Gambling Deductions Tax Reform

As a result of the December 20, 2017 Tax Reform legislation, the following items will affect your Tax Year 2019 Tax Return.

• Changes the Seven Tax Rates: The new rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. They will phase out in eight years.
• Doubles the Standard Deduction: The standard deduction amount is increased from $6,350 to $12,000 for Single and Married Filing Separately filers, $12,700 to $24,000 for Married Filing Jointly and Widow filers, and $9,350 to $18,000 for Heads of Household.
• Eliminates the Personal Tax Exemption: The doubled standard deduction replaces the personal tax exemption.
• Eliminates Some Itemized Deductions Subject to the 2% AGI floor for Eight Years
• Eliminates Income Phaseout on Total Itemized Deductions for Eight Years
• Decreases the Mortgage Loan Amount Limit for the Mortgage Interest Tax Deduction: For new loans starting in 2018, taxpayers can deduct their mortgage interest of a loan up to $750,000 ($375,000 for Married Filing Separately taxpayers). This is a decrease from the current loan amount of $1 million. It will go back to the original $1 million amount in 2026.
• Increases the Tax Deduction for Charitable Contributions: The limit for charitable cash donations to public charities and certain other organizations increases from 50% to 60% (except deductions combined with preferred seating at college sports events). The charitable standard mileage rate stays at 14% with no adjustment for inflation.
• Increases the Child Tax Credit: The Child Tax Credit is increased from $1,000 to $2,000 per child (first $1,400 is refundable). The credit will start to phase out at $400,000 and more than $200,000 for other taxpayers. This increased amount would phase out in eight years.
• Adds a New Tax Credit for Non-Child Dependents: There is a new $500 nonrefundable tax credit for non-child dependents/parents who are U.S. citizens. The credit can be applied to children over 17 years old, senior parents, or children with disabilities. The dependent’s Social Security Number (SSN) must be issued and provided to the IRS by the due date of a tax return in order to qualify for the credit.
• Reduces the State and Local Tax Deduction: State and local property taxes up to $10,000 can be deducted, in addition to income taxes or sales taxes.
• Decreases the Medical Tax Deduction Rate: The Medical Tax Deduction rate is decreased from 10% to 7.5% for 2017 and 2018 Tax Returns, regardless of age. It will rise back to 10% in 2019.
• Eliminates the Moving Expenses Deduction: You can no longer deduct moving expenses related to a new job (there are some exceptions for active duty military). These expenses include the use of a vehicle as part of a move. This will expire in 2025.
• Eliminates the Tax Deduction for Casualty and Theft Loss: All tax deductions for casualty and theft loss are eliminated (except for those losses attributable to a federal disaster as declared by the President) from 2018 to 2025.
• Eliminates the Tax Deduction for Educator Expenses
• Eliminates the Tax Deduction for Tax Return Preparation Expenses
• Doubles the Estate or “Death” Tax: The Estate Tax amount is doubled from $5.5 million to $11.2 million ($22.4 million for married taxpayers), which will increase with inflation. The doubled amount will expire on December 31, 2025.
• Eliminates the Individual Health Care Tax Penalty: The tax penalty for not having health insurance will be eliminated in 2019. This means you would still be required to pay the penalty in 2018 (for 2017 Tax Returns) and 2019 (for 2018 Tax Returns), but not in 2020 (for 2019 Tax Returns).
• Eliminates Roth IRA Reconversion: If you converted your traditional IRA to a Roth IRA, you can no longer reconvert it back to an traditional IRA. Initial conversions from traditional Roth IRA are not affected.
• Includes All Gambling Expenses as Deductible Losses Up to Amount of Total Winnings
• Eliminates Home Office Deduction for Employees
• Eliminates Business Mileage Rates As Itemized Deductions For Un-Reimbursed Employee Travel Expenses

Tax Reform Changes for Tax Years 2019 and 2020

1. With the tax code changes, will casual gamblers that do not itemize deductions be able to offset winnings with gambling losses? Hope so, or I will have to avoid W-2Gs at all cost. Given the recent passage of the tax reform bill, could you please provide some insight on how this will impact the recreational gambler?
2. For instance, you can continue to deduct gambling losses, up to the amount of winnings, on 2017 returns and beyond. The TCJA did, however, modify the gambling loss deduction, beginning in 2018.

• Eliminates the Tax Deduction for Alimony (only applies to payments required under a divorce or separation agreement made after the end of 2018)

Doubles the Standard Deduction: The standard deduction amount is increased from $6,350 to $12,000 for Single and Married Filing Separately filers, $12,700 to $24,000 for Married Filing Jointly and Widow filers, and $9,350 to $18,000 for Heads of Household.

