I have had several individuals request that I repost an article that originally appeared on TwoPlusTwo.com’s Internet Magazine. Without further ado, here is the article that first appeared in the February 2007 TwoPlusTwo Internet Magazine.
TAX MYTHS FOR THE POKER PLAYER
By Russell Fox, E.A.
Note: This opinion is limited to the one or more Federal tax issues addressed in the opinion. Additional issues may exist that could affect the Federal tax treatment of the transaction or matter that is the subject of this opinion and the opinion does not consider or provide a conclusion with respect to any additional issues. With respect to any significant Federal tax issues outside the limited scope of this opinion, the article was not written, and cannot be used by the taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.
When I read a post on a poker site such as Two Plus Two or rec.gambling.poker that deals with U.S. taxes, it’s usually with fear and trepidation. Much of the time, the information presented is either wrong or only partially correct. In this article I will examine some of the major tax myths that I’ve seen and hopefully steer you in the right direction.
Myth #1. I’m a U.S. citizen, but I now live in Costa Rica. I don’t have to pay U.S. income tax. The United States taxes citizens on their worldwide income. If you’re a U.S. citizen, you must pay income tax on your income no matter where you reside, be it Moscow, Idaho or Moscow, Russia. You do, though, generally receive an extra two months (until June 15th) to both file and pay your income taxes if you’re outside of the U.S. on April 15th, but you will owe interest on the tax due.
Myth #2. I can renounce my U.S. citizenship, and then I won’t owe any tax. Well, that may be true, or it might not be. The United States has an Expatriation Tax (Section 877 of the Internal Revenue Code). From the ten years following your expatriation, you must file information returns. If you are in the U.S. for thirty days you will owe U.S. income tax for that year. Additionally, if you are considered a high-income individual under this section of the Code, you can owe tax. There are notification rules under this section of the Code, too. Warning: This is a complex area and you absolutely need to consult a tax professional and an attorney before renouncing your U.S. citizenship.
Myth #3. Online poker winnings aren’t taxable because the sites are overseas and/or it’s illegal and illegal income isn’t taxed. Not only does the United States impose an income tax on your worldwide legal income, illegal income is also taxable (see James v. United States, 366 U.S. 213, 218 (1961)). Early in 2006, a woman in Tullahoma, Tennessee pled guilty to four counts of tax evasion for not paying tax on $500,000 she embezzled. She will likely receive 18 to 24 months in prison. Internet gambling winnings are taxable income.
Myth #4. I won $2,000 at the Grand Casino in Tunica, MS. They withheld $500. I can claim that $500 in tax on my state tax return. This is only a partial myth. Generally, you can only pay tax to one state for any specific income. On your state income tax return, you can receive a credit for tax paid to other states. For example, you’re a resident of California, and you get a W-2G from a casino in Mississippi for $500. You will have to file a Mississippi tax return, attach a copy of that return to your California return, and you can claim a credit for the tax paid on line 28 of Form 540. Warning: The treatment of credits for other states’ taxes varies depending on the states involved. Sometimes the credit will be taken on the other state’s tax return. Consult a professional tax advisor for the correct treatment in your situation.
Myth #5. I work in a salaried, full-time position. I can also file as a professional gambler. This is almost certainly not true. In Commissioner v. Groetzinger (480 U.S. 23), the Supreme Court noted, “…[W]e conclude that if one’s gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business within the meaning of the statutes with which we are here concerned.” The key terms herein are full time, good faith, regularity, and livelihood. If you have a full-time job, it’s unlikely you can file as a professional gambler.
Myth #6. I can net my wins and my losses. Unless you’re a professional, the sum of your winning sessions are Other Income (line 21, Form 1040); your losing sessions, up to the amount of your winning sessions, are an itemized deduction taken on Schedule A. Professionals do get to net their results and file using Schedule C (Profit or Loss >From Business). Professionals, though, must pay self-employment tax on their net income, at 15.3% of the first $94,000 of net income, and 2.9% above this (2006 numbers). While half of the self-employment tax is a deduction (line 27 of Form 1040), unless the professional earns a substantial six-figure income, he can pay more in tax.
Myth #7. I can lump my play on the Internet for a full day (or week, month, or year) as a session. Unless there are specific rules stating otherwise, the tax treatment of the virtual world is the same as the brick and mortar world. I have previously written on the definition of a session. There’s no way that play for a year, month, or week will pass the IRS’ smell test. Indeed, I do not believe that defining a session as a day will be accepted unless you’re playing for a full, continual 24-hour period.
