Taxation of Gambling: Tax Implications of Staking Activity
In poker terms, a staking arrangement arises when one gives money to a another player to engage in gambling activity with the money. Staking is often seen in tournament play. A common arrangement is a “staker” (or backer) contributing 100% of the entry fee, and is entitled to 50% of whatever winnings the “stakee” (or player) wins, if any, in excess of the entry fee.
Assuming for the moment both the staker and stakee are US residents, we have straightforward tax consequences of the staking activity. Suppose I am staked for the 2012 World Series of Poker Main Event, which begins later this year on July 7 at the Rio All-Suite Hotel & Casino in Las Vegas. The entry fee is $10,000. There are two possible outcomes: (1) I win nothing or (2) I place and win some money.
If I win nothing, my backer has a $10,000 gambling loss and I have no tax consequences. If I place and win $100,000, for example, my backer and I each have $45,000 of gambling winnings from the tournament ($100,000 less $10,000 entry fee then divided in half).
A casino is required to issue a Form W-2G to a US resident who wins more than $5,000 in a poker tournament. The W-2G is also sent to the IRS. Applied to the example, I receive a W-2G for $90,000. Problem is, the IRS believes I won $90,000, when I actually only won $45,000 because half of the winnings are attributable to the staker. I don’t want to pay tax on income that isn’t mine.
What can I do? There’s good news and bad news.
Takeaway #1: Player and staker may submit to the casino Form 5754 so the casino can appropriate the winnings between player and staker.
The good news: In the example above, I would complete with my backer Form 5754, Statement by Person(s) Receiving Gambling Winnings. When I go to receive the $100,000, I would provide the casino the form. The casino should then prepare two Form W-2Gs: One for me and one for my backer, both reflecting $45,000 of gambling winnings.
Notice I italicized “should.” Now the bad news.
Takeaway #2: The World Series of Poker has not recognized partnerships, and has not accepted Form 5754.
In my example, one Form W-2G would be issued to me for $90,000 even though I completed with my backer a Form 5754. As a result, the IRS would believe I have $90,000 income and my staker has no income from the tournament.
There are some possible accounting methods one may implement in order to produce proper allocation of the winnings. There is no “one size fits all” approach, however, because professionals and amateurs are treated differently for tax purposes. Be sure to consult your own tax professional to discuss these options.
To this point we have assumed both the player and staker are US residents. Do the tax consequences change at all if the player or staker are not residents of the US?
Yes. Before delving into the issues, some background discussion is necessary.
Takeaway #3: In general, US gambling winnings paid to foreign individuals are subject to 30% withholding for federal income tax, assuming the income is not effectively connected with a US trade or business and is not exempted by treaty.
For example, if a resident of Canada enters New York State and gambles at one of the Tribal casinos in the state, the player’s winnings are subject to 30% withholding.
Exception: No tax is imposed on nonbusiness gambling income a nonresident wins playing blackjack, baccarat, craps, roulette, or big-6 wheel in the US. So, a Canadian resident who only plays blackjack at a Tribal casino in New York State will not be subject to US income tax on those gambling winnings, if any.
Now let’s talk about tax treaties. An applicable tax treaty between the US and a treaty partner may reduce the amount withheld by a US casino. US gambling winnings earned by residents of the following foreign countries is not taxable in the US:
Austria, Belgium, Bulgaria, Czech Republic, Denmark, Finland, France, Germany, Hungary, Iceland, Ireland, Italy, Japan, Latvia, Lithuania, Luxembourg, Netherlands, Russia, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Tunisia, Turkey, Ukranie, and the United Kingdom.
Claimants must provide the casino a Form W-8BEN (with a TIN) to claim treay benefits on gambling income that is not effectively connected with a US trade or business. Sometimes a payer may accept a W-8BEN without a TIN. If the income is effectively connected with a US trade or business, claimants must provide a Form W-8ECI to claim treaty benefits.
Let’s go back to our Canadian resident, and let’s call him Stu. Suppose in 2011, Stu won $10,000 in a poker tournament held at a Tribal casino in New York State. The casino is required to withhold $3,000 (30% of $10,000) and issue to Stu a Form 1042-S, Foreign Person’s US Source Income Subject to Withholding.
For income paid in 2011 subject to 1042-S withholding, the casino is required to file Form 1042, Annual Withholding Tax Return for US Source Income of Foreign Persons and Form 1042-S with the IRS no later than March 15, 2012. Penalties may be imposed if either requirement is not satisfied.
Takeaway #4: When staking activity involves US nonresidents, Form 1042 and Form 1042-S filing requirements may apply not only to casinos but also to the recipients of the winnings.
How? Back to the original facts. Assume the player wins $100,000, $10,000 of which is a recovery of the entry fee. $45,000 is attributable to both the player and the backer. There are three scenarios to consider:
1. US stakee, nonresident staker
Here, the US resident receives the full $100,000, along with a Form W-2G reflecting $90,000 of gambling winnings. The staker then receives his share from the stakee, but not the full $45,000.
Why? Because US gambling winnings paid to nonresidents are subject to 30% withholding, the stakee withholds $13,500 (30% of $45,000) of the winnings. The stakee then completes a Form 1042-S and issues a copy to the staker, files a Form 1042 by March 15 of the following tax year, and deposits the $13,500 with the US Treasury within a certain timeframe.
Note the stakee is issued W-2G reflecting $90,000 of gambling winnings, half of which aren’t his. Again, consult a tax professional to discuss options on how to handle this situation for reporting purposes.
2. Nonresident stakee, US staker
Here, we reverse the roles. The casino withholds 30% of the $90,000, pays the stakee $73,000 (70% of $90,000 plus $10,000 entry fee), and issues to the stakee a Form 1042-S reflecting amounts won and withheld.
The US staker is entitled to $55,000 ($10,000 entry fee plus $45,000 winnings). When the stakee pays this amount, then the stakee is left with only $18,000 cash in hand. Why so little? The 30% withholding imposed by the casino should have applied to only half of the $90,000, but it applied to the full $90,000.
After the close of the tax year, the stakee may file a Form 1040-NR, US Nonresident Alien Income Tax Return to reflect amounts paid and owed. Depending on the taxpayer’s other activity during the year, he may receive a refund from the overpayment of tax from the staking activity.
3. Nonresident stakee, nonresident staker
In this last scenario, the consequences are the same as those under (2), except the stakee must withhold 30% of the staker’s winnings, and pays the staker the $10,000 entry fee plus $31,500 of winnings after withholding. Filing and depositing requirements apply to the stakee, as described in (1).
As you can see, staking activity can create some tricky tax situations. I haven’t heard whether the World Series of Poker will change its policy regarding partnerships for 2012. For now, we have to operate under the assumption that it won’t.
Author’s note: I must remind all readers that it is impossible to offer comprehensive tax advice on the internet. Information I write on this blog is not legal advice, and is not intended to address anyone’s particular tax situation. Should you seek such advice, consult with a tax professional to discuss your facts and circumstances.
IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, I inform you that any US federal tax advice contained in this blog is not intended or written to be used, and cannot be used, for the purposes of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this blog.