law and does not accept Maryland residents as customers. Additionally, all of the debit card networks (Stars, Cirrus, etc.) are owned and operated by U.S. entities and will cooperate with an IRS subpoena. The major credit card networks (Visa, MasterCard, and American Express) are also U.S. owned and operated and will cooperate with the IRS. If the IRS finds out about you, or you get audited and the IRS suspects something (e.g. you report income of $25,000 but you drive a Mercedes), the IRS will examine your financial records in depth. Tax evasion is a serious crime and you can find yourself in prison if you commit it (ask Richard Hatch about that). Note: Since this article first appeared, Neteller's founders were arrested, and Neteller settled various federal charges with the US Department of Justice. It is believed that Neteller turned over all of its records on all of its US customers to the Department of Justice.

Myth #12. The IRS can’t share information from my tax return with other government agencies because of the “Silver Platter” doctrine. Another falsehood. As noted above, the IRS routinely shares information with state tax agencies. In Garner v. United States (424 U.S. 648 (1976)) the Court held that the occupation listed on a tax return can be shared. If you are foolish enough to list your occupation on your tax return as “illegal drug dealer,” the IRS can forward your name to other law enforcement agencies.

Myth #13. The IRS will never go after a poker professional because we’re small potatoes. This may have been true a few years ago. Unfortunately, it’s no longer the case. The IRS announced in both its 2006-2007 and 2005-2006 Priority Guidance Plans that they wished to implement, “Legal requirements to withhold on the winner’s prizes at poker tournaments.” (To date such regulations have not been written.) Like it or not, poker players are celebrities. Prosecuting a high-profile poker player for tax evasion would likely have a deterrence effect on other gamblers. I think it’s only a question of when, not if. The IRS is looking at PayPal records from the time that PayPal was used to fund Internet gambling. It may take a year or two, but I think some gambler will be prosecuted because of this.

The U.S. Tax Code is complex. It’s unfair to gamblers. Parts of it are just plain stupid. But it’s the law. And when you break the law, there are consequences. It’s a whole lot easier to pay your taxes now than to wait for the IRS to find you and pay taxes, interest, penalties, and possibly find your way to prison.


© 2006, 2007 by Russell Fox, All Rights Reserved.

Russell Fox, E.A. is a tax practitioner enrolled to practice before the Internal Revenue Service. He is also a poker player and is the co-author of Why You Lose at Poker.

Several months ago, I participated in a phone form on the FBAR program (Foreign Bank Account Rreporting); generally, if you have a foreign bank account with $10,000 or more in it you must file Form TD F90-22.1 with the Department of the Treasury by June 30th of each year. Today I received information on questions that were asked in that phone forum (the phone forum was in early June, so it took nearly six months for the answers to be distributed...).

Some of the answers are different than what I was led to believe during the conference call.

1. The due date of the FBAR is June 30th, but the form must be received by June 30th, not postmarked by June 30th. This is different from tax forms which have a postmark due date.



2. You must file a form if you have $10,000 in one or more foreign bank accounts. This is determined by adding the maximum balance in each account during the year, not the maximum balance of all the accounts at one point during the year. For example, the maximum you have in foreign accounts is $9,500 ($9,000 in account 1 and $5,000 in account 2 on June 15th). However, the maximum you had in account 2 was $4,000 on August 10th (the maximum in account 1 was $9,000). You are required to file Form TD F90-22.1.



3. A faxed signature is not acceptable for an FBAR.



4. Foreign life insurance can be considered a foreign financial account subject to reporting (by the policyholder) on an FBAR.



5. A line of credit does not have to be reported on an FBAR.

There were many other items listed in this email; I've only posted the highlights. Anyone who believes they are impacted by this should talk with their tax professional to get full information on their situation.

Can a woman who owns and operates a trucking business also be considered a professional gambler? That's what the Tax Court had to decide.

Linda Myers operated a trucking business in the Twin Cities. The trucking business was substantial; there were 11 drivers using eight trucks. Ms. Myers earned a reasonable income (including both salary and nonemployee compensation) from the trucking business.

