You decided to not only play Powerball, but also are sure you will win Powerball. With the purse hovering and climbing at 800M, it is easy to understand why lottery fever has captured the attention and -- dollar bills, of countless people across the country.
Whether you are among the lucky folk whose net worth increases January, 9, 2016 at 11pm, or as the odds predict, simply a few dollars lighter when you wake up on Sunday, there are some aspects you must consider from gambling winnings and losses. Mainly, understanding the tax rules for reporting your gambling activity on your tax return.
Gambling is a 240 billion dollar generator to the U.S. economy and some of us at one time or another have likely been part of the mix. If you’re fortunate enough to win a qualified prize from the Powerball lottery, a contest, jackpot, or a similar game that gives you the option of receiving multiyear payments, you may not have to pay tax on the future years’ payments until they’re received. This is an exception to the general rule that could otherwise require the entire prize to be taxed in the year of the win.
- In order to qualify for this exception, you would have to elect to receive the multiyear payments within 60 days of winning, the multiyear payments must extend over 10 years, and the prize cannot be compensation for some past or future services provided by the winner. Some winners have tried to reclassify the characteristic of the income from their future winnings from ordinary income to capital gain, by selling the rights to future prize payments received to a third party in order to receive favorable capital gain treatment. However, recent rulings have repeatedly rejected this concept, and any future proceeds are treated as ordinary income.
- Typically, if you win more than $600 and the winnings are more than 300 times your original wager, the casino will provide you with a W-2G. There are also minimum dollar limitations that apply to different types of wagers. If you win $1,200 from slots or bingo, $1,500 from Keno, or $5,000 from poker tournaments, you should also be issued a W-2G by the gaming institution from at which you wagered. It’s important to note that if you receive a W-2G, the IRS has also received a copy, so be sure to report all winnings appropriately.
- Generally, you’re required to report the full amount of winnings, net of the amount of the bet or wager you placed, on line 21 (“Other Income” line) of Form 1040. This includes any installment receipts from previously won lotteries or raffles. Any amounts that are comped by the casino (i.e. meals and lodging) should also be added to the winnings, as the courts have ruled that comps are considered gambling winnings.
- Although you can claim gambling losses to the extent of gambling winnings, you cannot net the gambling losses against gambling winnings on line 21 of Form 1040. You must claim your gambling losses on Schedule A as a miscellaneous itemized deduction, although gambling losses aren’t be subject to the 2% of AGI limitation.
- Unlike most miscellaneous itemized deductions, gambling losses are not disallowed under the alternative minimum tax (AMT) rules. However, if you are unable to itemize your deductions, you won’t be able to deduct any gambling losses. Unfortunately, unused losses do not carry forward to the following year; they simply evaporate if not used in the year they were incurred. Additionally, if you’re married and file jointly, you may utilize your combined gambling losses up to your combined gambling winnings, even if one spouse had more gambling losses than gambling winnings.
Current rules state that every amateur gambler must report the full amount of each and every individual win from each individual wager. However, reporting gross gambling winnings in such a manner could cause certain deductions and credits to be phased out, due to adjusted gross income (AGI) limitations. Luckily, the IRS has changed their position on this excessive record keeping requirement for gambling winning and losses. The current IRS position states that a casual gambler may record net winnings or net losses on a per session basis. A session is defined as ending when a player either cashes out or runs out of money and can then determine the extent of their net wins or losses.
The IRS has recently proposed a new revenue procedure providing a new safe harbor method for tracking net gambling winnings and losses per gambling session when it comes to electronically tracked slot machine play. To further ease the recordkeeping burden of the per session rules currently in place, taxpayers may measure net gambling winnings and losses per calendar day/per gaming establishment.
For example, if you were to go to a casino in the morning and play the slots, grab a meal, catch a show, and then resume playing the slots at the same casino, you would determine the net gambling wins or losses from that calendar day, which would end at 11:59 PM. If you happened to leave that gambling institution or play beyond 11:59 PM, any electronically tracked slot machine gambling activity should be recorded under a separate session.
Any gambler that uses this safe-harbor gambling session definition for any day in a calendar year at a particular gaming institution, then you must use this method for all slot machine winnings and losses at that institution for the entire year. Under the safe harbor method, a wagering gain would exist if the total payouts from the gambling session measured exceed the total wagers placed. Otherwise, a wagering loss would exist. It should be noted that this is a proposed revenue procedure, and, therefore, is not yet in effect. Should this revenue procedure become final, the rule would apply to the tax year on or after the date of the publication of the final revenue procedure.
Who, me? A professional gambler?
Now, although amateur gamblers must report all winnings and may only offset these winnings to the extent of gambling losses, professional gamblers may be able to take advantage of additional deductions related to gambling. However, it should be noted, it is extremely rare and very difficult to receive recognition as a professional gambler for income tax purposes.
For those who are fortunate enough to be recognized as professional gamblers, there are additional deductions and different reporting requirements from amateur gamblers. For professional gamblers, all gambling winnings and comps will be reported as business income on Schedule C, with allowable losses and other business expenses reported as business expenses. This may prove beneficial as the gambling losses are not limited by the itemized deduction rules.
Uncle Sam
Before you file your next tax return and report your gambling activity as a business venture, be aware that many taxpayers have lost their cases attempting to claim their gambling activities as a business, as opposed to a personal hobby. There are a few hurdles that must be met to treat your gambling activity as a legitimate business in the eyes of the IRS. Most importantly, you’ll have to prove that you devote substantial time on a regular basis to gambling, and that you are dependent on the income from gambling as a meaningful source of income. It would also help to make your case if you conduct your gambling activities in a business-like manner, and keep detailed records and show some strategy evaluation to increase your odds of earning income.
While you may benefit from being recognized as a professional gambler and including your gambling losses as business expenses, your gambling losses are still limited to gambling winnings. This rule has been maintained by the courts. Being recognized as a professional gambler does come with additional tax deduction perks. In addition to reporting gambling losses as a business expense to directly offset gambling income, you may be able to deduct other expenses, such as travel, 50% of meals and entertainment, and other business expenses. Older court cases have ruled that the combined gambling losses and business expenses related to the losses were limited to gambling winnings. However, the IRS has recently taken the position that only gambling losses are subject to this rule, and that other business expenses are still allowable, even if the total business expenses and losses combined exceed gambling winnings. It is important to note that a professional gambler's net income is subject to the self-employment tax. In certain scenarios, self-employment tax may actually make claiming professional gambler status more expensive than claiming amateur gambler status.
One sure bet
Whether you’re an amateur or professional gambler, it’s important to maintain good recordkeeping when it comes to documenting losses. Depending on the type of gambling that you do, it’s important that you maintain some receipts and evidence to support the gambling winning and deductions reported on your tax return (W-2G’s, activity reports from casinos, credit card receipts, or waging vouchers). In some rare cases, the courts have held that no recordkeeping would suffice. However, in that case, the taxpayer was an addicted gambler, who was gambling so much that he had lost his car and was depending on family members to support his living expenses. Therefore, if your gambling circumstances aren’t similar, it’s advised to keep detailed records.
Powerball fever is high. However, I have a feeling come Monday morning, I will not have jetted off to a remote island that I rename as my own from my take of the jackpot, but rather driving back to the firm to guide and advise clients for a properly structured financial position.
For more information about reporting gambling activities for tax purposes, please contact me at 216-831-0733 or mhermes@zinnerco.com. I’m ready to review your situation, plan effective strategies and position you for financial success.
