Source: http://www.morrellawpllc.com/tax-preparation-and-resolution/taxation-of-recreational-gamblers-an-overview-of-how-to-report-wagering-gains-and-losses-ea-journal/
Timestamp: 2019-04-19 01:23:01+00:00

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Gambling is a $140 billion per year industry. Although the consumer electronics industry is larger ($186.4 billion), the gambling industry is larger than the cable TV ($97.6 billion), outdoor equipment ($11 billion), U.S. box office ($10.2 billion), and U.S. music ($7.0 billion) industries combined. As a matter of fact, in the twenty years from 1991 to 2011, consumer spending on commercial casino gaming grew from $8.6 billion to $35.6 billion—an increase of 314 percent!
With such a dramatic increase in gambling activity in the United States, gambling reporting has also increased. But exactly how to report this activity can be confusing.
To further complicate matters, the IRS computer matching program, which makes sure that a taxpayer includes all of his gambling winnings reported on Form-W2Gs, completely ignores the IRS-preferred and Tax Court-approved methodology of gambling sessions. This inconsistency is also repeated by every tax software package that the author has personally reviewed.
It should come as no surprise then that with such vague instructions, it is likely that the vast majority of tax returns that report gambling income—whether prepared by the taxpayer, a tax professional, or tax software— are prepared incorrectly. This article will provide a step-by-step guide for the proper treatment of gambling income.
Another common myth suggests that only amounts reported to the IRS on Form W-2Gs should be included. This is obviously incorrect. It does not matter if the wagering gains are won on a cruise ship in international waters or in a foreign country; the amounts need to be included. If an individual has wagering gains from an Internet website, the amounts need to be included. If the wagering gains are from friendly wagers or from a March Madness office pool, the amounts need to be included. If a taxpayer has wagering gains below the Form W-2G reporting thresholds, a very common scenario, the wagering gains still need to be included.
The IRS and judges get suspicious if the amount of gambling income reported by a taxpayer exactly matches the total amount of gambling income reported on Form W-2Gs.On audit, the IRS is more likely to demand that a taxpayer substantiate his or her gambling losses. In like manner, the courts require something more than the (possibly) self-serving oral testimony of the taxpayer As evidence of gambling losses. In several reported cases, the courts suspected that the taxpayers had more gambling income than what was reported to the IRS by the casinos on the Form W-2Gs. As a makeshift form of King Solomon’s splitting-the-baby wisdom, the courts reasoned that their disallowance of the taxpayer’s gambling losses sufficiently offset the taxpayer’s underreported gambling income. (Footnote 9) Either course of action is frequently to the detriment of the taxpayer. Simply put, all means all.
Rev. Rul. 83-103, 1983-2 C.B. 148, provides that the “basis” of a wager is excluded from the amount of a “wagering gain.” For example, if a taxpayer purchased a $20 lottery ticket that ultimately won $1 million, then his wagering gain is $999,980 and not $1 million.This step is frequently overlooked or mistakenly included as part of the calculation for wagering losses.
With this zealous emphasis on transactions, the courts recognized early on that it was impractical for a taxpayer to report every single roll of the dice, pull of a slot machine handle, draw of a card, or spin of the wheel. (Footnote 12) As a result, a bright-line test was devised. A taxpayer’s “accession to wealth” (i.e. wagering gain or loss) is determined when the taxpayer stops gambling. (Footnote 13) Th us, the concept of a “gambling session” was born.
different casinos on the same day would have at least two gambling sessions (different places). A taxpayer who played slot machines and black jack on the same day at the same casino would have at least two gambling sessions (different activities). A taxpayer who played slot machines over three days would have at least three gambling sessions (different times). But by comparison, a taxpayer involved in a three-day poker tournament would have only one gambling session since any accession to wealth cannot be determined until the tournament is finished and the final payouts to the participants are calculated and made.