But that wasn't Ms. Myers' only activity. After she finished her daily activities with the trucking company, she headed to the casino to play the slot machines. And this wasn't a passing fancy; she spent about 40 hours per week at a casino.

The Court stated, "She considered herself a professional gambler by 2000. Petitioner viewed herself as a gambling expert but found no pleasure in gambling. Instead, she considered gambling stressful, tiring, and time consuming. She did not go to the casino with friends or companions and was focused on doing everything she could to win while she was there."

In 2003 she reported her gambling winnings as a professional gambler, deducting her gambling losses up to the amount of her winnings as an expense (on a Schedule C). The IRS examined her return, and issued her a deficiency notice which led to the Tax Court filing. The sole question the Court had to answer was whether Ms. Myers' gambling rose to the level of being a professional: Was she in the trade or business of gambling in 2003?

The key is the Groetzinger decision: "An activity must be conducted with continuity, regularity, and the primary purpose of earning a profit to be considered a trade or business under section 162. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987)." Both Ms. Myers and the IRS agreed that she gambled with continuity and regularity. However, was she trying to earn a profit?

The Court used a nine-factor test:

"Sec. 1.183-2(b), Income Tax Regs. The nine factors are: (1) The manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer or his or her advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that the assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer’s history of income or loss with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved."

While the Court noted that she hadn't had profits, that was the only factor that favored the IRS. Ms. Myers used Slot Club records, was knowledgeable about gambling, spent considerable time and effort, was successful in other business operations (the trucking company), and testified credibly that she derived no pleasure from the gambling. So Ms. Myers was a professional gambler for 2003.

Do note that this decision is a memorandum decision of the Tax Court, and cannot be used as a precedent. It does, though, show the factors and issues that you will need to prevail in a case where you maintain multiple businesses and want to be considered as a professional gambler.

Case: Myers v. Commissioner, T.C. Memo 2007-194

In March 2006, I wrote about Renato Medina, the principal owner of Lucky Chance's. Lucky Chance's is a cardroom located in Colma, just south of San Francisco. Mr. Medina and his niece and nephew were accused of tax evasion and conspiracy. At the time, they all stated their innocence. Mr. Medina's attorney (then) said, "This is a simple tax case...[and Mr. Medina] asserts his innocence."

Not anymore. As part of a plea agreement, Mr. Medina pleaded guilty to three counts of tax evasion (the remaining charges were dropped). He agreed to pay back the back taxes, penalties, and interest, which will likely total about $1 million.

Mr. Medina's arrest and the charges stem from a corruption probe of the small town of Colma. The first victims were two former mayors of Colma, Philip Lum and Ronald Maldonado. Both were accused of accepting free airline trips to the Philippines from Mr. Medina but not disclosing the gifts on required disclosure forms.

Mr. Medina has also agreed, as part of his plea deal, to serve between 15 and 21 months at ClubFed. Additionally, under California law he must give up his 100% ownership of Lucky Chance's. That had already been in the works, ostensibly for estate planning reasons, with the ownership transfer to his sons approved by both Colma and the California Gambling Control Commission.

Finally, Mr. Medina asked the government to drop the charges against his niece and nephew. The Department of Justice has yet to decide whether or not to do so.

News Story Here

As I reported earlier, the IRS has revisited Revenue Procedure 2007-57, which would have required withholding on all poker tournament payouts of more than $5,000. I had been told by someone at the IRS that the IRS was going to try to put into place the Binion's closing agreement ($600), which would have sent lots of paper to the IRS.

Apparently, the American Gaming Association has some good negotiators. This IRS Press Release states that reporting will be required on, "...tournament winnings of more than $5,000, usually on an IRS Form W-2G."

So instead of more reporting and withholding, there will actually be no change in withholding and less reporting of winnings! Casinos that currently follow the Binion's Closing Agreement will now only have to issue W-2Gs if a poker tournament winner receives more than $5,000 rather than $600.

