Taxation of Gambling: Introduction and Recordkeeping Taxation of Gambling: Introduction and Recordkeeping

Part 1 of our new series on tax for professional poker players.

I am a tax attorney in New York and I used to play poker quite a bit. Fortunately, I have stayed close to the game by focusing my tax practice on gaming industry issues. Let me be clear: The taxation of gambling winnings is an area filled with misconceptions. With tax season upon us, I am running a weekly series of posts at pokerfuse in order to address poker-related U.S. tax issues until Tax Day, April 17, 2012.

No, that is not a typo. When the usual Tax Day, April 15, falls on a weekend, Emancipation Day, or any other holiday, tax returns are due the following business day. This year, April 15 falls on a Sunday and Emancipation Day is April 16, so Tax Day is April 17.

Takeaway #1: Under the Internal Revenue Code, all gambling winnings of U.S. residents are taxable.

Let’s start simple. IRC section 61(a) states all income from whatever source derived is includible in a U.S. resident’s gross income. In other words, the minimum taxable amount of gambling winnings is $.01. Pretty straightforward stuff.

Takeaway #2: The Internal Revenue Service requires taxpayers to maintain an accurate diary of all gambling winnings and losses.

I am often asked the following: “If you could provide only one piece of advice for taxpayers with gambling winnings, what would it be?”

My answer: Keep very, very, very good records of the gambling activity.

There is a reason for this, of course. If a taxpayer who reports gambling income is audited, the IRS agent may ask the taxpayer for records substantiating the gambling activity. The burden of proof is on the taxpayer to demonstrate the basis for reporting items on a tax return. I have seen time and time again taxpayers who fail to provide sufficient records of their gambling activity, resulting in additional tax, interest, and penalties. So, what kind of records is the IRS looking for?

IRS Publication 529 states a taxpayer must keep an accurate diary or similar record of all losses and winnings. The diary should contain:

  • The date and type of the specific wager or wagering activity.
  • The name and address or location of the gambling establishment.
  • The names of other persons present at the gaming establishment.
  • The amount(s) won or lost.

The IRS likes written, contemporaneous records. The reason is they give the appearance of authenticity. Computer records maintained in an “electronic storage system” may also be acceptable. See IRS Publication 552 for more details.

Let’s focus on the fourth bullet point above, the amount(s) won or lost. In general, a taxpayer cannot simply “net” gambling winnings and losses from the year and report that amount. (I will discuss an exception for the professional gambler next week.)

Takeaway #3: The Internal Revenue Code requires a taxpayer to separately total all gambling winning sessions and all gambling losing sessions.

Unfortunately, neither the tax code nor the IRS provides any guidance on what constitutes a gambling “session.” A court is likely to apply the ordinary meaning of a word when not defined by law. The Merriam-Webster Dictionary offers six definitions for a “session,” and the most relevant reads “a meeting or period devoted to a particular activity (a recording session).” Applying this definition to poker, we need to consider the two formats of poker games: (1) tournaments and (2) cash games.

Let’s first look at poker tournaments. Players enter by paying a specified amount and play until eliminated or emerge victorious. It seems clear that playing in one poker tournament is a period devoted to a particular activity. Thus, in my view, one poker tournament constitutes one gambling “session.”

Cash games are a bit trickier in this context, as players generally only play against others at one table and are at liberty to leave at any time. A simple and practical way to determine a cash game “session” is to treat continuous cash game play from start to finish as one gambling “session.” This approach mirrors the treatment of a single tournament.

Here is an example to illustrate. Suppose I enter a casino seeking to play $3/$6 Pot Limit Omaha. Unfortunately, the game has no open seats so I am placed on the waiting list. While waiting, I take a seat at a $2/$4 PLO table for one hour, winning $250. After the hour, my $3/$6 seat becomes available, so I take my chips there and proceed to play for two hours, losing $75. In my view, I can treat all of the gambling activity as one winning session of $175.

Suppose instead I play $2/$4 Texas Hold’em while waiting for a $3/$6 PLO seat. Because these games have different rules, the IRS may not consider the combined three hour play as one continuous session. Therefore, the prudent approach is to separate the activity into two sessions, or one $250 winning session and one $75 losing session.

How do we treat online poker play? One attractive aspect of online play is the ability for one to play at multiple tables simultaneously. To the extent the multi-table play is the same game and continuous, the resulting amounts may be netted under one gambling “session.”

Next week we will look at how the tax code treats professional and amateur gamblers differently, and the criteria to determine whether one is a professional or amateur for tax purposes.

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 U.S. 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.