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The Form shows that no money has been withdrawn yet from the Winings.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

A good friend of mine called me late this afternoon and asked me for a referral. I asked him what he needed, and he told me, "Your side business." I'm a writer (and I'm certain he knew that), so this made no sense. After I expressed my bewilderment he said, "Can't you provide me with the same kind of service you did for Eliot Spitzer?"

Ah yes, the Governor of New York. Mr. Spitzer, a Democrat who decided to partake of the world's oldest profession, chose a rather expensive prostitution ring. He apparently paid somewhere between $1000 to $4300 an hour, and may have spent $80,000 of his own money.

So why did my friend call me? He had heard that the ringleader of the prostitution ring (called the Emperors Club VIP) was an Enrolled Agent. Of course, ABC gets some details of what an Enrolled Agent is wrong:

"He is also a licensed "enrolled agent" of the IRS, spokesman Rob Marvin confirmed. That means Brener was allowed to prepare and submit other people's taxes, represent others in tax court and in negotiations with the IRS, and receive information directly from the IRS on behalf of others."

For the record, an Enrolled Agent represents taxpayers before the IRS; we are not employees of the IRS. We do prepare tax returns and represent individuals and businesses in negotiations with the IRS and other tax agencies.

I had to disappoint my friend; I didn't have a Kristen to send his way. My side business doesn't earn me $4000 an hour in illegal income. Unless your name is Tom Clancy or John Grisham writers just don't make that kind of money.

On the positive side, at least Enrolled Agents are making the news....

New York is facing a budget shortfall this coming year. Governor Eliot Spitzer has an interesting idea about how to fill the gap: a crack tax. I've written about these taxes before. Many states have these taxes (21 at last count); however, they sometimes don't survive the courts.

In any case, Governor Spitzer's proposal is to tax marijuana $3.50/gram and cocaine $200.00/gram. The proposal is estimated to bring in $13 million if it is enacted into law.

That doesn't seem certain. Jeffrion Aubry (D-Queens) vows to fight this "boneheaded" proposal. And given that it would only bring in $13 million, other revenue enhancers (or cuts in spending) will be needed to balance New York's budget.

News Story: Washington Post

It hasn't been a good year for Governor Eliot Spitzer (D-NY).

First, he's been accused of using state troopers to spy on political opponents. Next, he proposes to give illegal aliens drivers licenses—a measure that's overwhelmingly not supported by New York residents. Eventually he abandons the idea. Then he supports a stretching of the definition of "nexus" for state sales taxes to include affiliate programs. Yesterday, he dropped the idea—at least for the time being.

Republicans were going to paint Spitzer as the "Grinch who stole Christmas." Spitzer won't have to deal with that, for now.

However, New Yorkers should still watch what happens in Albany. The State Department of Taxation and Finance still believes they're right in their expansive view of nexus. This plan will likely reappear sometime in 2008.

Governor Eliot Spitzer (D-NY) is leading the way. But it's a taxing way. The New York Department of Taxation and Finance says that any company that has an affiliate program that has any affiliates in New York must charge sales tax on sales shipped to New York.

Currently, companies must charge sales tax when a business has a "nexus" in the state. That's usually caused by having a physical presence (an office) or employees in that state. Amazon.com doesn't have an office or employees in New York. Thus, they haven't charged New Yorkers sales tax.

However, New York now says that having an affiliate in the state is enough to give a company a nexus in New York. This is an interesting theory, but it could run into difficulties. Glenn Reynolds, the Instanpundit, thinks it wouldn't stand up in court.

In any case, Governor Spitzer is looking at a $4 billion deficit for next year and has pledged not to increase taxes. The Department of Taxation and Finance calls this a policy clarification. I hope they have a big budget for legal fees as that's likely where this is headed.

In February, Steven Green pleaded guilty to not filing tax returns from 2001 to 2003 and to using a fake social security number when applying for a loan. He was sentenced to 2 years and nine months in prison, with the sentence to commence in June.

Normally, it would be just another story of tax fraud that I'd highlight—a real estate mogul who made some mistakes.

However, last night Mr. Green was walking out of Club Posh in midtown Manhattan when he was hit by a hit and run driver. His attorney, Louis Cherico, told the Associated Press that the prognosis for recovery is good (he had surgery earlier today).

Hopefully, the NYPD will catch what the New York Daily News calls "the cowardly driver."

Associated Press Story

New York is known as a high-tax state. Those who live in New York City or Yonkers must pay state and city income tax. That's bad. The amateur gambler is in for a surprise, too. While New York allows itemized deductions for gambling losses, New York's tax rules give a very rude surprise for the gambler.

Let's take a typical case. John Smith makes $90,000 working in New York City. He also gambles, and nets $50,000. As I've written before, the amateur gambler cannot net his wins and losses. Wins are other income (line 21) while losses are an itemized deduction that is not subject to the 2% AGI restriction on miscellaneous itemized deductions.

Joe won $500,000 and lost $450,000. Those kinds of totals aren't atypical for the successful amateur. Joe discovers that when he substitutes his true totals for his net number, his federal tax has increased by $2600. He's shocked to find that his state tax jumps by $27,000!

If your Adjusted Gross Income (AGI) is over $500,000, you lose 50% of your itemized deductions on your New York tax return. You keep all of your itemized deductions when your AGI is $100,000 or less. There's a sliding scale between $100,000 and $500,000.

So New York joins my list of states for gamblers to avoid. For the record, here's the complete list:

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

So New York may be the city that never sleeps, but New Jersey never looked so good for the amateur gambler.

Sometimes you just can't make this stuff up. If you're a proprietor in New York state of "Gentleman's Clubs," make sure you add sales tax on those lap dances, if they're in a private room at your establishment. That's definitely taxable because "...it's an admission fee to that particular room," according to Michael Bucci, a spokesman for the New York State Department of Taxation and Finance. And, as this news story notes, Bucci noted that lap dance in the public part of the club are not taxable.

Still, Richard Snowden and his "Tally-Ho Club" of Cheektowaga, NY (suburban Buffalo) are in trouble with the Department of Taxation. New York alleges that he owes $216,000 in sales taxes on private lap dances. Additionally, he has a residency dispute with New York. Snowden believes his primary residence was in Nevada in 2002 and 2003 (he owns a Las Vegas strip club, too); however, New York tax authorities disagree and want another $250,000 in income tax.

Still, the idea of a tax on lap dances is certainly intriguing...and different. Which is one reason I believe that the chances for uniform sales tax rules and regulations throughout the United States is essentially zero.

Suppose you work as a telecommuter in one state, but your corporate headquarters is in another state. To which state must you pay state income taxes? The obvious answer is the state you live in. Of course, if you visit your corporate headquarters, you will owe state taxes to that state based on the number of days you are at the corporate headquarters.

However, in a case decided earlier this year, the New York Court of Appeals (the highest state court in New York) ruled that a telecommuter who works outside of New York State but works for a New York based company must pay New York state income taxes. The 4-3 decision in Huckaby v. New York State Division of Tax Appeals may have aided New York's coffers, but it certainly made New York less attractive to corporations that encourage telecommuting. New York has a rule that allows the state to tax out-of-state employees if they work out of state "for the convenience of the employer." Luckily, California doesn't have that rule—yet.

The Supreme Court yesterday refused to review the case. This means that if you work for a New York based employer but telecommute, you owe New York state income tax.