Betting It All
If clients don't keep track of their gambling winnings and losses, it's Uncle Sam who hits the jackpot at tax time.
By Julian Block
</BEG_STORY>August 1, 2005- For better or worse, gambling is big business in this country. ESPN's coverage of the World Series of Poker--which made Texas Hold 'Em a household phrase--draws ratings comparable to Major League Baseball and the NBA. The 36th annual tournament, which kicked off in Las Vegas on July 7, offered a prize pool of $100 million, bigger than the Indy 500, the Kentucky Derby, or the Master's, to over 23,000 hopefuls from more than 45 nations. <!--<table align=right><tr><td width=10>/images/spacer.gif</td><td align="center">Advertisement
<!-include virtual="/cgi-bin/show_dart_ad.pl?pg=ros&sz=300x250"-></td></tr></table>-->
At a more prosaic level, the dream of hitting it big drives several industries--legal and otherwise. In 2004, 228 Native American tribes operated 405 gaming facilities in 30 states, generated $19 billion in gaming revenues. That's up 12% from 2003. North Americans spend more than $45 billion on gambling annually, and 57% of the population admit to purchasing a lottery ticket within the last year. What's more, the Federal Bureau of Investigation estimates that we wager over $2.5 billion on the NCAA men's basketball tournament each year, even though the bets are illegal in every state except Nevada.
People who gamble a great deal usually don't like to be reminded of how much they lose. But it's a good idea for those who wager substantial amounts to keep close tabs on their wins and losses. Otherwise, the Internal Revenue Service (IRS) might stack the deck against them when (and if) they hit the jackpot.
The tax rules for gamblers can be summed up simply: Heads, the IRS wins; tails, gamblers lose. The Feds routinely nail gamblers for taxes on their entire winnings from horses, lotteries, slot machines, cards or other games of chance. But their losses are deductible only to the extent of their winnings. And losing bets that undergo IRS scrutiny generally are allowed only when they are corroborated by records that pass muster with the agency. More on records below.
So if you have clients who gamble, how can you help them? Alert them to strategies that can keep their taxes to the legal minimum and keep them out of trouble with the IRS. THE BASICS
Generally, if a client receives $600 ($1,200 from bingo and slot machines and $1,500 from keno) or more in gambling winnings and the winnings are at least 300 times the amount of the wager, the payer must issue a Form W-2G. Winnings that are to be split, as with a lottery pool, are reported on Form 5754. If the client wins more than $5,000, the payer may be required to withhold 25% of the proceeds for federal income tax (28% if the payer has no Social Security number for the recipient). The IRS receives nearly four million Forms W-2G and 5754 each year.
Gamblers cannot reduce winnings by losses and report the difference, the way investors do. They must report winnings and losses separately on Form 1040. Winnings go on the 1040 line for "other income"--and bettors must specify gambling as the source of the income. This remains the case even if the client's losses exceed winnings.
Gamblers can use their losses to erase taxes on their winnings, courtesy of Internal Revenue Code (IRC) section 165(d). But under no circumstances can the deduction for losses exceed reported winnings for the year in question, whether those losses are incurred by recreational or professional gamblers.
Moreover, the law absolutely bars any use of excess losses to offset wages, dividends, interest and other kinds of income. These rules are similar to the ones for hobbies. Hobby expenses are allowable only up to the amount of income generated by the hobby and cannot offset income from other sources.
To deduct losses, gamblers must itemize. Individuals who use the standard deduction (a category that accounts for about 70% of all filers) instead of itemizing on Schedule A lose their chance. Year in and year out, gamblers get tripped up by this limitation.
On the plus side, gambling losses are considered miscellaneous deductions. But IRC section 67(b)(3) specifies that gambling losses are not subject to the nondeductible floor of 2% of adjusted gross income (AGI) that applies to other kinds of miscellaneous expenses--for instance, fees for tax-return preparation and planning, investment advice, job-hunting costs and unreimbursed employee business expenses, such as union dues, or safe deposit boxes.
Gamblers should not list their gambling losses on lines 20, 21 or 22 of schedule A. The correct place to report losses is on line 27 of the Schedule A under "other miscellaneous deductions." Otherwise they will needlessly lose out on a portion of an allowable deduction and overpay their taxes, perhaps by a sizable sum.
