Online Gambling Taxation

Totaling a taxpayer's Forms W-2G, Certain Gambling Winnings, for the year would seem to be the straightforward way to determine the amount of gambling winnings to report on a tax return. Forms W-2G, however, do not necessarily capture all of a taxpayer's gambling winnings and losses for the year. How are these amounts reported and substantiated on a tax return? Does the answer change if the taxpayer seeks to make a living as a poker player? Do states tax gambling differently?

There are many nuances and recent developments under federal and state tax laws about gambling and other similar activities. With proper recordkeeping and guidance, a taxpayer with gambling winnings may significantly reduce audit exposure.

Income and Permitted Deductions

(b) Gaming Tax – imposed solely on the betting revenue generated by the remote gaming company, the rates of which differ depending on the type of gaming license issued: In all cases, the total maximum tax payable per annum by one licensee in respect of one licence shall not exceed € 466,000 per annum. OVERVIEW For many of us, gambling means buying the occasional lottery ticket on the way home from work, but the Internal Revenue Service says that casual gambling also includes raffles, casino games, poker, sports betting—and, yes, even fantasy football. When you win, your winnings are taxable income, subject to its own tax rules. There are often questions about how any money you win gambling online can be taxed. Online gambling taxes do have a few gray areas. Many of the current gambling venues are striving to offer online sportsbooks, so this type of gambling and how taxes apply is important. What the IRS does is specify what is taxable and what is non-taxable income.

Under Sec. 61(a), all income from whatever source derived is includible in a U.S. resident's gross income. Whether the gambling winnings are $5 or $500,000, all amounts are taxable.

A taxpayer may deduct losses from wagering transactions to the extent of gains from those transactions under Sec. 165(d). For amateur gamblers, gambling losses are reported as an itemized deduction on Schedule A, Itemized Deductions. The law is not as kind to nonresidents: While nonresidents must also include U.S.-source gambling winnings as income, they cannot deduct gambling losses against those winnings. Nonresidents whose gambling winnings are connected to a trade or business may deduct gambling losses to the extent of winnings, however, under Sec. 873.

Case law and IRS guidance have established that a taxpayer may determine gambling winnings and losses on a session basis.

Neither the Code nor the regulations define the term 'transactions' as stated in Sec. 165(d). Tax Court cases have recognized that gross income from slot machine transactions is determined on a session basis (see Shollenberger, T.C. Memo. 2009-306; LaPlante, T.C. Memo. 2009-226).

What Is a Session?

In 2008, the IRS Chief Counsel opined that a slot machine player recognizes a wagering gain or loss at the time she redeems her tokens because fluctuating wins and losses left in play are not accessions to wealth until the taxpayer can definitely calculate the amount realized (Advice Memorandum 2008-011). This method is also recognized in both Schollenberger and LaPlante, as a by-bet method would be unduly burdensome and unreasonable for taxpayers. To this end, the IRS issued Notice 2015-21, which provides taxpayers a proposed safe harbor to determine gains or losses from electronically tracked slot machine play.

Under Notice 2015-21, a taxpayer determines wagering gain or loss from electronically tracked slot machine play at the end of a single session of play, rather than on a by-bet basis. Electronically tracked slot machine play uses an electronic player system controlled by the gaming establishment—such as the use of a player's card—that records the amount a specific individual won and wagered on slot machine play. A single session of play begins when a taxpayer places a wager on a particular type of game and ends when the taxpayer completes his or her last wager on the same type of game before the end of the same calendar day.

A taxpayer recognizes a wagering gain if, at the end of a single session of play, the total dollar amount of payouts from electronically tracked slot machine play during that session exceeds the total dollar amount of wagers placed by the taxpayer on the electronically tracked slot machine play during that session. A taxpayer recognizes a wagering loss if, at the end of a single session of play, the total dollar amount of wagers placed by the taxpayer on electronically tracked slot machine play exceeds the total dollar amount of payouts from electronically tracked slot machine play during the session.

There is little to no guidance defining a session for other casino games, such as poker. Furthermore, because there are different poker game formats (cash and tournament) and game types (Texas hold 'em, pot limit Omaha, etc.), it is unclear whether the one-session-per-day analysis would apply to poker in general. A taxpayer who plays different types of poker games may have to record separate sessions for each type of poker game played each day.

In a 2015 Chief Counsel memorandum (CCM), the IRS concluded that a taxpayer's multiple buy-ins for the same poker tournament could not be aggregated for purposes of determining the reportable amount on a taxpayer's Form W-2G (CCM 20153601F). This analysis implies that the IRS may view each poker tournament buy-in as a separate gambling session. A key point leading to the conclusion was that the buy-ins were not identical because the tournament circumstances were different each time the taxpayer made an additional buy-in.

Requirement to Maintain Accurate Records

In Rev. Proc. 77-29, the IRS states that a taxpayer must keep an accurate diary or other similar record of all losses and winnings. According to Rev. Proc. 77-29, 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 gambling establishment; and
• The amounts won or lost.

