Gambling and Tax Traps
Article Highlights:
Winnings
Losses
Documentation
Charity Raffles
Social Security Income
Health Care Insurance Premium Subsidies
Medicare B & D Premiums
Online Gambling Accounts
Dependents
Although gambling may seem to be a recreational activity for many taxpayers it is not for THE government. They look at it as a source of tax revenue and as one might expect, the government takes a cut if a gambler wins. What makes matters worse, tax laws do not allow recreational gamblers to claim a loss in excess of their winnings. There are far more tax issues related to gambling than one might expect, and they may impact taxes in more ways than one might believe. Here is a rundown on the many issues:
Reporting Winnings – Taxpayers must report the full amount of their gambling winnings for the year as income on their 1040 returns. Gambling income includes, but is not limited to, winnings from lotteries, raffles, lotto tickets and scratchers, horse and dog races, and casinos, as well as the fair market value of prizes such as cars, houses, trips, or other non-cash prizes. The full amount of the winnings must be reported, not the net after subtracting losses. The exception to the last statement is that the cost of the winning ticket or winning spin on a slot machine is deductible from the gross winnings. For example, if a gambler put $1 into a slot machine and won $500, they would include $499 as the amount of their gross winnings, even if they had previously spent $50 feeding the machine.
Frequently, gamblers with winnings only expect to report those winnings included on Form W-2G. However, while that form is only issued for “Certain Gambling Winnings,” the tax code requires all winnings to be reported. All winnings from gambling activities must be included when computing the deductible gambling losses, which is generally always an issue in a gambling loss audit.
If winnings at one time hit certain levels, the government requires the gambling establishment to collect an individual’s Social Security number and report their winnings to Uncle Sam on a Form W-2G. Gambling establishments will issue a Form W-2G if the winnings are:
$1,200 or more on a slot machine or from bingo.
$1,500 or more on a keno jackpot.
More than $5,000 in a poker tournament.
$600 or more from all other games, but only if the payout is at least 300 times the wager.
TAX TRAP #1 – The way the tax laws work, gambling winnings are included in a taxpayer’s adjusted gross income (AGI), while losses are an itemized deduction. Since winnings and losses can’t be netted, the full amount of the winnings ends up in a taxpayer’s adjusted gross income (AGI). The AGI is used to limit other tax benefits, as discussed later. So, the higher the AGI, the more other tax benefits may be limited.
If the winnings minus the wager exceed $5,000 and the winnings are at least 300 times the wager, the gambling establishment is required to withhold 24% of the proceeds, which they then pay over to the government. The lucky taxpayer then claims this amount, which will be included on the W-2G form in box 4, as income tax withheld on their 1040 form. Some states may also require state income tax to be withheld. Taxpayers who have big gambling winnings on which tax isn’t withheld should consider making estimated tax payments to avoid underpayment of tax penalties.
Reporting Losses – A taxpayer may deduct gambling losses suffered in the tax year as a miscellaneous itemized deduction but only to the extent of that year's gambling gains.
TAX TRAP #2 – If a taxpayer does not itemize their deductions, they can’t deduct their losses. Thus, individuals taking the standard deduction will end up paying taxes on all of their winnings, even if they had a net loss.
Documenting Losses – The next logical question is: how to document gambling losses if audited? Taxpayers shouldn’t rush down to the track and start collecting discarded tickets, since they generally aren’t acceptable documentation because of their ready availability. The IRS has published guidelines on acceptable documentation to verify losses. They indicate that an accurate diary or similar record that is regularly maintained by the taxpayer, supplemented by verifiable documentation, will usually be acceptable evidence for substantiation of wagering winnings and losses. In general, this diary should contain at least the following information:
(1) The date and the type of specific wager or wagering activity,
(2) The name of the gambling establishment,
(3) The address or location of the gambling establishment,
(4) The names of other persons (if any) present with the taxpayer at the gambling establishment, and
(5) The amounts won or lost.
Save all available documentation, including items such as losing lottery and keno tickets, checks, and casino credit slips. Also save any related documentation such as hotel bills, plane tickets, entry tickets, and other items that would document a taxpayer’s presence at a gambling location. If a taxpayer is a member of a slot club, the casino may be able to provide a record of electronic play. Affidavits from responsible gambling officials at the gambling facility may prove helpful. With regard to specific wagering transactions, winnings and losses might be further supported by:
Keno – Copies of keno tickets purchased by the taxpayer and validated by the gambling establishment.
Slot Machines – A record of all winnings by date and time that each machine was played.
Table Games – The number of the table at which the taxpayer was playing as well as casino credit card data indicating whether credit was issued in the pit or at the cashier's cage.
Bingo – A record of the number of games played, the cost of tickets purchased, and the amounts collected on winning tickets.
Racing – A record of the races, entries, amounts of wagers, and amounts collected on winning tickets and lost on losing tickets. Supplemental records include unredeemed tickets and payment records from the racetrack.