The only caveat I'll place on all this is that the IRS still must re-release the Revenue Procedure. But it really appears that this is very good news for both poker tournament organizers and for poker players.

News Story: Reuters

The Las Vegas Sun reports today that the American Gaming Association and the IRS reached agreement that for poker tournaments if a casino/cardroom issues W-2Gs, then withholding at 25% will not be required on wins above $5,000.

From the IRS's point of view, poker tournaments have been seen as a part of the "Tax Gap." Players win, but because few W-2Gs are issued, the IRS hasn't been collecting its fair share. The goal in writing Revenue Procedure 2007-57 was to increase reporting.

It is my understanding that for a casino to not have to withhold, they will have to agree to abide by the Binion's closing agreement. (Many years ago, Binion's Horseshoe Casino and the IRS reached an agreement stating that they would issue W-2Gs on all gross wins of $600 or more, and that the IRS agreed not to require withholding except where the win was at least 300 times the buy-in.) However, casinos that do not agree to this rule will have to withhold 25% of payouts on wins of $5,000 or more.

Withholding will still be required on wins where the payout is 300 times (or more) of the buy-in (this impacts very few poker tournaments), and for non-US citizens where withholding is required either by tax treaty or by other regulations/rules.

While I still think that no withholding is required, and that Revenue Procedure 2007-57 is wrong, I do understand the IRS' motivation. It is very clear that many poker players do not report gambling winnings correctly. (Of course, the fact that gamblers are not well treated under the US Tax Code has something to do with that, too.) Given that no casino wants to get into a battle with the IRS, this outcome was probably the best that could be hoped for.

A reader asks,

"I'm currently studying in undergraduate university in the U.S., where I hold my only citizenship. I was thinking about studying abroad, probably in Australia. I was thinking about going from around Jan.1-December 31st of 2009, or from Sept.1 08-Sept.09. I receive financial aid grants from the university/government(?), but the school financial office says those are never taxed the way they do it, so presumably it's a non-issue for Australian as well as U.S. tax. I think if I study abroad everything is billed to my U.S. university account which is where the grants are credited to. So while in Australia I might want to focus on poker, both live and online. I was wondering what kind of liability I'd be looking at, I'm guessing I could get the U.S. exemption if I am there for the whole year as long as my income is less than ~82k? And after reading my understanding is that it's unclear but unlikely that people have liability for poker in Australia. If you can help elucidate the rough idea for the situation I'd be in I would greatly appreciate it."

There are several things you need to consider. First, Australia only taxes professional gamblers. So if you're not a professional gambler, your gambling income will not be taxed by Australia. However, if you are a professional gambler, and if you were required to pay Australian income tax, you would have to pay income tax on the gambling. (I don't know anything about whether your scholarships would be taxable in Australia; your university can probably answer that question. I also do not know if full-time students are exempt from Australian income tax.)

As a US citizen, you must file tax returns each year, whether you reside in the US or Australia. When you write about the "U.S. exemption," I assume you mean the foreign earned income exclusion. That will pose a problem for you, as gambling income is not considered earned income, and only earned income is eligible for the exclusion. (There are other requirements in order to take the foreign earned income exclusion.)

Now, a professional gambler living abroad (one who files a Schedule C) can take the foreign earned income exclusion ($85,700 in 2007). However, a professional gambler must pay self-employment tax on his net gambling income.

So without knowing more about your entire situation, it appears on the surface that you are not a professional gambler (as you are a full-time student). Thus, your gambling winnings will remain taxable whether you are studying here or in Australia.

A CPA likes to gamble, and shows his gambling activity as a second business (his other business activity is his accounting practice). The IRS challenges this, claiming that he's really an amateur gambler. The Tax Court has to decide who is right.

Ali Mohammadpour is a CPA who also likes to gamble. On his 2003 tax return, he shows his accounting practice on Schedule C. He also shows his gambling on another Schedule C. He won $84,730 while gambling. However, the petitioner lost at least as much as that, and reported a net gambling income of $0.

