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Gambling With Your Taxes: How to Report Your Wagers

This week, Gail explains how you need to deal with those big gambling wins (you hope)!

Dear Gail-
Like a lot of retirees, my husband and I like to occasionally head to one of the riverboat casinos about an hour from our home. It’s a lot of fun, plus they provide a free dinner. Don’t ask me why, but I usually come home with more money than I left with. It’s not a lot, but when you’re living on Social Security an extra $50-100 is a big help. I know we’re supposed to report these winnings but I’m not sure if I need a special tax form or can put this on the 1040-EZ we usually file? Can I deduct my losses?

Thanks for your help,
Audrey

Dear Audrey—
Gambling winnings are considered income and must be reported. This includes the proceeds from such things as betting on horses, slot machines, black jack, bingo, the lottery, etc. It doesn’t matter if your prize is cash, a new car, or a vacation. (With tangible prizes you have to report the cash value.)

Section 61 of the Internal Revenue code is pretty clear:
“gross income” must be reported and includes “all income from whatever source derived.”

In some cases, the sponsor of the contest will provide you with Form W-2G spelling out the exact value of your winnings and whether any federal tax was withheld. But even if you don’t receive this, you’re legally required to report any prizes you win.

Unfortunately, if you have gambling income, the only income tax form you can use is the long, “Form 1040.” The total amount of your winnings for the year is entered on Line 21.

Realistically, it’s not likely the I.R.S. is going to police the bingo game played in the church basement. But if your prize comes to more than a few bucks, there’s a good chance the organization sponsoring the activity is going to report it to the I.R.S.

You’d better report it, too.

This point was painfully driven home to Bill Remos last year. Thanks to an audit, the I.R.S. discovered that Remos had failed to report $50,000 he’d won at blackjack in 1999 and ordered him to pay back taxes plus a penalty for “underpayment” of taxes.

Remos’ defense? He testified that the pit boss at the casino had told him that winnings you receive on a gambling table are not considered “income,” while money you win from a slot machine is. In case you have any doubts, re-read paragraph two above. (Can you already see where this case is headed?)

Furthermore, Remos claimed that he actually lost more than he won in 1999, so this completely offset his winnings and wiped out any income tax that he might owe. In court, he submitted a computer printout from the casino that listed such things as “money in” and “money out,” but he couldn’t explain how the numbers were generated. It also didn’t help that Remos’s name wasn’t on the printout, so there was no way for the court to know if it even applied to him!

The Tax Court acknowledged that although Remos “most likely had some gambling losses during the year, we are unable to determine… the amount of those losses on the basis of the record at hand.” He lost the case.

Document Your Deduction!
What would have helped Remos? A running diary of the dates he gambled, the amounts wagered, amounts won, and any expenses incurred. You don’t need the casino or racetrack to sign off on the record you keep, you just need to document how much you bet and the payouts you received.

If betting on the lottery is your thing, then hold on to your ticket stubs. The court is very clear that the burden of proof is on the taxpayer to demonstrate s/he sustained any losses.

Provided you’ve kept good records, you can deduct your gambling losses. But you don’t do this by subtracting them from the total amount of your winnings. Instead, they are considered a “Miscellaneous Itemized Deduction.” This means that your gambling losses won’t reduce your tax bill unless they, and the other items you list under “Miscellaneous Itemized Deductions” (such as tax return preparation fees and home office expenses) add up to more than 2% of your Adjusted Gross Income.

Furthermore, you can only deduct losses up to the amount of your winnings- you can’t deduct losses over and above the amount you win. For instance, if your total gambling winnings amount to $2000 and your losses add up to $2,500, the maximum amount you can list as a Miscellaneous Itemized Deduction is $2,000.

The Gambler
What if you’re a professional gambler? In this case, you can deduct your gambling losses as a business expense on Schedule C. The benefit is there is no 2% threshold you have to exceed- every dollar is deductible. However, you should be aware of the higher standard of proof required.

The U.S. Supreme Court has ruled that for an activity to be elevated from the level of “hobby” to constitute a “trade or business” it must be “pursued full time, in good faith, and with regularity, to the production of income for a livelihood.”*

No Dice
Last year the Tax Court ruled that although a taxpayer had the records to prove she played the slots on a regular basis, she didn’t do so on a full-time basis. She admitted that her primary source of income was her flower shop.

Thus, she was not entitled to deduct her gambling losses as a business expense.

You Win
On the other hand, just this month the Tax Court ruled against the I.R.S. in favor of a taxpayer. The court said the fact that he spent about 250 days a year gambling and handicapping horse races demonstrated that he pursued this activity with “regularity.” Based on the documentation provided, the judges also found that the taxpayer conducted his gambling in a “businesslike” manner with the intent of generating a profit.

No Wager, No Gamble
It’s important to note that sweepstakes winnings may or may not be considered “gambling income.” It depends upon whether contestants are required to purchase anything. In other words, did you put up something of value, i.e. take a gamble?

In a Technical Advice Memorandum (T.A.M.) issued in 2004, the I.R.S. explained that three conditions must exist for an activity to be considered “gambling.” There must be: 1) a prize, (2) a chance, and 3) consideration paid by contestants.

To see how this might come into play, suppose you spend $10 per week on lotto tickets. You also respond to those contests aimed at generating magazine subscriptions where the chance of winning is one-in-a-gazillion. Furthermore, let’s assume that when you enter these contests you don’t take the bait, i.e. you send in your entry but don’t sign up for any magazines.

Over the course of the year, although you spend $5,200 on lotto tickets, you never hit the jackpot. You end up with $5,200 in gambling losses.

If you miraculously win the magazine sweepstakes, you won’t be able to use your lotto losses to offset this income. Since you didn’t wager anything to participate in the sweepstakes it isn’t considered “gambling.” Remember: you can only deduct gambling losses to the extent you have gambling income.

You can find out more about reporting gambling winnings/deductions from I.R.S. Publications 529, “Miscellaneous Deductions,” and 525, “Taxable and Nontaxable Income.” You can download these from the I.R.S. website, www.irs.gov, or order them by calling 1-800-TAX-FORM.

Hope this helps!
Gail


*[Groetzinger], 87-1 USTC Paragraph 9191,480 U.S. 23

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