Lotteries – A record of ticket purchase dates, winnings, and losses. Supplemental records include unredeemed tickets, payment slips, and winning statements.
Gambling Sessions - There is a concept of gambling “sessions” where the IRS allows netting of gain and losses. However, the record-keeping requirements are so stringent that they make its application extremely limited, and it is not covered in detail in this article. The concept basically allows gamblers to net gains and losses from gambling sessions. However, a gambling session is very limited in scope. It must be the same type of uninterrupted wagering during a specific uninterrupted period of time at a specific location. Thus, if a taxpayer entered a casino and played slots for an hour, then switched to craps for the next hour, that would be two separate gambling sessions. If a taxpayer entered Casino #1 and played slots for an hour and then went to Casino #2 and continued to play slots, that would be two separate gambling activities because two locations were involved. Plus, all of that must be adequately documented.
Charity Raffles – The IRS considers raffles, bingo, lotteries, etc., to be gambling, even if the sponsor of the activity is a charitable organization. So, winnings and losses are treated the same as for any other gambling activity, and the amounts paid to buy raffle or lottery tickets or to play bingo or other games of chance are not deductible as a charitable contribution.
SIDE EFFECTS OF GAMBLING
Social Security Income – For taxpayers receiving Social Security benefits, whether those benefits are taxable depends upon the taxpayer’s income (AGI) for the year. The taxation threshold for Social Security benefits is $32,000 for married taxpayers filing jointly, $0 for married taxpayers filing separately, and $25,000 for all other filing statuses. If the sum of AGI (before including any SS income), interest income from municipal bonds, and one-half the amount of SS benefits received for the year exceeds the threshold amount, then 50–85% of the SS benefit is taxable.
TAX TRAP #3 – If an individual’s gambling winnings push their AGI for the year over the threshold amount, the gambling winnings—even if they had a net loss—can cause up to 85% of their Social Security benefits to become taxable.
Health Insurance Subsidies – Lower-income individuals who purchase their health insurance from a government marketplace are given a subsidy in the form of a tax credit to help pay the cost of their health insurance. Most people eligible for the tax credit use it to reduce their monthly health insurance premiums. That tax credit is based upon the AGIs of all members of the family. The higher the family income, the lower the subsidy becomes.
TAX TRAP #4 – The addition of gambling income to a family’s income can result in significant reductions in the health insurance subsidy, requiring families to pay more for their health insurance coverage for the year. Additionally, if the subsidy was based upon estimated income for the year, if the family’s premiums were reduced by applying the subsidy in advance, and if they subsequently had some gambling winnings, then they could get stuck with paying back some or all of the subsidy when they file their return for the year.
Medicare B & D Premiums – If a taxpayer is covered by Medicare, the amount they are required to pay (generally withheld from their Social Security benefits) for Medicare B premiums for 2021 is normally $148.50 per month and is based on their AGI two years prior. However, if that AGI was above $88,000 $176,000 for married taxpayers filing jointly), the monthly premiums can increase to as much as $504.90. If they also have prescription drug coverage through Medicare Part D, and if their AGI exceeds the $88,000 /$176,000 threshold, the monthly surcharge for Part D coverage will range from $12.30 to $77.10. The normal monthly premium amount, the AGI thresholds, and the Part D monthly surcharge vary from year to year, and for 2022 are $170.10, $91,000/$182,000, and $12.40 respectively.
TAX TRAP #5 – The addition of gambling winnings to AGI can result in higher Medicare B & D premiums.
Online Gambling Accounts – If an individual has an online gambling account, there is a good chance that the account is with a foreign company. All U.S. persons with a financial interest or signature authority over foreign accounts with an aggregate balance of over $10,000 anytime during the prior calendar year must report those accounts to the Treasury by the April due date for filing individual tax returns or face draconian penalties.
TAX TRAP #6 – Regardless of whether an individual is a gambling winner or loser, if their online account was over $10,000 at any time during the year, they will be required to file FinCEN Form 114 (Report of Foreign Bank and Financial Accounts), commonly referred to as the FBAR. For non-willful violations, civil penalties up to $10,000 may be imposed; the penalty for willful violations is the greater of $100,000 or 50% of the account’s balance at the time of the violation. The $10,000 and $100,000 penalty amounts are subject to adjustment for inflation, and after January 21, 2022, are $14,489 and $144,886, respectively.
Parents As Dependents - If a taxpayer claims someone as a dependent – say, their mother – and Mom happens to hit a jackpot at the local casino, they may end up being unable to claim her as a dependent for the year if the gambling winnings push Mom’s income over the annual gross income limit for claiming her.
Other Limitations – The aforementioned are the most significant “gotchas.” Numerous other tax rules limit tax benefits based on AGI, as discussed in gotcha #1. These include medical deductions, certain casualty losses, child and dependent care credits, the Child Tax Credit, and the Earned Income Tax Credit, just to name a few.
If you have questions related to gambling winnings, losses and potential tax traps please give this office a call.
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