For example, assume that Arthur and Mabel Grant declare an AGI of $100,000 and fall into a 30% federal and state tax bracket. The Grants have otherwise allowable gambling losses of $10,000. Suppose the couple erroneously enters their losses on line 22 for other miscellaneous deductions. They will automatically lose $2,000 ($100,000 times 2%) of their write-off. As a result, they overpay their taxes by $600. The Grants should not count on the IRS to catch their incorrect entry. These kinds of errors are spotted during audits, if at all. THE ITEMIZER'S TRIFECTA
IRC section 68(c)(3) exempts gambling losses from the 3% disallowance of state and local income taxes and several other categories of itemized deductions when AGI exceeds a specified amount that is adjusted annually to account for inflation. For 2005, the magic number is $149,950. Moreover, section 56(b)(1)(A)(i) provides that wagering losses are not subject to the numbingly complex alternative minimum tax, which disallows most miscellaneous expenses. Think of these two exceptions and the one for miscellaneous expenses as a sort of trifecta.
The IRS also does not object when gamblers offset losses from one kind of wager against winnings from others. For example, say Arthur Grant declares lottery winnings. His itemized deductibles are not restricted to what he paid for losing lottery tickets. They also include his losses from horse races, cards, church and school raffles and the like.
Another plus for Arthur is that losses from any illegal bets he may have made are deductible, too. If the IRS decides to question Arthur's return and his documentation is acceptable, an agent will not single out bets placed with bookies for unfavorable treatment.
Still, Arthur should not bet the farm on the agent's immediately agreeing to accept his documentation. At the very least, he should expect some searching questions. After all, an audit is basically an adversarial proceeding. But unlike a criminal trial, where there is a presumption of Arthur's innocence until the government proves him guilty, the burden of proof in a tax dispute falls on him, not the IRS. More on the burden of proof later.
IRS Regulations 1.165-10 does dispense some leeway for married couples. Filing joint returns allows them to pool their gambling losses and winnings for the year; his losses are deductible from her winnings, or vice versa.
For the year in question, assume Arthur wins $15,000 and loses $30,000, while Mabel wins $25,000. As joint filers, their combined winnings of $40,000 are offset by an itemized deduction of $30,000. It makes no difference that his losses surpass her winnings.
Each year's results, though, must stand on their own. Suppose Arthur's losses exceeded his winnings for last year, and the reverse is true for this year. He cannot carry forward or back unused gambling losses for one year and deduct them from winnings for another year. KEEPING RECORDS
A concerned IRS wants to reduce record-keeping disputes with gamblers singled out for audit. To help them with their bookkeeping, the IRS provides guidelines that spell out what sort of records and other substantiation are acceptable.
Revenue Procedure 77-29 recommends that bettors record their winnings and losses in "an accurate diary or similar record"--the identical method that the agency encourages businesspeople to use to keep tabs on their travel and entertainment expenditures. But keeping diaries can turn out to be a waste of time and effort for gamblers whose entries fail to show the information called for by the guidelines. To be on the safe side, bettors should make certain their diaries contain at least the following: dates and types of specific wagers or wagering activities; names and addresses or locations of gambling establishments; the names of other persons, if any, present with the bettors at gambling places; and amounts won or lost.
The best way to keep diaries is to develop the habit of recording bets when they are made. It's tough to compile a diary at filing time. And one that's not prepared until just before a taxpayer shows up for an audit is bound to be unacceptable.
The IRS warns gamblers to keep what the agency dubs "verifiable documentation," a term that includes betting tickets, canceled checks and credit records. Whenever possible, the IRS would prefer the diary and backup documentation to be supported by other proof of wagering activities or visits to gambling sites. The guidelines specify such items as hotel bills, airline tickets, gasoline credit-card slips, bank deposits and withdrawals, and affidavits or testimony from "responsible gambling officials," a term the IRS has conveniently opted to leave unexplained.
For instance, the advice for lotto players is to record ticket purchases, dates, winnings and losses, and to keep unredeemed tickets, payment slips and winnings statements. As for frequenters of horse and dog tracks, tax collectors ask them to list the races, entries, amounts of wagers and what was won on the winners and lost on the losers, and to keep unredeemed tickets and any payment records from the racetrack.
The IRS discreetly describes its guidelines as "suggestions" and says that most bettors will satisfy the recordkeeping requirements if they follow them. Nevertheless, it cautions that its guidelines are not intended to cover all possible situations and that whether a bettor will get nicked for extra taxes depends on the facts and circumstances in a particular situation. This implies that gamblers who comply generally will avoid a dispute with the IRS, while a failure to comply is not necessarily fatal. CASINO COMPS
Airlines have frequent fliers; casinos have "preferred customers," their euphemism for someone who receives the kinds of perks conferred on high-stakes gamblers--complimentary goods and services, or "comps." The comps roster typically includes free drinks, meals and rooms, although some casinos throw in lots of other tchotchkes.