The IRS’s course-of-play statements have two major implications. First, the IRS recognizes the reality that a taxpayer may indeed “recycle” his gambling winnings during a single gambling session. For example, if a gambler starts the day with $10,000 in cash, and ends the day with $15,000 in cash but generates $100,000 of W-2Gs in the process, the taxpayer’s gambling winnings for the gambling session are $5,000—not the $100,000 of W-2Gs. In essence, a gambler who recycles his winnings is no different than a day trader who repeatedly buys and sells stocks or a real estate developer who flips houses.
Second, the IRS realizes that ignoring a gambling-session calculation penalizes the taxpayer by overstating the taxpayer’s adjusted gross income (AGI). For example, in the previous hypothetical, without a gambling-session calculation, the taxpayer is required to include $100,000 as gambling winnings as other income and deduct $95,000 of gambling losses on Schedule A. While this method results in the same amount of taxable income ($5,000), the taxpayer’s AGI is greatly inflated. Such an overstatement can easily penalize a taxpayer since AGI is used to calculate the phaseout levels for some deductions and as a multiplier for others.
To exacerbate the issue, several popular tax-preparation programs reviewed by the author ignore the gambling-session methodology as well; they merely total the W-2Gs. Such a limitation requires tax return preparers to alter, modify, override, or otherwise finesse their software so as to include all the individual W-2Gs and satisfy the IRS computer matching system, but simultaneously reduce other income by the amount of recycled gambling winnings so as to properly report the taxpayer’s AGI.
IRS computers do a thorough job of matching amounts from documents submitted by third parties to the amounts reported on income tax returns. However, the IRS does not provide a gambling-session equivalent of Schedule D (Capital Gains and Losses), and IRS computers have not been programmed to process gambling- session calculations. Therefore, the tax preparer should consider completing a Form 8275 (Disclosure Statement), notifying the IRS that the gambling-session calculations were prepared in accordance with Chief Counsel Memorandum 2008-011 and Shollenberger v. Commissioner of Internal Revenue. Furthermore, a detailed analysis of each gambling session and a copy of any available gambling diaries should be included. By doing so, a manual review, if necessary, will permit the IRS to find and match up the Form W-2Gs reported under the taxpayer’s identification number.
An often forgotten step is the treatment of gambling winnings and losses at the state level. While the number of state-level audits triggered due to gambling issues is almost nonexistent, a few basic issue-spotting pointers can help identify the major concerns in preparation of income tax returns for the various states.
Obviously, if the taxpayer resides in a state without an income tax, then the taxpayer won’t have to pay state income tax on his gambling income.
But what about amounts won by nonresidents in states that have an income tax? Initially, some states made it a point to aggressively pursue nonresident winners. Then, these states decided to automatically withhold state taxes from any winnings. (It is also important to remember that Native American gambling establishments are exempt from state withholding requirements.) This in turn may require the taxpayer to file nonresident returns in order to receive the appropriate refunds.
But then there is Mississippi. Mississippi automatically withholds three percent from everybody, and it is considered a nonrefundable income tax. Fortunately, it is not necessary to file a nonresident Mississippi income tax return since the documents provided by the casinos are considered to be the income tax return and proof that the tax was paid to Mississippi. Hopefully, the taxpayer’s state of residence will allow a credit for the tax paid to Mississippi.
For the most part, the majority of states follow the federal example of allowing gambling losses to be deducted. However, some states base their income taxes on the federal AGI. As such, these “above-the-line” states do not allow itemized deductions, including gambling losses. Currently, these states include: Connecticut, Illinois, Indiana, Louisiana, Massachusetts, Michigan, Ohio, West Virginia, and Wisconsin. The nonrecognition of itemized deductions, such as gambling losses, makes the gambling-session concept even more important to understand and implement.
As a word of warning, do not assume anything, and frequently research the status of the state laws. For example, many of the general principles discussed previously regarding state taxes are riddled with exceptions if the winnings are from various sources such as lotteries. Furthermore, the political winds can change quickly. As a case in point, in July 2009 the state of Hawaii eliminated the deduction for gambling losses. But on April 16, 2010, legislation was enacted to repeal the prohibition and make it retroactive to 2009. When in doubt, check it out.
To learn more about this topic, go to the NAEA webboard.