There's nothing wrong with an individual having multiple businesses. Indeed, many accountants have two (or more) businesses so that during their off season they can also earn an income.

Unfortunately for the petitioner in this case, there were several questions as to whether he really was a professional. To be a professional gambler, one must, "[engage] in the gambling activity with continuity and regularity and with the primary purpose of making a profit." This means gambling full-time, for your livelihood.

In contrast, the petitioner in this case "...dedicated approximately 900 hours to his gambling activity in 2003 (or approximately 17 hours per week on average), which appear to have been distributed over 136 days." That's definitely not full-time. The Court also noted that the petitioner did not show positive net gambling income in the two years prior to 2003 or in the year after (or, for that matter, the year in question).

More damaging to the petitioner's case was his lack of recordkeeping. The IRS expects a professional to keep records, no matter what the profession. Gamblers, whether professionals or amateurs, must keep a gambling log.

"Also in contrast to the taxpayer in Commissioner v. Groetzinger, supra, petitioners did not keep reliable records of Mr. Mohammadpour’s gambling activity. This was due in part to error, and also to the fact that Mr. Mohammadpour intentionally ignored, for record-keeping purposes, bets on which he won less than $600 and which therefore were not reported to the IRS by means of Form W-2G. These winning bets of less than $600 made up approximately 10 percent of all Mr. Mohammadpour’s bets. In other words, petitioners adopted record-keeping practices which would merely approximate Mr. Mohammadpour’s gambling performance. Such is inconsistent with a conclusion that Mr. Mohammadpour engaged in his gambling activity with the primary purpose of making a profit." [footnote omitted]

Mr. Mohammadpour was determined by the Tax Court to be an amateur. If you want to be considered a professional, you need to treat your business as a profession. Not only must you try to earn an income (a livelihood), but you need to keep complete and accurate records. In this case the petitioner was a CPA and should have known this.

Case: Mohammadpour v. Commissioner, T.C. Summary 2007-163

The Tax Court decided an interesting case today. An individual receives gambling income, but has given the payee a Form 5754, stating that the income belongs to another individual. However, the other individual doesn't claim the income. The IRS goes after the individual who picked up the money. Who owes the tax?

Willie Albert worked at the Los Angeles Turf Club, an off-track betting parlor. During 2003, Mr. Albert presented winning tickets worth $12,258. When he presented those tickets, he also presented Form 5754. Form 5754 is used to assign gambling winnings to others. For example, poker players use this when they are backed to show that instead of the player being responsible for 100% of the winnings, she is responsible for (say) 60%. In this case, Mr. Albert's forms (which are signed under penalty of perjury) show that one Romeo Umali was responsible for 100% of the winnings.

That would be all and good if Mr. Umali claimed those winnings on his tax return. He didn't. So the IRS went after Mr. Albert. The dispute ended up in Tax Court.

The key points of the case are summed up by the Tax Court:

In general, section 61(a) defines the term “gross income” to include “all income from whatever source derived” unless it is specifically excepted.

Under the claim of right doctrine, if a taxpayer receives money under a claim of right and without restriction as to its disposition, then he has received income that he is required to report even though it may still be claimed that he is not entitled to retain the money and may be ordered to restore its equivalent. N. Am. Oil Consol. v. Burnet, 286 U.S. 417 (1932). But under the conduit theory, if a person receives funds merely to enable him to act as a conduit of the funds to another, then he does not have a claim of right to the funds, and the funds received are not income to him to the extent that he passes them on to the person for whom the funds were intended. Goodwin v. Commissioner, 73 T.C. 215, 232 (1979).

The main problem for Mr. Albert was that his testimony was unconvincing. He was inconsistent on the stand, and the Court felt his testimony was self-serving. He also presented no corroboration of his testimony. He had no witnesses, his bank statements didn't prove whether or not he received the income, and Mr. Umali's tax return did not show the income. So the Court found that the gambling income came under the Right of Claim, and Mr. Albert owed the tax.


Case: Albert v. Commissioner, T.C. Summary 2007-162

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