Three interesting questions were recently emailed to me regarding gambling tax issues. Let’s take a look at some of the issues of concern:
1. “I’m planning on playing at an upcoming poker tournament in Los Angeles and heard that if I win a prize California will withhold 5% of my winnings. I’m a Canadian citizen and can’t see how they can do that. (I know that the IRS will withhold 30%, and that I am able under the US-Canada Tax Treaty to get some to all of that back.) Please advise.”
Well, I have bad news for you. The withholding rate is not 5%; rather, it’s 7%. You are earning that income in California, and California law says that anyone who earns that income is subject to state income tax.
I do have good news for you in one respect. If you’re a professional gambler and are paying Canadian income tax, the tax you pay to California is a foreign income tax that you will be able to get a tax credit for. However, if you’re an amateur gambler you are just plain out of luck (Canada doesn’t tax gambling income from amateurs).
As to why you’re paying the tax, that’s a long and convoluted story. The Tax Foundation conducted a study on this tax (back in 2004) and concluded that it was “poor tax policy and should be stopped.” The jock tax started, believe it or not, with Michael Jordan of the Chicago Bulls. The Franchise Tax Board got the idea that they should share in Mr. Jordan’s salary. Illinois then retaliated and instituted their own jock tax. Now they’re universal.
And California wants the jock tax from anyone and everyone. If you win a contest in California expect to have some of your money withheld. The Bronze Golden State is broke and this isn’t going to change soon.
2. “I’m a professional poker player who won a very nice six-figure bad beat jackpot. I’ve also won into well six figures this year [earnings] from poker. My question is can I treat the BBJ as gambling winnings while treating my poker income as, er, income.”
First, for the non-poker players reading this, a bad beat jackpot is when a very good hand (say, four of a kind) is beaten by a better hand (say, a straight flush). The rules for bad beat jackpots vary from casino to casino and they are not universal. Indeed, many cardrooms don’t have bad beat jackpots.
The answer to this gentleman’s question, like lots of poker answers, is it depends. Was the jackpot casino funded or player funded? A jackpot funded by the casino is a prize; when you win such a prize it’s like winning a sweepstakes. The casino is providing this out of the goodness of its heart (or hoping that the publicity helps draw more gamblers to their casino); the jackpot in this case should be reported on a Form 1099-MISC and would be included in Other Income (line 21, Form 1040).
However, if the jackpot is funded out by a “jackpot drop” or an additional small rake (usually $1 out of each pot), then it’s funded by the players themselves. In that case, the jackpot is gambling income and should be reported on a Form W-2G.
The person who asked this question is a professional gambler (and a successful one, too). He’d like the jackpot to be reported as Other Income because then he wouldn’t owe self-employment tax on the income. My suspicion, though, is that it was player-funded and gambling income subject to self-employment tax. That’s just a suspicion, and only the correspondent knows for sure.
3. “Two years ago I was traveling to Costa Rica and won over $100,000 at the casino. Now my ex is threatening to tell the IRS about the win. What should I do?”
I’ve said on several occasions that one of the IRS’ best sources of tips are disgruntled ex-spouses and ex-girlfriends. I’m not a marital counselor so I can’t give any advice on that portion of the problem.
It sounds like you didn’t report the gambling income. Why not amend your tax return and report the income, pay the tax, penalties, and interest? It’s almost always better to come forward than to have the IRS come after you. (Don’t forget your state income tax, too.) Given that this issue has legal ramifications you should consult an attorney if you have not already done so.
Three questions, and three answers that likely didn’t make anyone happy. The Tax Code remains unfair towards gamblers and I don’t expect that to change anytime soon.