William J. Bennett, a career moralist brought low by his affinity for high-stakes gambling, was one recipient of casinos' largesse. Investigative reporters sifting through a decade's worth of internal casino documents discovered the list of goodies for the culture commissar included limousines and "tens of thousands of dollars in complimentary hotel rooms and other amenities."
The reporters were unable to determine just what those comps were worth. But their value does concern the IRS, because the Tax Court has parsed "gambling income" as including more than just winning wagers. It includes comps as gambling income. Therefore, you can count the value of comps as gains and deduct losses against them.
The court allowed these deductions in 1996 in a dispute that pitted the IRS against Robert Libutti, whose comps decidedly were not chopped liver. Trump's Casino in Atlantic City conferred comps valued at more than $2.5 million during 1987 and 1989, a period in which he lost more than $8 million.
The comps included jewelry (a 2.7 carat diamond among other serious bling), tickets to sporting events, European jaunts and 10 expensive automobiles. Libutti never grasped the steering wheels of the five Rolls Royces, three Ferraris, Bentley Corniche and Mercedes-Benz, because Trump's simultaneously sold the vehicles on his behalf for cash--most, if not all, of which he then proceeded to gamble away at the casino.
The IRS maintained that the court should exclude Libutti's comps from gambling income because The Donald's casino bestowed comps to motivate Libutti to gamble at its tables rather than others'. Hence, they were insufficiently linked to his gambling transactions.
As you would have thought, that view was unpersuasive. The court held that Libutti received them only because he wagered extensively for high stakes (total bets for one roll of the dice ranged from $50,000 to $100,000). True, the casino's decisions on when to dole out comps did not depend on whether specific bets were winners or losers. Still, the court easily found a link.
Whether your clients are high rollers who know the Vegas dealers by name or occasional lottery players with a dollar and a dream, you need to explain the tax consequences of gambling winnings and losses. Otherwise, that dream could easily become a nightmare. Julian Block is a syndicated columnist and attorney based in Larchmont, N.Y. He can be contacted at julianblock@yahoo.com.
If clients don't keep track of their gambling winnings and losses, it's Uncle Sam who hits the jackpot at tax time.
By Julian Block
</BEG_STORY>August 1, 2005- For better or worse, gambling is big business in this country. ESPN's coverage of the World Series of Poker--which made Texas Hold 'Em a household phrase--draws ratings comparable to Major League Baseball and the NBA. The 36th annual tournament, which kicked off in Las Vegas on July 7, offered a prize pool of $100 million, bigger than the Indy 500, the Kentucky Derby, or the Master's, to over 23,000 hopefuls from more than 45 nations. <!--<table align=right><tr><td width=10>/images/spacer.gif</td><td align="center">Advertisement
<!-include virtual="/cgi-bin/show_dart_ad.pl?pg=ros&sz=300x250"-></td></tr></table>-->
At a more prosaic level, the dream of hitting it big drives several industries--legal and otherwise. In 2004, 228 Native American tribes operated 405 gaming facilities in 30 states, generated $19 billion in gaming revenues. That's up 12% from 2003. North Americans spend more than $45 billion on gambling annually, and 57% of the population admit to purchasing a lottery ticket within the last year. What's more, the Federal Bureau of Investigation estimates that we wager over $2.5 billion on the NCAA men's basketball tournament each year, even though the bets are illegal in every state except Nevada.
People who gamble a great deal usually don't like to be reminded of how much they lose. But it's a good idea for those who wager substantial amounts to keep close tabs on their wins and losses. Otherwise, the Internal Revenue Service (IRS) might stack the deck against them when (and if) they hit the jackpot.
The tax rules for gamblers can be summed up simply: Heads, the IRS wins; tails, gamblers lose. The Feds routinely nail gamblers for taxes on their entire winnings from horses, lotteries, slot machines, cards or other games of chance. But their losses are deductible only to the extent of their winnings. And losing bets that undergo IRS scrutiny generally are allowed only when they are corroborated by records that pass muster with the agency. More on records below.
