Taxable Talk

Back at the end of July came news that the US Department of Justice had settled with PokerStars and Full Tilt Poker on civil claims, and that players would be paid back. I wrote,

When will players be repaid? If you are outside of the US (and this is determined by your residence on June 29, 2011), you likely will be repaid no later than November. If you are in the US, this remains unclear, but I’d expect you to be repaid before Christmas.

I was wrong.

I was expecting the DOJ to treat this differently from a ‘standard’ remission case, given that all the money was on hand and there was a complete list of who needed to be repaid. I was wrong: The bureaucratic procedure will be followed.

Yesterday, John Pappas, Executive Director of the Poker Players Alliance met with officials from the DOJ. A full statement from Mr. Pappas regarding the meeting is available. The gist of it is that is:

Our third objective was to get a sense of timing. Unfortunately, completion of a refund claims process is a long way away.

I now expect this to take many more months, perhaps more than one year for players to be repaid. Unfortunately, a realistic time-frame is 12 to 18 months from now. It could take less time if all the stars align, but it could take longer if something goes wrong. Poker players will be dealing with “bureaucracy at work.”

While what’s below isn’t the process, from a poker player’s perspective it might as well be. It’s definitely an example of how bureaucracy functions most of the time.

“The 2011 Purdue University Rube Goldberg machine shattered the world record for most steps ever successfully completed by such a machine. In 244 steps the ‘Time Machine’ traces the history of the world from Big Bang to the Apocalypse before accomplishing the assigned everyday task of watering a flower. The record has been sanctioned by the Guinness Book of World Records and the World Records Academy.”

News came out this morning that the long-rumored deal that would have PokerStars acquire Full Tilt Poker, agree to pay the DOJ $731 million (the rumored amount was $750 million), and pay back players while settling the civil charges it faced came to fruition this morning. Press releases were issued by Full Tilt and PokerStars announcing the deal; a press release will be issued later today by the DOJ. The obvious questions are:

- Who will be repaying the Full Tilt players?
- When will players be repaid?
- What does this mean for US players’ taxes?
- Will PokerStars (or Full Tilt Poker) be returning to the US anytime soon?

Who will be repaying the Full Tilt players? If you are outside of the US, PokerStars will repay you. A fund of $184 million will be set up, and withdrawals will begin within 90 days of the completion of the transaction — likely by the end of October.

If you are within the United States, you will be repaid by the Department of Justice (the US Attorney’s Office for the Southern District of New York). You will have to apply through remission with the DOJ to be repaid. I assume (but am not certain) that the FTP site or client will be reopened so that US players can look to see what their balances were. A fund of $150 million will be set up for the repayment. The exact process will likely be revealed in the press release to come from the DOJ, but here is a sample remission petition (Hat Tip: Taxdood).

When will players be repaid? If you are outside of the US (and this is determined by your residence on June 29, 2011), you likely will be repaid no later than November. If you are in the US, this remains unclear, but I’d expect you to be repaid before Christmas.

What does this mean for US players’ taxes? That income that wasn’t constructively received in 2011 will likely be constructively received in 2012. That means you will need to report your Full Tilt income on your 2012 tax returns. You may need to adjust your fourth quarter 2012 estimated payment.

Will PokerStars (or Full Tilt Poker) be returning to the US anytime soon? No. While the agreement specifically allows for PokerStars to apply for licenses if and when online poker is legalized in the US, the criminal charges against PokerStars were not settled. As long as PokerStars (or any of its owners, executives, or managers) faces a criminal indictment, they will not be licensed in the US.

Most gaming licensing boards are extremely reticent about licensing anyone with any sort of criminal past. If PokerStars were found innocent of the criminal charges against it, then they would have a chance of obtaining a US (or state) license. Until then, it is extremely doubtful that US players will see PokerStars (or Full Tilt Poker) back in the United States.

Buried in the DOJ Press release is the following:

In a related matter, the U.S. Attorney’s office also filed a motion requesting that the Court enter a settlement agreement reached with Absolute Poker/Ultimate Bet that requires the company to forfeit all of its assets (the “Absolute Assets”) in order to fully resolve this action. The motion also requests that the Government be permitted to liquidate the Absolute Assets, with the net proceeds of that sale to be held pending the resolution of claims filed by other parties who have asserted an ownership interest in the Absolute Assets.

It appears that US players can also apply for remission on their AP/UB balances. However, it is likely they’ll receive pennies on the dollar (or perhaps a penny on the dollar) as it is unlikely the assets of AP/UB have much value.

Once the DOJ announces the remission process, I’ll post about that. I now return to my scheduled vacation.

UPDATES: It’s remission, not rendition; the date being used to determine US (or rest of the world) residency is June 29, 2011, not April 14, 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.

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.