Don’t Let Your Weekend Gambling Create a Tax NightmareTax Planning
If you gamble, you must pay attention to your taxes.
Imagine this. You gamble during the year, lose money, and pay $13,898 in taxes on your gambling activity. This, or worse, could happen to you as a casual gambler. You will see, later in this article, how it happened in real life.
But first, here’s a quick look at the federal income tax rules for the non-professional gambler:
- Your winnings are “above-the-line” taxable.
- Your losses are “below-the-line” itemized deductions and thus deductible, but (a) only to the extent of your winnings and (b) only if you itemize.
- Casinos and other payors of your winnings may have to report your winnings to the IRS on Form W-2G and send a copy to you.
Example. Wilson, who is married, filing jointly, wins $15,000 and losses $40,000. Two things here:
- His itemized deduction for his gambling losses is limited to $15,000.
- If he doesn’t itemize, he pays taxes on the $15,000 with no offset for his losses.
Let’s review. Wilson could pay taxes on $15,000 even though he loses $40,000. Okay, you can see how this might get ugly. Let’s look at a recent court case.
Jacob Bright gambled extensively and lost more than he won at three Midwestern casinos.
Bright had several large wins at slot machines during the year. As required by law, the casinos reported those winnings on IRS Form W-2G. Casinos must file this form whenever a gambler wins $1,200 or more at a slot machine. Bright’s W-2Gs for the year totaled a whopping $110,553.
Bright hired a tax preparer, who classified him as a professional gambler and listed $240,895 of gross gambling receipts and an equal amount of losses on his Schedule C.
On audit, the IRS
- concluded that Bright was not a professional gambler;
- accepted the reported $240,895 in winnings;
- disallowed the losses; and
- asserted $68,214 in taxes plus $13,643 as an understatement penalty.
Bright petitioned the Tax Court. He admitted that he was not a professional gambler, but claimed that his gambling income should be either $110,533 or zero.
Tax Court Cuts Bright a Break
Most amateur gamblers are not good at recordkeeping. True to form, Bright kept no records of his wins and losses.
The Tax Court refused to reduce the amount of Bright’s gambling income, since he provided the court with no evidence it should be less than $240,895.
Casino records and Bright’s testimony made it clear that Bright didn’t have any net winnings for the year: His bank statements showed he was broke much of the time.
The Tax Court decided to cut Bright a huge break. He normally used a player’s card when he gambled at the three casinos, so Bright had casino win/loss statements based on his player’s card to show the Tax Court. Two of the cards were annual statements, while one casino provided monthly win/loss statements.
Under the authority of the Cohan rule, which allows the court to estimate expenses where there is some basis for doing so, the Tax Court used the win/loss statements to determine the minimum amounts Bright must have lost.
And the court did this in a way that was particularly favorable for Bright: it determined separately the minimum annual losses he must have incurred at each of the three casinos where he gambled.
The two annual casino win/loss statements showed net losses for the year, and eight of 10 of the monthly win/loss statements from the third casino also showed losses. The Tax Court added to these losses the amount of winnings shown on each Form W2-G from each casino. The court reasoned (rightly, in our opinion) that Bright must have lost
all the W-2G winnings to have net losses on each win/loss statement.
After adding the $110,533 shown on the W-2Gs to the losses shown on the win/loss statements, the Tax Court ruled that Bright had total losses of $191,756 that he could deduct as itemized deductions on Schedule A.
That left him with $49,130 in taxable winnings for the year. The Tax Court also held that he didn’t have to pay an underpayment penalty.
All in all, Bright did about as well as he could have hoped in Tax Court. But keep this in mind: here you have a guy with no gambling winnings, no money, and a tax bill of $13,898.
What Did Bright Do Wrong?
Bright testified that he lost more than he won gambling, and the Tax Court believed him.
But he had no proof of his actual losses that the Tax Court could use. Gamblers, including recreational gamblers, are supposed to keep contemporaneous records of their wins and losses.
Ideally, this should be in the form of a paper or electronic gambling log or diary containing all the following information:
- Name and address (or location) of the gambling establishment
- Type of wagers you made
- Amounts you won or lost during each gambling session
- Names of any other people with you during the session
You don’t have to keep track of each individual bet you make.
Instead, you can track gambling wins and losses by the gambling session.8 At the end of the year, you separately add winning gambling sessions (the above-the-line amount) and all your losing sessions (the itemized deduction amount).
Key point. Recreational gamblers roll snake eyes if they don’t itemize when they file their taxes: Why? They get no deduction for their losses—but they pay taxes on their gambling winnings!
There is no precise definition of what a gambling session is. Generally, it means any period of play at the same game at the same establishment for up to a day.
For slot play, the IRS proposed a safe harbor for determining a gambling session: any period of continuous slot play at the same gaming establishment up to one calendar day.
Key point. Had Bright tracked his wins and losses by the session, his losses during those sessions would offset his
session winnings, undoubtedly reducing his winnings substantially for the year.
Lessons for Recreational Gamblers
The obvious lesson is: Don’t be like Jacob Bright, particularly if you gamble a lot. Keep track of your wins and losses by the session. You never know when you’ll win a big jackpot that will be reported to the IRS.
This is exactly what happened to Bright: he was a losing gambler overall, but he won several big jackpots that were reported to the IRS.
You should also do the one thing Bright did right: always use a player’s card when you gamble at a casino, so your wins and losses will be electronically tracked and you’ll be able to obtain casino win/loss statements.
But note that win/loss statements are not really a good substitute for session-based gambling records you create yourself. Win/loss statements do not track your wins and losses by the session and are not always accurate.
The casinos themselves typically include disclaimers on their win/loss statements noting that the statements are only estimates, not accurate accounting records. Both the IRS and the Tax Court often use win/loss statements where no other records are available, but they don’t have to.
If you lack session-based gambling records and are audited by the IRS, follow Bright’s example and provide both your win/loss statements and bank records showing you won no large amounts during the period in question (if that is the case).
Ask the IRS examiner to estimate your annual losses the same way the Tax Court did in Bright’s case. If a win/loss statement shows an annual loss, the amount of any Form W-2Gs issued by that casino should be added to the losses shown on the statement.
If you gamble, you need to become a gambling bookkeeper.
With no records, you are at the mercy of the IRS or the courts. These are not good places to look for mercy.
Most gambling establishments, including those online, have players cards or other records that can help you establish your wins and losses.
You want to track your gambling by session because then the individual winning bets do not create above-the-line taxable income. Instead, for the session, you can offset wins and losses and use the net result.
Session records are the best.
If all you have are the casino or other win/loss statements, you are not dead. Although the IRS and Tax Court don't have to accept win/loss statements, but they often do if there are no other available records.
Remember this important point: If all you have are win/loss statements that show a net loss for the year, you need to adjust the loss amount. Add jackpot wins, including those reported on Forms W2-G, to the loss amount, because you had to lose those winnings to have a loss for the year.