Taxation of Gambling Income
The tax code discourages gambling. Winnings from gambling, sweepstakes, lotteries, and raffles are fully taxable as "Other Income" on Form 1040, but losses cannot be netted against winnings. Wagering gains or losses in 1 year cannot be used offset losses or gains in another year nor can wagering losses be used to offset non-wagering income. Instead, losses must be claimed as an itemized deduction on Schedule A, Itemized Deductions that is not subject to the 2% adjusted gross income (AGI) floor, but the amount of losses claimed cannot exceed the winnings. So, for example, if a taxpayer wins $2000, but later loses $1500, then the taxpayer must still claim $2000 as other income, while the $1500 loss must be claimed as an itemized deduction. If the taxpayer does not itemize, but instead, claims the standard deduction, then the gambling losses cannot be deducted at all. However, lottery and sweepstake winnings that are paid out annually as installments are reported as income in the year in which the installments are received rather than in the year of the winning. However, any gambling losses incurred during the installment payout period can only be deducted up to the amount of the installment for that year. Another exception to the no-netting rule exists for slot machines. When a taxpayer enters a casino and plays slot machines, then any losses can be netted with the winnings until the taxpayer redeems the tokens (cashes in the chips) (Chief Counsel Advice 2008-011). The no-netting rule is generally not applied when many sequential wagers can be placed within a short time, making it difficult to keep track of winnings and losses and to calculate the tax basis for each wager.
As an itemized deduction, gambling losses do not lower AGI, which can hurt many low income gamblers, since a higher AGI is not only taxed more heavily but it may lower the amount of tax credits and deductions that depend on AGI, such as the earned income credit. Hence, a taxpayer who has many winnings and losses may, paradoxically, have a high AGI but a low income.
Expenses related to gambling are not deductible at all unless the taxpayer is considered a professional gambler. So if a casual gambler travels to another city to participate in a game show and wins a lot of money, none of the expenses associated with the participation, such as travel and hotel costs, are deductible, not even as an itemized deduction.
To encourage gambling, many casinos offer comps, such as free hotel rooms and meals, tickets to sporting events, and even jewelry, automobiles, and European vacations to people who spend considerable sums gambling, especially for high rollers. Although comps must be claimed as income, the Tax Court ruled that gambling losses could be deducted as a miscellaneous deduction from comps even though the comps were not earned by wagering, but, were nonetheless sufficiently related to gambling to allow their reduction by gambling losses.
A professional gambler is someone who engages in the business of gambling to earn a living rather than conducting it as a hobby. As a business owner, the professional gambler must keep track of profits and expenses, and follow the other requirements of conducting a business. Although expenses are deductible, the expenses can only be used to offset gambling income, not other income. This contrasts with losses in other businesses, where such losses can be used offset income from other businesses or even from employment income. To avoid this treatment of gambling expenses, so that she could deduct losses against other income, a professional gambler argued that poker tournaments should be considered more as a sport or a form of entertainment rather than gambling, but the tax court ruled that since it involves wagers, it is gambling.
Reporting Gambling Income
Gambling businesses are required to report gross receipts over certain dollar amounts for each gambler. The payers of gambling winnings must send a Form W-2G, Certain Gambling Winnings to the recipients. A Form W-2G must be issued for winners earning:
- at least $1200 from bingo or slot machines;
- at least $1500 more than the wager from Kino;
- more than $5000 over the wager from poker;
- at least $600 in gambling winnings if the payout ≥ 300 × wager; and
- any other gambling winnings subject to withholding by the tax law.
A Form W-2G is not required to report winnings, regardless of the amount, from table games such as baccarat, blackjack, craps, pai gow, and roulette. Nonetheless, taxpayers must still report such income, however small, to the IRS. Indeed, gambling income must be reported even for winnings on an Indian reservation, from illegal activities, or even from foreign countries, such as Macau. (I'll bet that the percentage of unreported winnings claimed as income is a lot closer to 0% than to 100%!)
Accurate records must be maintained to deduct gambling losses, including receipts, tickets, and other documentation such as a diary, recording the location, the amount and the date of the wager, the type of game, and individual wins and losses.
Regular gambling withholding is based on gross proceeds (= winnings – amount wagered). The regular gambling withholding rate is 25% for cash payments and 33.33% for non-cash payments. If the payout is not subject to regular gambling withholding, then it is subject to backup withholding of 28%. If the winnings consist of property, then the appropriate rate is applied to the fair market value of the property. If the winning taxpayer does not provide a taxpayer identification number (TIN), then the backup withholding rate of 28% applies.
Under the Tax Cuts and Jobs Act of 2017, withholding on gambling winnings has been reduced from 25% to 24%! Gamblers everywhere should rejoice!
The payer of gambling winnings must also file the payment voucher Form 945, Annual Return of Withheld Federal Income Tax to pay withholdings to the IRS. Form 5754, Statement by Person(s)Receiving Gambling Winnings must be filled out by winners sharing a prize, so that the payer of the winnings can issue a Form W-2G to each of the winners. However, Form 5754 is not sent to the IRS. The winnings or prize is not divided among the winners to determine if withholding applies — only the total value of the prize or winnings matters. So if 10 people contribute $1 to buy a $10 sweepstake ticket, which subsequently wins $6010, then withholding applies because the total amount of $6000 (= $6010 – $10 price of ticket) exceeds the $5000 threshold subject to withholding for sweepstake prizes, even though each of the winners will only receive $600 apiece.
Most states also tax gambling income, either as a flat percentage rate or on a graduated scale commensurate with the amount of the winnings. Since state laws vary widely, the taxpayer should learn what applicable state laws apply.