It is hard to believe the IRS would disallow a taxpayer's gambling loss deduction solely because the taxpayer did not write down in her diary the names of other persons at her blackjack table. The IRS does acknowledge that a taxpayer may prove winnings and losses with other documentation, such as statements of actual winnings from the gambling establishment.

Special Rules for Professional Gamblers

The professional gambler reports gambling winnings and losses for federal purposes on Schedule C, Profit or Loss From Business. A professional gambler is viewed as engaged in the trade or business of gambling. To compute business income, the taxpayer may net all wagering activity but cannot report an overall wagering loss. In addition, the taxpayer may deduct 'ordinary and necessary' business expenses (expenses other than wagers) incurred in connection with the business.

Whether a gambler is an amateur or a professional for tax purposes is based on the 'facts and circumstances.' In Groetzinger, 480 U.S. 23 (1987), the Supreme Court established the professional gambler standard: 'If one's gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business.' The burden of proof is on the professional gambler to prove this status.

Despite receiving other forms of income in 1978, Robert Groetzinger was held to be a professional gambler for the year because he spent 60 to 80 hours per week gambling at dog races. Gambling was his full-time job and livelihood. Notably, Groetzinger had a net gambling loss in 1978. Thus, actual profit is not a requirement for professional gambler status.

In addition to applying the standard established in Groetzinger, courts sometimes apply the following nonexhaustive nine-factor test in Regs. Sec. 1.183-2(b)(1) used to determine intent to make a profit under the hobby loss rules to decide whether a taxpayer is a professional gambler:

• Manner in which the taxpayer carries on the activity;
• The expertise of the taxpayer or his advisers;
• The time and effort the taxpayer expended in carrying on the activity;
• Expectation that assets used in the activity may appreciate in value;
• The taxpayer's success in carrying on other similar or dissimilar activities;
• The taxpayer's history of income or losses with respect to the activity;
• The amount of occasional profits, if any, that are earned;
• The financial status of the taxpayer; and
• Elements of personal pleasure or recreation.

What if a professional gambler's ordinary and necessary business expenses exceed the net gambling winnings for the year? In Mayo, 136 T.C. 81 (2011), the court held the limitation on deducting gambling losses does not apply to ordinary and necessary business expenses incurred in connection with the trade or business of gambling. Therefore, a professional gambler may report a business loss, which may be applied against other income from the year.

Limitations on Loss Deductions

Some states do not permit amateur taxpayers to deduct gambling losses as an itemized deduction at all. These states include Connecticut, Illinois, Indiana, Kansas, Massachusetts, Michigan, North Carolina, Ohio, Rhode Island, West Virginia, and Wisconsin. A taxpayer who has $50,000 of gambling winnings and $50,000 of gambling losses in Wisconsin for a tax year, for example, must pay Wisconsin income tax on the $50,000 of gambling winnings despite breaking even from gambling for the year.

Because professional gamblers may deduct gambling losses for state income tax purposes, some state tax agencies aggressively challenge a taxpayer's professional gambler status. A taxpayer whose professional gambler status is disallowed could face a particularly egregious state income tax deficiency if the taxpayer reported on Schedule C the total of Forms W-2G instead of using the session method under Notice 2015-21. In this situation, the state may be willing to consider adjusting the assessment based on the session method if the taxpayer provides sufficient documentation.

Changes Ahead Likely

Tax laws addressing gambling and other similar activities will continue to evolve as new types of games and technologies emerge. Some related tax issues that will come to the forefront include session treatment for online gambling activity and whether daily fantasy sports are considered gambling. As more and more states legalize online gambling and daily fantasy sports, Congress or the IRS will have no choice but to address these issues.

EditorNotes

Mark Heroux is a principal with the Tax Services Group at Baker Tilly Virchow Krause LLP in Chicago.

For additional information about these items, contact Mr. Heroux at 312-729-8005 or mark.heroux@bakertilly.com.

Unless otherwise noted, contributors are members of or associated with Baker Tilly Virchow Krause LLP.

The tax rates for online gambling are literally and figuratively all over the map as jurisdictions across the United States move to approve, regulate – and profit from – mobile/online wagering.

As 2020 begins, there are only three states – Delaware, Pennsylvania, and New Jersey – with regulated online betting on slots, poker, and table games. Nine states across the country, including PA and NJ, have online sports betting.

Here, we break down the various state tax rates for online gambling and discuss the implications of the vast range that exists across markets.

Online casino rates all over the map

Tax rates for online casino operations run from as low as 15% in New Jersey, the top revenue generator, to the 62.5% found in Delaware. That number comes from totaling the state’s cut, referred to as “revenue sharing” in DE, plus a 12.5% state vendor fee.

Pennsylvania took a different approach, varying tax rates depending on the vertical. PA’s rates are 54% for online slots, but 16% for online poker and online table games.

*These rates apply after the initial $3.75 million in revenue all goes to the state.

**50% goes to revenue sharing with the state and an additional 12.5% to the state vendor.

Online sportsbook rates run the gamut

Online sportsbook rates vary even more widely across the nine states with mobile sports wagering operational. Those states are:

• Nevada
• New Jersey
• Pennsylvania
• Rhode Island
• West Virginia
• Oregon
• Iowa
• Indiana
• New Hampshire

The lowest tax rate among the online sportsbook jurisdictions is 6.75%, the rate employed in Nevada and Iowa.

