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.

Itemizing deductions – Schedule A

Posted by Bruce Mc on Jan 4, 2010 in | 0 comments

Getting the Most out of Itemizing your deductions.

Itemizing deductions is an incredibly easy theory to understand, yet the strategies behind it all can be intricate and countless.

Free Quicken Online automatically categorizes your expenses.

The rule for when to itemize is simple = you do it if the total of your itemized deductions is greater than your standard deduction.

First of all, your tax is based on your “taxable income.” That’s your total income after you’ve subtracted above-the-line deductions like your Individual Retirement Account (IRA) or other qualified retirement-plan contributions, moving expenses or alimony payments, plus your personal exemption and either :

Your standard deduction or, Your itemized deductions.

Your itemized deductions are sometimes referred to as “below-the-line” deductions. (“adjusted gross income” -aka AGI- is “the line.”) Clearly, the more you can deduct, the less in tax you’ll owe.

Here are the standard deductions that apply to 2011 taxes:

Some taxpayers must itemize, even if their deductions are less than the standard deduction. You must itemize your deductions if:

• You are married, filing separately, and your spouse itemizes.
• You are a U.S. citizen who can exclude income from U.S. possessions.
• You are a nonresident or dual-status alien.
• You file a short-period return because of a change in your accounting period.
  • There are eight sections  On Schedule A. Seven of which are itemized expenses that you can deduct on your taxes:

Medical and Dental expenses.

Taxes. These include state and local income taxes, property taxes on real estate, intangible taxes (on the value of stocks and bonds you own) and on personal property taxes on such things as cars. 

Interest expenses. For most people, these are limited to home mortgage interest, points (interest that’s prepaid to buy a home), and some interest on investments and education expenses. For most taxpayers, the mortgage deduction is what lets them itemize. If you take out a 30-year, $140,000 mortgage at 6%, you will generate about $8,350 in deductible interest in the first year.

Charitable contributions.

• See also my Fair Market Value Guide. (recently updated for 2010 filing)

Casualty – Theft losses

Job & Misc. Expenses

Other Misc. Deductions

Total Deductions

The key, then, is to maximize the value of your itemized deductions. Here’s where planning can put dollars in your pocket. Ask your Tax preparer a list of deductions to see What You Can Itemize.

Dealing with the floors

Some itemized deductions — including medical expenses or miscellaneous deductions such as investment expenses, safe deposit fees, professional education, employee job-hunting expenses and tax-preparation fees — are not allowed until they exceed a certain “floor” amount.

The toughest floor to exceed is medical expenses. No medical expenses are allowed as itemized deductions except for the amount that exceeds 7.5% of your adjusted gross income. That means if you have an adjusted gross income of $100,000, the first $7,500 of your medical expenses doesn’t count. But sometimes, elective medical expenses can be accelerated or even deferred. Orthodontia payments for you or your dependents can often be extended. They always can be accelerated. These expenses are deducted in the year they are paid, not necessarily in the year the service is rendered.

If you can already pass the 7.5% test for allowable expenses or these expenses would put you over the minimum hurdle, you should consider accelerating them. If you lack the cash, consider charging the expenses.

On credit card charges, you are allowed the deduction in the year of the charge, not in the year that the charge is paid off.

Don’t automatically accelerate if it puts you over the 7.5% floor. Remember, your total itemized deductions must exceed your standard deduction before you get any real additional benefit from any of them. Allowable medical expenses are just one component of the package.

If you don’t exceed the 7.5% floor or your total itemized deductions don’t exceed your standard deduction this year, you should consider deferring your payments or any elective medical procedures. You get the use of the money — and any investment returns. In any case, you may be able to use the deductions in the subsequent year when you revisit the itemization question.

Miscellaneous itemized expenses are also deductible only after they exceed a minimum floor. In this case, it’s 2% of your adjusted gross income. So, with an adjusted gross income of $100,000, your first $2,000 of miscellaneous itemized deductions won’t count.

But here again, many of these deductions can be either accelerated or deferred. Miscellaneous itemized deductions such as those mentioned above often can be paid in the year of your choice. Many of my clients send my tax-preparation fees to me on Dec. 31 in order to get the deduction in the year the check was mailed. I don’t get the income until I receive the check — in the new year.

The rule here is the same as with medical expenses. First, qualify the expenses to be included in the deductible pot. Then, only if you expect to itemize, accelerate. If not, defer.

Interest and tax payments

Some interest and tax payments can be handled in the same way.

Let’s look at the interest you are paying. Your January payment on your mortgage includes the interest you accrued for December of the previous year.

Example: By making your January 2012 payment on Dec. 31, 2011, you have accelerated a full month’s interest deduction into 2011.

In the 25% bracket for 2011 on a $1,000 interest payment, that saves you an immediate $250 on April 15, 2012. By doing that each year, you have created an interest-free loan of that $250 in perpetuity or at least until the loan is paid off.

Unfortunately, you can’t prepay two or three months in advance because the interest deduction must relate to the year the money was used. But your Dec. 31, 2011 payment will be for the use of the money during December 2011.

You can accelerate some tax payments as well. If you don’t pay your real-estate tax in your mortgage, you have the opportunity to accelerate your real-estate tax payments. I am billed in the 4^th quarter of my real-estate taxes January of the following year. But I actually make my payment on Dec. 31 of the previous year. The technique is the same with estimated state income tax payments. I make my estimated state income tax payment, due in January in December.

Any voluntary expenditure can be accelerated or deferred. Your gifts to charity are the best example. Whether your $1,000 pledge to your church or synagogue is sent on Dec. 31, 2011 or Jan. 1, 2012 makes little difference to the charity receiving the money. However, in the 25% bracket for 2011, it can make a $250 difference to your tax bill — but again, only if your total itemized deductions exceed your standard deduction.

Personally, if I can qualify for itemizing my taxes, I want to accelerate my tax savings.

And my favorite quotes fits here:

“Not everything that counts can be counted, and not everything that can be counted counts”. – Albert Einstein

Website update. . .

Posted by Bruce Mc on Sep 8, 2008 in Form 1040 Information | 1 comment

New pages are up. Although the rebuilding is slow. I am using Mambo and it is different from anything I have ever used. All through it, all is taking more time than I have. It’ll get there. I think I have cleared up a few weeks at the end of the month to spend a lot of time on it over all.

            The new pages I have up are:

o   Schedule A: What is it

o   What you can itemize

o   Medical and Dental Expenses

o   Taxes You Paid

o   Interest You Paid

o   Gifts to Charity

o   Fair Market Value Guide for Used Items

§  Household FMV

§  Clothing FMV

o   Casualty and theft losses

o   Job and miscellaneous expenses

o   Other miscellaneous deductions

o   Total itemized deductions

All the information was on one page on my other site (except the FMV Guide) and was a bit long to get through. Having broken this Form into different pages of its sections, I believe it will be easier to navigate. The information on these pages are for the filing of your 2007 returns (filed in 2008 – I’m assuming everyone has filed).

The Fair Market Value Guide for Used Items was updated for 2008. I imagine there might be a few updates towards the end of the year but for the most part it is right on the monies (within listed variables). If you’re making donations I highly recommend using the prices listed on both the Household FMV and the Clothing FMV pages. (After reading Fair Market Value Guide for Used Items.)

Schedule A: What is it describes what all the pages are. The whole series is based on the idea to give someone a general understanding of IRS Form Schedule A. I designed this section or series as somewhat of a walkthrough for the form. The information is far from all inclusive and by no means should be used that way.