Help clients understand the tax rules associated with gambling winnings

Professional or casual gambler? How to help your clients play their cards right

Here in New Mexico, it’s nearly impossible to go on a road trip without passing at least one tribal casino. That meant that during my tax prep days, I saw a lot of Form W-2GCertain Gambling Winnings. Those were all from casual gamblers, who are treated differently for tax purposes from professional gamblers.

Professional gamblers are dealt a better hand than casual gamblers

Casual gamblers – who make up the vast majority of gamblers – can deduct their losses from gambling on Schedule A of their tax returns, up to the amount of their winnings. Apparently, lady luck was watching out for gamblers when the Tax Cuts and Jobs Act was created; that tax break remains in place, unlike miscellaneous itemized deductions subject to the two percent threshold, which are suspended through 2025.

Professional gamblers report their results on Schedule C. In addition to the gambling losses that all gamblers can deduct, professional gamblers can also deduct business-type expenses. This includes things like travel expenses and educational materials. They pay self-employment tax on any net winnings.

But, in gambling, you win some, and you lose some. Prior to the 2017 tax reform, gamblers could deduct business-type expenses that exceeded their winnings to generate net operating losses. But, the TCJA amended Section 165(d) to clarify that total gambling expenses, including business-type expenses, are now limited to income from gambling.

Advisors should be aware that some states, including Connecticut, Illinois, Indiana, and Wisconsin, do not allow casual gamblers to deduct gambling losses as an itemized deduction. Professional gamblers are allowed to, but their returns may be subject to extra scrutiny.

How to get an edge as a professional gambler

To gauge whether your clients qualify as professional gamblers, you’ll have to measure their facts and circumstances against the factors in the 1987 Supreme Court Groetzinger case.

According to that case, “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.” This subset of the nine factors used to classify activities as hobbies or businesses contains the ones most relevant to gambling.

Poker player draws a losing hand

To see how these apply in real life, let’s look at the recent tax court case of James Zalesiak. As a college student, Zalesiak began playing poker. He had enough success that he began playing poker full time in 2009. In 2010, he took a year off from poker to “establish a different career.” By the end of that year, he began working as a construction manager, which remains his full-time job.

In 2011, he returned to poker, and spent nights and weekends playing. He made a small profit from poker in 2011 and again in 2015, the year the tax court was examining. On his 2015 return, he had poker winnings of $20,930, losses of $16,841, and business-type expenses of $2,970, resulting in net income of $1,119 from poker.

During 2015, his construction manager job kept him busy, so he wasn’t able to play at all for about five months, and only played poker about 75 days that year. A good chunk of that playing happened in December, when he took the month off, using accrued leave time. During that month, he combined travel to casinos with visits to friends and family, so that he “was able to get two birds with one stone.”

With a full-time job as a construction manager, Zalesiak clearly couldn’t play poker full time. As the judge noted, “simply spending all of one’s free time on an activity does not transform the activity into a trade or business, nor does it make the participant a professional.”

The judge did not deny that Zalesiak was playing poker with the good faith desire to win. However, he also took a good chunk of time that year off from playing poker, so he didn’t play with regularity. During 2015, 98.1 percent of Zalesiak’s income came from his job as a construction manager, so his poker playing clearly wasn’t producing income for a livelihood.

Therefore, the judge ruled that Zalesiak was not a professional gambler, and could only deduct his gambling losses on Schedule A. However, since the IRS had initially denied even that deduction, he was able to cut his losses.

Understanding the differences between casual and professional gamblers will help you ensure that your gambling clients play their cards right on their tax returns!

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