Contracts and Poker: Playing The Tax Game

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A recreational player spends $200 on transportation and lodging and pays a $100 entry fee in order to play in a poker tournament. The player wins $1,000 and then loses $100 on a sports bet. The casino gives the player $1,000 but does not give the player a Form W2-G. How will the player report these transactions on his tax return?

A. $900 as income and no deductions
B. $900 as income and $300 as deductions
C. $600 as net gambling income
D. $0 income since he did not get a W2-G

The tax woes of 2010 World Series of Poker main event winner Jonathan Duhamel were recently reported by Card Player. It seems that Canadian tax authorities wish to treat Duhamel’s winnings as business income. That is because, in Canada, business income is taxable while winnings from games of chance are not. And poker is considered a game of chance.

So, to avoid tax in Canada, Duhamel has to actually argue that his winnings were the product of luck rather than skill. As a Canadian, he was disadvantaged because he ran his poker career in a businesslike fashion.

In the U.S., poker players often claim the opposite — that poker is a game of skill rather than a game of chance — in order to evade laws that define gambling as involving chance. But regardless of whether poker players are skillful or lucky, their winnings are taxable income in the U.S.

Furthermore, in the U.S., you are better off if you are in the business of playing poker rather than playing recreationally. That point was established by Poker Hall of Famer Billy Baxter when he sued the IRS in 1986 to recover tax that the IRS had collected on his gambling income. Baxter won and established the principle that if gambling is your trade or business, then, as with any other business, your “ordinary and necessary” expenses are deductible.

So, for the professional gambler, the answer to our multiple-choice question is C. The professional gambler earned $900, so on Schedule C he would report income of $900 and deductions of $300, resulting in net gambling income of $600.

If you are a recreational player, however, you can deduct your losses and expenses, but you can’t net them against income. According to the IRS, you must report the income as income on your Form 1040 and may claim your expenses on Schedule A as itemized deductions.

This is a double whammy. First, the additional income can increase your Adjusted Gross Income, which can trigger other tax consequences. Second, Trump’s tax bill increased the standard deduction, so if, like most taxpayers, you take the standard deduction instead of itemizing on Schedule A, you don’t get the benefit of your losses and expenses. Thus, for the recreational player, the answer to our question could be B, but most of the time it will be A. Most recreational players will report $900 in income and no losses or expenses.

This does not make a lot of sense to me, because it is inconsistent with the tax treatment of other income that I earn from part-time business activities. If I earn $1,000 from freelance writing, for example, I can report that income on Schedule C as a Trade or Business. I can deduct the expenses incurred to earn that income and if those expenses amount to more than my freelance income, I can use that loss to offset other income.

I’m not sure why my part-time poker playing should not be treated the same. I suppose the answer is that since I described myself as a “recreational” player, my poker playing activity is a recreation, like playing tennis, and not a business. Though I take my poker playing seriously, and can make money from poker and not from tennis.

So unlike Duhamel, for Americans there can be tax advantages to being a professional poker player. If you are one, or are thinking of becoming one, you should consult a tax advisor.

Note, by the way, that the fact that the casino did not give the player a W2-G is not relevant. The IRS requires casinos to report certain payments to gamblers on Form W2-G, subtitled “Certain Gambling Winnings.” In the case of poker tournaments, the threshold is a win of $5,000. The IRS can match the information on that form against your tax return to determine whether you reported the income. But taxpayers have the responsibility to report all income on their tax return, not just the income that gets reported to the IRS, so in theory it does not matter whether the casino reports the income or not.

People in business usually do a good job of keeping track of their expenses in order to use those expenses as deductions from their income and thereby reduce their tax burden. While those deductions may be of less value to recreational players who take the standard deduction, it is still a good idea to keep a journal and file away receipts, including tournament tickets, just in case you have enough deductions to justify reporting those losses and expenses. ♠

Scott J. Burnham is Professor Emeritus at Gonzaga University School of Law in Spokane, Washington. He can be reached at [email protected].