2. IRS Pub. 525, Taxable and Nontaxable Income, p. 31 (2012 Edition).
3. IRS Pub. 529, Miscellaneous Deductions, pp. 12–13 (2012 Ed.). The recordkeeping suggestions listed in this publication merely restate Sec. 3 of Rev. Proc. 77-29, 1977-2 C.B. 538, 1977 WL 42691 (IRS RPR).
5. However, tax treaties provide the exception to this general rule. For example, the United States has a tax treaty with the Federal Republic of Germany that allows the exclusion of gambling income for German citizens. As such, German nonresident aliens are not subject to U.S. income tax. This fact was demonstrated in 2011 when Pius Heinz, a 22-year old professional poker player from Cologne, Germany, won the World Series of Poker. His $8.72 million winnings were tax free. Reportedly, he refused to take a check or wire transfer and insisted that his winnings be paid in cash.As a result of the large payout, the casino ran out of large denomination bills and eventually had to use $5 and$10 dollar bills in order to complete the transaction.
6. Rev. Rul. 54-339 (1954-2 C.B. 89).
7. Commissioner of Internal Revenue v. Glenshaw Glass Co. , 348U. S. 426 (1955); Johnston v. Commissioner of Internal Revenue, 25 T.C. 106 (1955); Umstead v. Commissioner of Internal Revenue,T. C. Memo. 1982-573 (U.S. Tax Ct. 1982); and Commissioner of Internal Revenue v. Groetzinger , 480 U.S. 23 (1987).
8. Bauman v. Commissioner of Internal Revenue , T.C. Memo.1993-112 (U.S. Tax Court 1993). This mistake also resulted in penalties for negligence, failure to file, and failure to pay estimated taxes. The Court held that the tax deficiency was $20,384, and the penalties were $7,417.70— for a total of $27,801.70. In 1988, the only other income Mr. Bauman had totaled $10,574.
9. Carmack et ux. V. Commissioner of Internal Revenue , 183 F. 2d 1 (5th Cir. 1950); Norgaard v. Commissioner of Internal Revenue, 939 F.2d 87 (9th Cir. 1991); and LaPlante v. Commissioner of Internal Revenue , T.C. Memo. 2009-226 (U.S. Tax Ct. 2009).
10. United States v. Scholl , 166 F.3d 964 (9th Cir. 1999); and Shollenberger v. Commissioner of Internal Revenue, T.C. Memo. 2009-306 (U.S. Tax Ct. 2009).
11. Spencer v. Commissioner of Internal Revenue, T.C. Summ.Op. 2006-95 (U.S. Tax Ct. 2006) – a $2,525 deficiency; LaPlante v. Commissioner of Internal Revenue , T.C. Memo.2009-226 (U.S. Tax Ct. 2009)—a $1,808 deficiency; and Shollenberger v. Commissioner of Internal Revenue, T.C. Memo 2009-306 (U.S. Tax Ct. 2009)—a $555 deficiency.
12 Green v. Commissioner of Internal Revenue , 66 T.C. 538 (U.S. Tax Ct. 1976); and Szkirscak v. Commissioner of Internal Revenue, T.C. Memo. 1980-129 (U.S. Tax Ct. 1980).
13. Commissioner of Internal Revenue v. Glenshaw Glass Co. , 348 U. S. 426 (1955).
14. Johnston v. Commissioner of Internal Revenue, 25 T.C. 106 (U.S. Tax Ct. 1955); and Shollenberger v. Commissioner of Internal Revenue, T.C. Memo. 2009-306 (U.S. Tax Ct. 2009).
15. Gamblers are typically described as “recreational” or “professional.” Recreational gamblers must separately compute and report their gambling winnings and gambling losses as described in this article. On the other hand, professional gamblers are allowed to compute and report their gambling winnings and gambling losses on Schedule C. Such treatment allows the professional gambler to avoid inflation of his or her adjusted gross income (AGI). Throughout tax literature, the terms “recreational” and “casual” are used interchangeably to describe a non-professional gambler.
This article was previously published in the March/April 2012 edition the EA Journal, a publication of the National Association of Enrolled Agents. Online reprints of the article are available HERE and HERE.

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