Thursday, March 23, 2017
Gambling Taxation - Part 4. How to Be a Professional Gambler
Two posts back, I discussed the Internal Revenue Code section that limits any deduction for gambling losses to the amount of gambling winnings. In other words, if a bettor has a bad year and ends up with a net loss, that loss cannot be applied against other income, such as a salary or a consulting fee, to reduce total taxable income. But, even with that limitation, it’s better if the IRS says you’re in the “trade or business” of gambling, as opposed to gambling as a hobby or recreation. Here’s why.
Someone who’s in a trade or business can deduct all the “ordinary and necessary” expenses of that business. For a horse-race bettor, that would include the cost of past performances (yes, you, Daily Racing Form, with your $9 tabloids!), handicapping software and advice, travel to the track, as long as it’s not a daily commute, track admission and parking, internet service provider costs for those who bet online, some of the cost of meals while at the track, and even, in a couple of cases, ATM fees at the track. No, you can’t deduct net gambling losses, but these other expenses are still valuable as deductions.
Even more important – and here I have to get a little wonkish – being in a trade or business lets you take your deductions on a Schedule C, for sole-proprietorships, instead of on a Schedule A, for personal deductions. Here’s why that’s important.
First, when gambling income is listed on the Form 1040, and then gambling expenses and losses (the latter only up to the amount of winnings) are taken as personal deductions, that has the effect of increasing a taxpayer’s gross income. That, in turn, means that the Internal Revenue Code’s limits on personal deductions are also increased. Some deductions disappear entirely for taxpayers with high gross incomes, and some, like those for “miscellaneous business expenses” (those Racing Forms again) and medical expenses, must exceed a certain fraction of the taxpayer’s gross income to qualify. So, the higher the gross income, the higher the threshold before those expenses can be deducted.
Second, even apart from the increase in gross income, having to report expenses as personal, on a Schedule A, has its own drawbacks. Under current law, those miscellaneous deductions are allowable only to the extent that they are more than 2% of gross income. So, for a taxpayer with $100,000 in gross income, that means the first $2,000 of expenses are non-deductible.
In contrast, if someone is in the trade or business of gambling, then all this income and all these deductions go into the Schedule C business form. Instead of having to take the wagering losses and the expenses as personal deductions, they get subtracted from the wagering income right on the Schedule C, and only the bottom line of the Schedule moves over as income or loss onto the Form 1040. No limitation on deductions, no artificial increase in gross income.
So, how do you get to be a professional, in the “trade or business” of gambling? The answer is in Internal Revenue Code Section 183 and the Regulations and court cases that have interpreted it.
Section 183 distinguishes between activities engaged in for profit, on the one hand, and all other activities. If an activity is not engaged in for profit, then the only allowable deductions are (1) deductions that would be allowable without regard to trade or business status (e.g., certain state and local taxes or interest); and (2) business-related deductions incurred in the activity, including a professional gambler's wagering losses and incidental expenses, but only to the extent of any taxable income that remains after subtracting the first category of generally allowable deductions. So, if you’re not a professional gambler, you can never have a net loss from gambling that reduces your tax bill from non-gambling activity.
Section 183 also establishes a presumption that an activity is engaged in for profit if gross income from the activity exceeds the deductions attributable to it in at least three of the most recent five taxable years. It’s only a presumption, though. The IRS can still argue that your gambling is just a hobby, even if you show that three-out-of-five-year profit.
The Treasury Regulations spell out the factors that matter in deciding if you’re in a trade or business. You don’t need a perfect six out of six, but most people who win their cases have at least a majority of the factors on their side.
First, the manner in which the taxpayer carries on the activity, in particular whether he or she carries it on in a businesslike way and maintains complete and accurate books and records. On this criterion, the casual gambler, going to the track or the casino every few weeks and not maintaining regular ledgers, would appear to fall in the hobby/recreation category, while those (relatively few) gamblers who maintain detailed and complete records would be seen as reasonably seeking a profit.
Second, the expertise of the taxpayer (or of the taxpayer's advisers). On this criterion, the gambler who has read all of Andy Beyer or who has served a faithful apprenticeship to an acknowledged expert in the field – think Andy Serling sitting in Steve Crist’s box at Belmont all those years -- is more likely to be seen as engaging in the activity for profit. Buying a tip sheet on your way into the track might not qualify. Interestingly, the Tax Court has treated a taxpayer’s development of a “system” for beating slot machines as evidence of expertise. I guess the Tax Court judges themselves are a bit lacking in such expertise.
Third, the amount of time and effort the taxpayer spends on the activity. Unless, according to the regulations, if the time and activity has substantial personal or recreational aspects. In other words, the more fun one is having, the less likely the IRS is to view the activity as engaged in for profit. The more you hate going to the track, the more likely you are to be a professional.
Fourth, the presumption that an activity is carried on for profit if it actually shows a profit in three of five years. Aha! You think, I can show a $100 profit in each of three years and a $10,000 loss in each of the other two. Nope. The relative size of the profits and losses is also relevant. A presumption is just that, a presumption.
Fifth, the financial status of the taxpayer. Do you really look to gambling to pay the rent and buy groceries? The wealthy industrialist or actor, for example, who gambles heavily, might not be seen to be engaging in gambling for profit, but the working-class retiree, whose only other source of income is a Social Security check, might have a stronger case.
Sixth and last, whether the activity contains elements of personal pleasure or recreation. This raises some generally troubling issues; most people, presumably, would prefer to work in occupations that gave them some personal satisfaction. To say that achieving such a goal puts the tax deductibility of legitimate expenses in jeopardy seems perverse.
No one of these factors is decisive. In each case the IRS and the courts weigh them all and reach a decision.
There has been a flurry of court cases in the past decade involving gamblers who seek to be classified as being in the trade or business. There have been several cases where the IRS agreed that the taxpayer was a professional gambler, others in which the Tax Court rejected the gambler’s claims, and a few where the Tax Court overruled the initial IRS determination and found the taxpayer actually was in a trade or business, most recently, in February of this year, in the case of a poker player who succeeded in deducting travel expenses for his trips to Las Vegas and Atlantic City casinos by showing the court that he played tournaments most weeks in the year.
But the general trend of the cases is against us. Relatively few gamblers approach their task with the single-mindedness of purpose necessary to escape the limitations described above. Those that do win in court typically spend at least 40 hours a week gambling. Thus, most losing gamblers would still not be able to deduct losses and expenses in excess of their winnings.
Next, the importance of keeping good records.