Handling Gambling Winnings

Posted by Bruce Mc on Mar 8, 2011 in Information, Opinions, Schedule C, Tax Planning | 1 comment

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.

How do I know if I have to worry about the AMT?

Posted by Bruce Mc on Nov 19, 2009 in AMT, Information, Opinions | 0 comments

          One of the big problems with the AMT, there’s no good answer to this common question. You can owe AMT liability due to any number of reason/s. Could be just one thing, could be a lot of little things. Some things that can contribute to an AMT liability are mundane items that appear on many tax returns. (See this list Top 10 Things that Cause AMT Liability.)

          If you use computer software to prepare your tax return, the program should (I would hope) be able to do the AMT calculations for you. If you’re preparing your return by hand, the only way to know for sure is to fill out IRS Form 6251 – a very laborious process, on that I charge almost $80.00 for, and that price is adjusted (usually up) almost every time.

         The best way to understand the alternative minimum tax liability is to see how it’s calculated. So, here’s what you do.

         First, you figure the amount of tax you would owe under the different rules. What’s different about these rules? Roughly speaking, there are three things:

1. Various tax benefits that are available under the regular tax are reduced or eliminated.
2. You get a special deduction called the AMT exemption, which is designed to prevent the AMT from applying to taxpayers with modest income. This deduction phases out when your income reaches higher levels, a fact that causes significant problems with the alternative minimum tax.
3. You calculate the tax using AMT rates, which start at 26% and move to 28% at higher income levels. By comparison, the regular tax rates start at 10% and then move through a series of steps to a high of 35%.

          The result of this calculation is the amount of income tax you would owe under this “alternative” system of tax.

          Okay, got that number? Now then, compare this “tax” with your regular tax. If the regular tax is higher, you don’t owe any AMT. However, if the regular tax is lower, the difference between the two taxes is the amount of AMT you have to pay.

         You should definitely run the numbers if your gross income is above $75,000 and you have write-offs for personal exemptions, taxes and home-equity loan interest. if your income is over $150,000, run the numbers just because.

        Running the numbers means filling out Form 6251. In effect, you are simply adding back some tax deductions and income exclusions to your regular taxable income to arrive at your new alternative minimum taxable income (AMTI).

“Here is where the middle class gets screwed by the goat. If you are planning on doing all this on your own please call a tax pro for some guidance and a better understanding.”

         The AMT form has quite a few other pluses and minuses, but you can probably ignore them unless you own a business, rental properties or interests in partnerships or S corporations. If you do, you may need a tax pro to prepare at least the Form 6251 part of your return for you.

         Finally, you get to deduct the AMT exemption however, this exemption is reduced by 25 cents for each dollar of AMT taxable income above $150,000 for couples ($112,500 for singles and $75,000 for married filing separate status), and it’s not adjusted for inflation, which is one of the reasons why more people owe the AMT every year.

         After the exemption (if any) has been deducted, the result is subject to AMT rates. Again, the AMT brackets are not adjusted for inflation, which causes much greater exposure to the tax as the years go by. If the AMT exceeds your regular tax, you have to pay the greater amount. Basically, the AMT is just more tax, above and beyond your regular tax. Technically, the AMT is just the liability over and above the regular tax, and this figure is entered on page 2 of Form 1040.

Other notes:

         To calculate and report your AMT liability you need to fill out Form 6251, Alternative Minimum Tax – Individuals. If you use this form by all means please read the instructions.

         You’re required to take your AMT liability into account in determining how much estimated tax you pay. For information about estimated tax payments, see this Guide to Estimated Tax.

Form 1040 “New for 2009, Filing”

Posted by Bruce Mc on Oct 29, 2009 in Form 1040 Information, Information, Tax Preparation | 0 comments

            Well the IRS has released its “draft” of the 2009 Form 1040. Clicking the photo on the right will take you in a new window so you can see it if you like. 

The only change in the “Income” section is line 19. It is still for “Unemployment compensation”, but they added the phrase “. . . in excess of $2,400 per recipient (see page 27)” This is done so that those who are not aware (and prepare their own returns) that this is something new. If you need clarification, please visit Unemployment Compensation at the IRS site for Tax Changes for Individuals. 

            In the section for “Adjusted Gross Income”, line 23 now reads, “Educator expenses (see page 29)”. So, what used to be there is “Archer MSA deduction. Attach Form 8853” is no more. For more information on Archer MSA deduction please see Publication 696. 

