Taxable Talk

I recently read a blog where a very successful online poker player wrote,

There really aren’t IRS regulations on online gambling. It exists in a grey area. As fun160 pointed out “In the financial markets money earned off-shore is not taxable until it is repatriated. A strong case can be made that the same is true for off-shore gambling.”

I have talked to CPAs about whether the taxes should be paid upon earning the money or upon cashing out and the answer I was given is that a strong argument could be made for either. In the end it would be up to a court.

Well, some of the statements this player made are true: there aren’t any IRS regulations on online gambling and I’m sure he spoke with a CPA. As to the rest…

1. The recognition of income is a long-decided principle in the United States based on the concept of Constructive Receipt of Income. As the IRS’s Publication 525 states, “You are generally taxed on income that is available to you, regardless of whether or not it is in your posession.” Let’s say you win $500 at the poker club, but you decide to leave it in the form of chips and put it in your safety deposit box. It’s still income.

2. “But I won the money online, and it’s in [Gibraltar, the Isle of Man, Costa Rica, etc.], and not in my hands….” So what! When there are no specific rules governing the online world, the rules of the real world govern. The rules for gambling income are quite clear. You must keep a log of your sessions, you must report wins and losses by session, with your wins going on Line 21 (Other Income) and losses as an itemizable deduction not subject to the 2% limitation on AGI. Repatriation of income as far as gambling is totally irrelevant. Offshore casinos are considered by the IRS as just another taxpayer avoidance scheme (see here).

3. Repatriation of investment income isn’t relevant, either. Let’s say you have an investment in a hypothetical British company, BritCo Ltd. They declare a dividend of £2 per share today and you own 10 shares. You will owe the dollar equivalent of tax based on £20 on this year’s tax return. You will get a tax credit for any British taxes imposed on your investment, and you may be able to deduct investment expenses on your investment.

4. “In the end it would be up to a court.” Well, anyone can bring a case in Tax Court. Since there has yet to be a case in Tax Court on online gambling, it’s unlikely you’ll end up paying a frivolous penalty. But you’re going to lose. There have been many Tax Court cases dealing with the issue of constructive receipt. The opinion in a recent case, Millard v. Commissioner (TC Memo 2005-192) notes, “Consequently, a cash method taxpayer constructively receives income as of the date that a check is received absent a substantial limitation. Furstenberg v. Commissioner, 83 T.C. 755, 791 n.28 (1984); Kahler v. Commissioner, 18 T.C. 31, 34-35 (1952); Roberts v. Commissioner, T.C. Memo. 2002-281.” Now, I find it hard to believe that the Tax Court would rule that money put in a players’ online casino account wasn’t constructively received.

The tax rules for online gambling are quite clear—the rules are the exact same as in the brick and mortar world of casinos. This may not be what the typical online gambler wants to hear, but it’s the bitter truth.

In Part 3 (coming next week), I’ll examine how to keep records, what a session really is, and whether or not you are (or want to be) a professional gambler.

I’m a poker player. I’ve been playing competitive poker, including tournaments, for several years, quite successfully. And yes, I claim my winnings on my tax return. I’m also co-author of a poker book.

I’ve had a natural fascination with gambling and taxes for several years, and that’s a primary reason why one of my areas of emphasis is gambling taxes. Several individuals have asked me to give an overview on online gambling and taxes. Given the out-and-out lies and falsehoods that I see on the Internet, I’m going to present a short series on online gambling and taxes.

“If I gamble online, it’s overseas, and I don’t have to pay tax on it.” I see this statement all the time, and it’s absolutely false. Under the US Tax Code, all income for US citizens is taxable, whether earned in the US, overseas or on the Internet. Section 61(a) defines gross income as “all income from whatever source derived,” including gambling, unless otherwise provided. McClanahan v. United States, 292 F.2d 630, 631-632 (5th Cir. 1961).

“Internet gambling is illegal, so I don’t have to pay taxes on it.” Ignoring (for the moment) the legality of Internet gambling, this is also false. The US taxes legal and illegal income. Remember Al Capone? He went to prison not for the murders he committed, but for tax evasion.

“The government has no way of tracking how much I win, so I’m not going to report it, and they’ll never find out.” If you’re not audited for some other reason, the government is not likely to find out. However, if for whatever reason you are audited, and you have unreported income that the government finds out about, you will, at a minimum, pay tax, penalties and interest. If the IRS determines that you willfully evaded taxes, you could even be subject to imprisonment.

“I didn’t receive a W-2G, so I don’t have to report the gambling income.” Another falsehood. Whether you receive paperwork or not, all gambling income is taxable.

“I can net my gambling wins and losses.” Some gamblers can net their wins and losses—if they are professional gamblers. Most gamblers, however, must put their gambling income on line 21 (Other Income) and take their losses, up to the amount of their winnings, as an itemized deduction on Schedule A. This deduction is not subject to the 2% AGI limitation.

Finally, “I don’t have to claim my online gambling winnings until the money is repatriated into the United States.” This is yet another falsehood for gambling income. When you win your wager, you have gambling income, no matter if the bet is in the United States, the United Kingdom, or any other country. This falsehood, though, deserves a complete debunking and that will be the subject of the next installment of this series, next week.