You win a poker tournament, and the floorperson asks you, “Do you want to leave anything for the dealers?” That’s a tip (or gratuity). I was recently asked, “Is that tax deductible? And what about when you’re playing a cash game; is the dollar you tip the dealer deductible?”
The Tax Code states that those in business can take deductions of their business expenses. That IRC § 162:
(a) In general
There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business….
The Tax Court has looked at this many times; for example, in Lychuk v. Commissioner (116 T.C. No. 27),
The Treasury regulations specify that ordinary and necessary business expenses include “the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer’s trade or business”, sec. 1.162-1(a), Income Tax Regs., such as “a reasonable allowance for salaries or other compensation for personal services actually rendered”, sec. 1.162-7(a), Income Tax Regs. The Supreme Court has explained that a cash method taxpayer such as ACC may deduct an expenditure under section 162(a) if the expenditure is: (1) An expense, (2) an ordinary expense, (3) a necessary expense, (4) paid during the taxable year, and (5) made to carry on a trade or business…The Supreme Court has stated that a necessary expense is an expense that is appropriate or helpful to the development of the taxpayer’s business…and that an ordinary expense is an expense that is “normal, usual, or customary” in the type of business involved, [internal citations omitted]
So let’s look at tipping when you win a poker tournament. First, it’s definitely an ordinary expense. Tipping is part of the culture of gambling and poker tournaments; it’s expected that winners will tip (especially when nothing is taken from the prize pool specifically for dealers). As long as the tip is reasonable, it’s clear that a professional poker player can deduct the tip as a business expense.
However, that’s not the case for amateur gamblers. Only those who are in the business of gambling can take business deductions. Thus, an amateur gambler cannot deduct his gratuities.
A secondary question arose: Does a player’s net win for W-2G purposes subtract any gratuities left? The answer to this is clear: No. A gratuity is not required, and only professionals are allowed to deduct gratuities. Thus, a W-2G simply takes a player’s gross win (what he cashed for) and subtracts his entry fee to determine the amount noted on the W-2G.
Now, what about cash games? It’s customary when winning a hand of poker to take a dollar out of the pot and give it to the dealer (as a tip). The same rules apply for cash games as tournaments. For professionals, gratuities are deductible; for amateurs, they are not. Technically, an amateur player needs to add back any gratuities given for his net win or loss. However, from a practical standpoint the custom (and it is just that, a custom) of tipping out of the pot makes it effectively already included in a player’s net win or loss for the session. Few (if any) players will calculate the amount of tips in a session and adjust their session results accordingly. From a practical standpoint, tips in cash games are already included in a player’s sessions results. This also means that you can’t separately deduct gratuities in cash games because you’ve already included them in your sessions results.