            Line 34 now reads “Tuition and fees deduction. Attach Form 8917”, it used to be, “Jury duty pay you gave to your employer” This is not something new, just reworded from last years form. 

            Those are the only notable first glance changes to page one. Now . . .

 Page two.  (I did that in my best Paul Harvey voice I could muster.) 

            In the “Tax and Credits” area, line 39c from last year is gone (if you’ll remember this was a “check box” if you increased your standard deduction using your real estate taxes). 

         Line 40 is now “a” and “b”. “A” is the standard “Itemized deductions (from Schedule A) or tour standard deduction” which, as normal is listed on the left side of the form. Now part “b”. This reads “If you are increasing your standard deduction by certain real estate taxes, new motor vehicle taxes, or a net disaster loss, attach Schedule L (a new Form) and check here (see page 35)” and has a corresponding check box.

(I’ll talk more about the new schedules in other upcoming post) 

         Line 42 is the same ol thing but now reads “Exemptions. If line 38 is $125,100 or less and you did not provide housing to a Midwestern displaced individual, multiply $3,650 by the number on line 6d. Otherwise, see page 37” 

         Lines 47 through 55 are the same with two notable differences. This is the credit section of this part. They are rearranged (what was line 47 is now down on line 50 and such). The credit for the elderly or disabled is no longer listed there. Schedule R Although that line has been omitted altogether, the credit has not, it is still a viable credit. You’ll just enter it on line 53 and put a check in the box for other credit forms (this is “c”). 

Okay now for “Other Taxes”, well nothing new in that section. 

In the “Payments” section line 63 reads “Making work pay and government retiree credits. Attach Schedule M”. Again, I’ll talk more about the new schedules in other upcoming post.

          Line 66 “Refundable education credit from Form 8863, line 16” this is new for the American Opportunity Credit.

          So there are the basics of the new form and what is new and so forth. To further prepare yourself for the upcoming filing season please view the instructions for the new 2009 return.

photo credit: nalilo

Some IRS History. . .

Posted by Bruce Mc on Aug 29, 2008 in Form 1040 Information, History, Taxes | 4 comments

             The U.S. government’s privilege to levy taxes was incorporated into the Constitution in 1787. The responsibility for how to collect these taxes fell to the Treasury Department where it has stayed. 30years later the issue of taxes was abandoned due to our governments needs were being met by taxes on imports. So no more taxes for citizens.

            45 years later the Revenue Act of July1, 1862 was signed by President Lincoln due to the outbreak of the Civil War and the governments need for funding it. This established our nation’s first real income tax. The Internal Revenue Service is officially born.

            When the war ended, as before, the nation’s financial needs were being met by the taxes on imports, along with taxes on tobacco and alcohol. This resulting in some 90% of our internal revenue. In 1872 (10 years after its birth) the “income tax” was once again abolished.

            Congress revived the income tax in 1894, but the Supreme Court ruled it unconstitutional the following year.

            18 years after the Supreme Court ruling, Wyoming ratification of the 16^th Amendment, provided the three-quarter majority of states necessary to amend the Constitution. The 16^th Amendment gave Congress the authority to more or less re-enact an income tax. That same year, the first Form 1040 appeared after Congress levied a one percent tax on net personal incomes above $3,000 with a 6 percent surtax on incomes of more than $500,000.

            Five years later, during World War I, the top rate of the income tax was raised to 77 percent to help finance the war effort. In the post-war years, that dropped down to 24 percent by 1929, and rose again during the Depression.

During World War II, Congress introduced payroll withholding and quarterly tax payments.

I am compiling a historical highlight section for my website that I don’t have completed (not that my site is up yet either) yet but when it is going I will be directing more to it and from it.

If you want to get a look at what the first 1040 form looked like with it’s instructions follow the link below to where the IRS has as a pdf file reproduction.

“first 1040 form and instructions”

Some things of interest to notice:

1.                           Taxes were only paid on income above $3,000, equivalent to $61,000 in today’s dollars, at the initial rate of only 1%.

2.                            The highest marginal tax rate in 1913 was 6%, which applied to income above $500,000, equivalent in today’s dollars to a little over $10 million.

3.                           The entire 1040 tax form in 1913, including all forms and instructions, and was only 4 pages. All instructions in 1913 were contained on a single page, compared to the 2007 1040 Instructions, which held 92 pages long, (without any forms).