The highest, Rhode Island, comes in at a staggering 83% when adding the 51% revenue sharing amount and the 32% cut for the state’s vendor.

Delaware comes in second-highest with its 62.5% tax rate set for online casino.

*Includes 50% revenue share with the state plus 12.5% to the state vendor

**Includes 51% revenue share with the state plus 32% to the state vendor

Pitfalls of high taxes on online gambling

Nevada was the lone state with full-fledged sports betting prior to the 2018 overturning of PASPA that opened the way for other states to join in. Their reasonable 6.75% tax rate across the board has stood the test of time.

While states like New Jersey, Iowa, and Indiana have followed suit with operator-friendly tax rates, others have clearly opted for a different strategy – to their detriment.

The American Gaming Association (AGA) believes setting tax rates too high to foster competition in the market makes it difficult to compete against illegal gambling operations. The AGA tracks tax rates across the country in the organization’s annual State of the State’s report.

“To compete with the illegal market, states must implement sensible policies – including tax rates and licensing fees – that enable a seamless shift to safer alternatives for consumers,” said Casey Clark, the AGA’s senior vice president, strategic communications.

Market saturation is changing the gambling business

There is a longstanding tendency by governments to treat gambling taxation as an elastic cash cow, shifting program funding from a state’s voting constituents to outsider companies.

That may have worked when gambling was relatively new, but with the increasing competition in the Northeast and Mid-Atlantic gambling markets, high taxation in certain states has caused issues.

The high online tax rates in Pennsylvania come up when discussing the slowed rate of gambling market growth in the state. The huge 54% slot rate likely in large part explains why there are still just five online slot operators in a state as large and populous as Pennsylvania, with its nearly 13 million residents.

The other factor holding back expansion is likely PA’s decision to require computer servers to be housed within the borders of the Keystone State. This regulation stems from an early 2019 DOJ Wire Act opinion that has been taken at face value by the Pennsylvania Gaming Control Board, even as other states attribute little weight to the interpretation.

Online Gambling Taxes

With online casino growth left wanting, PA’s online sportsbook market has proven more appealing for operators, despite the hefty 36% tax rate on revenue.

Online sportsbook expansion is ‘hot’

There are currently eight online sportsbooks in PA with more expected to launch in the near future.

Pennsylvania’s online sports betting market has several factors working to their benefit.

Joe Bertolone, the executive director of the International Center for Gaming at the University of Nevada Las Vegas, said online sportsbook growth, even in high tax jurisdictions such as PA, will continue to drive expansion and innovation simply because that niche is considered “hot.”

Despite the high tax rate, the PA market is a “must” for operators due to the size of the state’s population of close to 13 million, added Bertolone.

“You’ve got to be there,” he said of PA.

Small market states feel negative effects of high tax rates

Smaller markets like Delaware and Rhode Island don’t carry the same draw for potential operators. The impact of high tax rates is magnified in these states, which can be further constrained by local law.

While “The First State” was indeed the first in the country to offer a form of legal online casino, revenues from online gambling have underwhelmed to date. In addition to a small population of around 1 million, Delaware is constrained by a law that allows for just three online casino operators, one for each land-based casino.

All three brands operate on one single platform run by 888 Holdings. Competition in the DE market, therefore, is lacking.

The first state (besides Nevada) to launch legal retail sports betting, Delaware is still limited to land-based wagering at their three casinos plus state lottery retailers which can accept parlays of three teams or more.

The state lottery runs Rhode Island‘s only legal online sportsbook, and it has limited features and offers no bonus incentives.

Both states have traditionally treated gambling operations like a goose with limitless gold eggs. But they may soon be forced to change with the times.

Online Gambling Taxation Definition

Competition necessitates adjustments

After being out ahead of the curve when it comes to offering legal gambling, Delaware seems to be falling behind in adjusting to the post-PASPA era of online wagering.

Between its three casino sportsbooks and lottery retailers, DE brought in $132.5 million in handle for the year 2019, $19.5 million being revenue.

A look at year-on-year figures from 2018 to 2019 in the popular betting month of November, Delaware saw a significant 46% drop in handle while revenue was stagnant at $1.3 million.

With competition in surrounding states increasing, gambling revenues in Rhode Island have also disappointed of late. The Providence Journal reported in November that the state would claim less than $10 million in revenue for sports betting for 2019. That’s less than half of the $22.7 million projected in profit.

The state also now expects only $105 million in handle via the state’s new mobile app, just a fraction of the $595 million assumed in prior projections.

Will high online tax rates survive?

Bertolone has cautioned that expansion is dynamic, and markets will continue to feel the “ripple” as saturation is reached.

Online Gambling Taxation Calculator

And yet, just like Delaware, Rhode Island’s tax rate remains in the stratosphere. PA’s rates likewise leave something to be desired, especially for potential online casino operators.

Online Gambling Taxation Certificate

Whether states will make changes to online gambling tax rates perceived by many to be unsustainable or stunting growth of the market remains to be seen.