So if you have clients who gamble, how can you help them? Alert them to strategies that can keep their taxes to the legal minimum and keep them out of trouble with the IRS. THE BASICS
Generally, if a client receives $600 ($1,200 from bingo and slot machines and $1,500 from keno) or more in gambling winnings and the winnings are at least 300 times the amount of the wager, the payer must issue a Form W-2G. Winnings that are to be split, as with a lottery pool, are reported on Form 5754. If the client wins more than $5,000, the payer may be required to withhold 25% of the proceeds for federal income tax (28% if the payer has no Social Security number for the recipient). The IRS receives nearly four million Forms W-2G and 5754 each year.
Gamblers cannot reduce winnings by losses and report the difference, the way investors do. They must report winnings and losses separately on Form 1040. Winnings go on the 1040 line for "other income"--and bettors must specify gambling as the source of the income. This remains the case even if the client's losses exceed winnings.
Gamblers can use their losses to erase taxes on their winnings, courtesy of Internal Revenue Code (IRC) section 165(d). But under no circumstances can the deduction for losses exceed reported winnings for the year in question, whether those losses are incurred by recreational or professional gamblers.
Moreover, the law absolutely bars any use of excess losses to offset wages, dividends, interest and other kinds of income. These rules are similar to the ones for hobbies. Hobby expenses are allowable only up to the amount of income generated by the hobby and cannot offset income from other sources.
To deduct losses, gamblers must itemize. Individuals who use the standard deduction (a category that accounts for about 70% of all filers) instead of itemizing on Schedule A lose their chance. Year in and year out, gamblers get tripped up by this limitation.
On the plus side, gambling losses are considered miscellaneous deductions. But IRC section 67(b)(3) specifies that gambling losses are not subject to the nondeductible floor of 2% of adjusted gross income (AGI) that applies to other kinds of miscellaneous expenses--for instance, fees for tax-return preparation and planning, investment advice, job-hunting costs and unreimbursed employee business expenses, such as union dues, or safe deposit boxes.
Gamblers should not list their gambling losses on lines 20, 21 or 22 of schedule A. The correct place to report losses is on line 27 of the Schedule A under "other miscellaneous deductions." Otherwise they will needlessly lose out on a portion of an allowable deduction and overpay their taxes, perhaps by a sizable sum.
For example, assume that Arthur and Mabel Grant declare an AGI of $100,000 and fall into a 30% federal and state tax bracket. The Grants have otherwise allowable gambling losses of $10,000. Suppose the couple erroneously enters their losses on line 22 for other miscellaneous deductions. They will automatically lose $2,000 ($100,000 times 2%) of their write-off. As a result, they overpay their taxes by $600. The Grants should not count on the IRS to catch their incorrect entry. These kinds of errors are spotted during audits, if at all. THE ITEMIZER'S TRIFECTA
IRC section 68(c)(3) exempts gambling losses from the 3% disallowance of state and local income taxes and several other categories of itemized deductions when AGI exceeds a specified amount that is adjusted annually to account for inflation. For 2005, the magic number is $149,950. Moreover, section 56(b)(1)(A)(i) provides that wagering losses are not subject to the numbingly complex alternative minimum tax, which disallows most miscellaneous expenses. Think of these two exceptions and the one for miscellaneous expenses as a sort of trifecta.
The IRS also does not object when gamblers offset losses from one kind of wager against winnings from others. For example, say Arthur Grant declares lottery winnings. His itemized deductibles are not restricted to what he paid for losing lottery tickets. They also include his losses from horse races, cards, church and school raffles and the like.
Another plus for Arthur is that losses from any illegal bets he may have made are deductible, too. If the IRS decides to question Arthur's return and his documentation is acceptable, an agent will not single out bets placed with bookies for unfavorable treatment.
Still, Arthur should not bet the farm on the agent's immediately agreeing to accept his documentation. At the very least, he should expect some searching questions. After all, an audit is basically an adversarial proceeding. But unlike a criminal trial, where there is a presumption of Arthur's innocence until the government proves him guilty, the burden of proof in a tax dispute falls on him, not the IRS. More on the burden of proof later.
IRS Regulations 1.165-10 does dispense some leeway for married couples. Filing joint returns allows them to pool their gambling losses and winnings for the year; his losses are deductible from her winnings, or vice versa.
For the year in question, assume Arthur wins $15,000 and loses $30,000, while Mabel wins $25,000. As joint filers, their combined winnings of $40,000 are offset by an itemized deduction of $30,000. It makes no difference that his losses surpass her winnings.
Each year's results, though, must stand on their own. Suppose Arthur's losses exceeded his winnings for last year, and the reverse is true for this year. He cannot carry forward or back unused gambling losses for one year and deduct them from winnings for another year. KEEPING RECORDS
A concerned IRS wants to reduce record-keeping disputes with gamblers singled out for audit. To help them with their bookkeeping, the IRS provides guidelines that spell out what sort of records and other substantiation are acceptable.
