Handling Gambling Winnings

This is a Guest post from Brad Polizzano.

I have friends and colleagues who frequent the “pokerverse.”  As a tax professional, I see or hear about the following type of situation far too often:

Person X is 25 years old, has a college degree, and currently earns most of his/her income by playing poker, either in person or online, or both.  Person X previously held jobs waiting tables and lifeguarding during the summers while in college, and his/her parents handled the taxes.  Player X is earning far more money than ever before, yet hasn’t reported the gambling winnings.

Call it uninformed.  Call it indifferent.  Call it negligent.  However you categorize such action (or lack thereof), the bottom line is the law is being broken.  Yet, with smart planning and sound guidance, potential problems can easily be avoided.

The general impression from the poker world is that most tax professionals are not very familiar with handling gambling winnings.  Whether or not accurate, I will take this opportunity to cover some basics.

1.  Gamblers must report as either a “Professional” Gambler or a “Recreational” Gambler

“Professional” gamblers report gambling winnings and gambling losses on Schedule C, Profit or Loss From Business, of the Form 1040.  The resulting net winnings amount, if any, is reported on line 12 of the 1040 as business income.  A business loss may be reported, but only to the extent of “ordinary and necessary” business expenses.  Further, professional gamblers must pay self-employment tax.

“Recreational” gamblers report gambling winnings on line 21 of the 1040, and report gambling losses, up to the extent of gambling winnings, as itemized deductions on Schedule A of the 1040.

A “professional” gambler is considered engaged in the trade or business of gambling, while a “recreational” gambler is considered not engaged in the trade or business of gambling.

To be engaged in the trade or business of gambling, the taxpayer must gamble with continuity, regularity, and with the primary purpose of deriving a profit.  The player need not actually have a reasonable expectation of profit, but instead have an actual and honest profit objective.  These inquiries are fact specific.  Typically, the facts make it fairly clear to ascertain whether the taxpayer is considered professional or recreational.  Some situations, however, allow the taxpayer to make a choice.  One common situation is the full-time college student.

2.  Gambling losses are allowed as a deduction to offset gambling winnings only to the extent of gambling winnings

In order to offset gambling winnings with gambling losses, all gambling activity must first be separated into “sessions.”

The definition of a poker session is not entirely clear, as the IRS has not issued guidance on the matter.  There has been ample discussion on the topic, however, to generate a consensus as to what the IRS would consider to be a poker session:

Each tournament is considered a separate poker session, whether it is online or live.  Cash games in one continuous sitting are considered one session, including online multi-tabling, unless different games are played (e.g. Texas Holdem, Omaha), in which case the different games are separate sessions.

3.   Accounts with offshore online casinos may be considered foreign financial accounts for FBAR purposes

The U.S. Department of Justice has taken position that the Unlawful Internet Gambling Enforcement Act of 2006 rendered illegal the hosting of any gambling website on U.S. soil, so U.S. poker players turned to offshore online casinos, which may be considered foreign financial accounts for Foreign Bank Account Reporting (FBAR) purposes.

If the total maximum balances of all foreign bank accounts of a U.S. person during the tax year exceed $10,000, then that person must file the FBAR (Form TD F 90.221) by June 30 of the following tax year.

On February 24, 2011, the Financial Crimes Enforcement Network (FinCEN) made final amended regulations to the Bank Secrecy Act.  These regulations changed, among other things, the definition of a “reportable account” for FBAR purposes.  The type of “reportable account” that previously seemed to include offshore online casino accounts now appears to not, although the IRS has not yet commented on this issue.  Ultimately, it is not entirely clear whether an offshore online casino account falls under the FBAR rules at this time.

The severity of FBAR penalties has baffled tax practitioners since institution of the reporting requirement.  There are both civil and criminal penalties.  The penalty for a willful violation of FBAR requirements is equal to the greater of (i) $100,000 or (ii) 50% of the balance in the account in question at the time of the violation.  The penalty for non-willful violations is $10,000.  These penalties are for each violation.  So, for example, if you don’t file an FBAR for three consecutive years and get caught, three separate penalties can be imposed.  For an organized compilation of all FBAR-related penalties, check out this chart.

If you have clients who have failed to timely file the FBAR, consider recommending them to participate in the 2011 Offshore Voluntary Disclosure Initiative.

Conclusion

I’d like to thank Bruce for giving me the opportunity to contribute to his informative tax blog.  I practice tax law in New York, primarily representing taxpayers under audit by the IRS and New York State.  I also blog about tax and poker at Taxes in the Back

More about Brad:

Brad is a tax attorney in New York who represents taxpayers under audit by the IRS and NYS.  Brad earned his J.D. at St. John’s University and his LL.M. in Taxation at New York University.  Brad also provides tax preparation services.

You can follow Brad on twitter -  Follow @taxdood on Twitter.

© 2011, Bruce Mc. All rights reserved.