Myth #8. All states treat gamblers identically. This is definitely not the case. Some states don’t have an income tax or only tax interest and dividends (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming). However, some states do not allow gambling losses as an itemized deduction. (Professionals can still take losses, as they would net their wins and losses on Schedule C or the state equivalent.) The states that gamblers should avoid residing in are Connecticut, Illinois, Indiana, Massachusetts, Michigan, Minnesota, Mississippi, New York, Ohio, West Virginia, and Wisconsin. Two states are today at the top of the “Don’t reside here list”: Washington and Ohio. I’m sure everyone is aware that Washington state made Internet gambling a felony. What you may not know is that Washington also has a Business & Occupation tax that a sole proprietorship, including a professional gambler, must pay. Ohio has a law that makes being a professional gambler a crime (Section 2915.02(A)(4), Ohio Revised Code). I’m not an attorney, and have no idea if this law is being enforced, but given how Ohio treats gamblers, I’d consider relocating if I were an Ohioan.
Myth #9. The IRS doesn’t share information with state tax agencies. Absolutely false. The IRS and state tax agencies actively share information. As far as I know the only state that does not share information with the IRS is Nevada. You can find a description of the information sharing program here.
Myth #10. I just won’t file. I’ll do everything with cash, and the IRS will never know. If you spend $10,000 or more, a currency transaction report is required to be generated and is sent to the IRS. Banking transactions of $10,000 or more in cash must be reported. So just keep everything small, right? Wrong. If you deliberately attempt to evade transaction reporting by engaging in a series of smaller transactions, you may be found guilty of the crime of “structuring,” which is a felony. Finally, banks and other financial institutions (casinos are considered a financial institution) are encouraged to report smaller transactions—anything that makes them suspicious.
Myth #11. The IRS can never catch me. On the contrary, they can, and probably will if you’re not paying your taxes and you owe an appreciable amount. First, the IRS has a reward program. The IRS’ largest source of tips are ex-spouses and girlfriends/boyfriends, so make sure your significant other is happy. Second, if you use a Neteller debit/credit card to avoid IRS scrutiny, think again. Neteller has cooperated with US government investigations in the past and undoubtedly will in the future. Indeed, Neteller obeys a Maryland state law and does not accept Maryland residents as customers. Additionally, all of the debit card networks (Stars, Cirrus, etc.) are owned and operated by U.S. entities and will cooperate with an IRS subpoena. The major credit card networks (Visa, MasterCard, and American Express) are also U.S. owned and operated and will cooperate with the IRS. If the IRS finds out about you, or you get audited and the IRS suspects something (e.g. you report income of $25,000 but you drive a Mercedes), the IRS will examine your financial records in depth. Tax evasion is a serious crime and you can find yourself in prison if you commit it (ask Richard Hatch about that). Note: Since this article first appeared, Neteller’s founders were arrested, and Neteller settled various federal charges with the US Department of Justice. It is believed that Neteller turned over all of its records on all of its US customers to the Department of Justice.
Myth #12. The IRS can’t share information from my tax return with other government agencies because of the “Silver Platter” doctrine. Another falsehood. As noted above, the IRS routinely shares information with state tax agencies. In Garner v. United States (424 U.S. 648 (1976)) the Court held that the occupation listed on a tax return can be shared. If you are foolish enough to list your occupation on your tax return as “illegal drug dealer,” the IRS can forward your name to other law enforcement agencies.
Myth #13. The IRS will never go after a poker professional because we’re small potatoes. This may have been true a few years ago. Unfortunately, it’s no longer the case. The IRS announced in both its 2006-2007 and 2005-2006 Priority Guidance Plans that they wished to implement, “Legal requirements to withhold on the winner’s prizes at poker tournaments.” (To date such regulations have not been written.) Like it or not, poker players are celebrities. Prosecuting a high-profile poker player for tax evasion would likely have a deterrence effect on other gamblers. I think it’s only a question of when, not if. The IRS is looking at PayPal records from the time that PayPal was used to fund Internet gambling. It may take a year or two, but I think some gambler will be prosecuted because of this.
The U.S. Tax Code is complex. It’s unfair to gamblers. Parts of it are just plain stupid. But it’s the law. And when you break the law, there are consequences. It’s a whole lot easier to pay your taxes now than to wait for the IRS to find you and pay taxes, interest, penalties, and possibly find your way to prison.
© 2006, 2007 by Russell Fox, All Rights Reserved.
Russell Fox, E.A. is a tax practitioner enrolled to practice before the Internal Revenue Service. He is also a poker player and is the co-author of Why You Lose at Poker.
You have a small error above. Myth Number #4 above, you picked Mississippi. As of a couple years ago, these are no longer included in the State tax return for residents of Mississippi. The establishment now withholds exact amount due the State and no return is required, if person is a non-resident. As a resident of Indiana, we simply include a copy of the W2G showing Mississippi withholdings to get the credit.
This was sure difficult to write and figure out your spammer blocks.
Jeff Day EA, Evansville, In