Revenue Procedure 77-29 recommends that bettors record their winnings and losses in "an accurate diary or similar record"--the identical method that the agency encourages businesspeople to use to keep tabs on their travel and entertainment expenditures. But keeping diaries can turn out to be a waste of time and effort for gamblers whose entries fail to show the information called for by the guidelines. To be on the safe side, bettors should make certain their diaries contain at least the following: dates and types of specific wagers or wagering activities; names and addresses or locations of gambling establishments; the names of other persons, if any, present with the bettors at gambling places; and amounts won or lost.
The best way to keep diaries is to develop the habit of recording bets when they are made. It's tough to compile a diary at filing time. And one that's not prepared until just before a taxpayer shows up for an audit is bound to be unacceptable.
The IRS warns gamblers to keep what the agency dubs "verifiable documentation," a term that includes betting tickets, canceled checks and credit records. Whenever possible, the IRS would prefer the diary and backup documentation to be supported by other proof of wagering activities or visits to gambling sites. The guidelines specify such items as hotel bills, airline tickets, gasoline credit-card slips, bank deposits and withdrawals, and affidavits or testimony from "responsible gambling officials," a term the IRS has conveniently opted to leave unexplained.
For instance, the advice for lotto players is to record ticket purchases, dates, winnings and losses, and to keep unredeemed tickets, payment slips and winnings statements. As for frequenters of horse and dog tracks, tax collectors ask them to list the races, entries, amounts of wagers and what was won on the winners and lost on the losers, and to keep unredeemed tickets and any payment records from the racetrack.
The IRS discreetly describes its guidelines as "suggestions" and says that most bettors will satisfy the recordkeeping requirements if they follow them. Nevertheless, it cautions that its guidelines are not intended to cover all possible situations and that whether a bettor will get nicked for extra taxes depends on the facts and circumstances in a particular situation. This implies that gamblers who comply generally will avoid a dispute with the IRS, while a failure to comply is not necessarily fatal. CASINO COMPS
Airlines have frequent fliers; casinos have "preferred customers," their euphemism for someone who receives the kinds of perks conferred on high-stakes gamblers--complimentary goods and services, or "comps." The comps roster typically includes free drinks, meals and rooms, although some casinos throw in lots of other tchotchkes.
William J. Bennett, a career moralist brought low by his affinity for high-stakes gambling, was one recipient of casinos' largesse. Investigative reporters sifting through a decade's worth of internal casino documents discovered the list of goodies for the culture commissar included limousines and "tens of thousands of dollars in complimentary hotel rooms and other amenities."
The reporters were unable to determine just what those comps were worth. But their value does concern the IRS, because the Tax Court has parsed "gambling income" as including more than just winning wagers. It includes comps as gambling income. Therefore, you can count the value of comps as gains and deduct losses against them.
The court allowed these deductions in 1996 in a dispute that pitted the IRS against Robert Libutti, whose comps decidedly were not chopped liver. Trump's Casino in Atlantic City conferred comps valued at more than $2.5 million during 1987 and 1989, a period in which he lost more than $8 million.
The comps included jewelry (a 2.7 carat diamond among other serious bling), tickets to sporting events, European jaunts and 10 expensive automobiles. Libutti never grasped the steering wheels of the five Rolls Royces, three Ferraris, Bentley Corniche and Mercedes-Benz, because Trump's simultaneously sold the vehicles on his behalf for cash--most, if not all, of which he then proceeded to gamble away at the casino.
The IRS maintained that the court should exclude Libutti's comps from gambling income because The Donald's casino bestowed comps to motivate Libutti to gamble at its tables rather than others'. Hence, they were insufficiently linked to his gambling transactions.
As you would have thought, that view was unpersuasive. The court held that Libutti received them only because he wagered extensively for high stakes (total bets for one roll of the dice ranged from $50,000 to $100,000). True, the casino's decisions on when to dole out comps did not depend on whether specific bets were winners or losers. Still, the court easily found a link.
Whether your clients are high rollers who know the Vegas dealers by name or occasional lottery players with a dollar and a dream, you need to explain the tax consequences of gambling winnings and losses. Otherwise, that dream could easily become a nightmare. Julian Block is a syndicated columnist and attorney based in Larchmont, N.Y. He can be contacted at julianblock@yahoo.com.