What is Not Changing in Tax Reform

Here are items from the current tax code that will not change:

• Earned Income Tax Credit: The maximum amount is $6,444 for taxpayers filing jointly who have 3 or more qualifying children.
• American Opportunity Tax Credit
• Student Loan Interest Deduction
• Adoption Tax Credit
• Alternative Minimum Tax: The amounts permanently adjusted for inflation are $70,300 for Single and Head of Household filers, $109,400 for Married Filing Joint filers and widowers, and $54,700 for Married Filing Separately filers.
• Tax Deductions for 401K and IRA Retirement Savings Options
• Capital Gains and Dividend Rates
• Investment Interest Expense Tax Deduction
• Real Estate Tax Deduction for State and Local Property Up to $10,000
• Home Office Deduction for Self-Employed Taxpayers

Tax Reform Individual Tax Rate Schedule

The ability to deduct expenses was curtailed by last year’s tax overhaul.

Professional gamblers' decadelong streak of being able to deduct a net loss from gambling as a trade or business was ended this year by P.L. 115-97, known as the Tax Cuts and Jobs Act of 2017 (TCJA). Although a relatively minor facet of the wide-ranging tax reform package, the TCJA's amendment to Sec. 165 overturning a 2011 Tax Court decision and 2008 IRS memo is momentous for taxpayers who claim to be engaged in the trade or business of gambling by virtue of their participation at card tables, racetracks, or other wagering venues, real or virtual.

CHANGING FORTUNES

While all taxpayers are required to report gambling winnings in gross income, what related deductions they can claim and in what way depends on whether their gambling rises to the level of a trade or business. A gambler not in the trade or business of gambling (a 'casual gambler') can deduct wagering losses as a deduction not subject to the 2%-of-adjusted-gross-income threshold (i.e., not among miscellaneous itemized deductions the TCJA suspended for tax years 2018 through 2025) on Schedule A, Itemized Deductions, but only to the extent of the winnings. On the other hand, a gambler engaged in the trade or business of gambling ('professional gambler') can net gambling winnings against losses and business expenses on Schedule C, Profit or Loss From Business.

Before amendment by the TCJA, Sec. 165(d) stated only, 'Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.' For many years before 2008, the IRS interpreted 'losses from wagering transactions' to include professional gamblers' business expenses, so that they were deductible, along with wagering losses, only to the extent of gambling winnings. Consequently, professional gamblers were not allowed to generate a net operating loss (NOL) from gambling activities. The Tax Court in Offutt, 16 T.C. 1214 (1951), sustained the IRS's perspective and followed this ruling in subsequent cases.

But the Tax Court did not do so consistently, as discussed below. Meanwhile, the Supreme Court in Sullivan, 356 U.S. 27 (1958), allowed business deductions of an illegal gambling enterprise (generally denied previously on public policy grounds). Then, in Groetzinger, 480 U.S. 23 (1987), the Supreme Court distinguished between Sec. 165(d) wagering losses and Sec. 162(a) business expenses of a taxpayer in the trade or business of gambling.

In 2008, the IRS in Chief Counsel Advice Memorandum AM 2008-013 concluded that the IRS should no longer follow Offutt. The Tax Court in Mayo, 136 T.C. 81 (2011), then likewise abandoned its Offutt holding, allowing a professional gambler to deduct business expenses in excess of net gambling winnings (while maintaining that direct wagering losses could still be deducted only to the extent of wagering gains under Sec. 165(d)). Therefore, professional gamblers were able to generate an NOL from gambling activities — until the TCJA amended Sec. 165(d). (For more on Mayo and factors by which courts determine whether gambling is a trade or business, see 'Better Odds for Pro Gamblers' Business Deductions,' JofA, April 2012.)

TAX REFORM RESETS THE RULES

The TCJA, however, put an end to professional gamblers' ability to deduct nonwagering business expenses in excess of net wagering income. It amended Sec. 165(d) by inserting the following sentence after the original one:

For purposes of the preceding sentence, in the case of taxable years beginning after December 31, 2017, and before January 1, 2026, the term 'losses from wagering transactions' includes any deduction otherwise allowable under this chapter incurred in carrying on any wagering transaction.

The House of Representatives described this provision in its committee report (H.R. Rep't No. 115-409, 115th Cong., 1st Sess. 167 (Nov. 13, 2017)):

The provision is intended to clarify that the limitation on losses from wagering transactions applies not only to the actual costs of wagers incurred by an individual, but to other expenses incurred by the individual in connection with the conduct of that individual's gambling activity. The provision clarifies, for instance, an individual's otherwise deductible expenses in traveling to or from a casino are subject to the limitation under section 165(d). [footnote omitted]

The report further noted that the provision was intended to reverse Mayo (id., fn. 135). Consequently, the deduction of professional gamblers' nonwagering business expenses is limited by Sec. 165(d) under the new law. The following example and the chart, 'Before and After the TCJA,' illustrate the amendment's effects.

Before and after the TCJA

Example

Assume that G had the following expenses related to his gambling activities in both tax years 2017 and 2018:

Gambling winnings: $10,000

Losing wagers: $12,000

Transportation: $3,000

Meals and entertainment: $1,500

Legal and professional services: $1,000

Lodging: $2,500

Subscriptions and books: $900

Telephone and online charges: $600

Depending on whether G is a professional or casual gambler, either of two tax treatments could result for each year. If G is a casual gambler, the amendment of Sec. 165(d) has no effect on him. He should report his gambling income of $10,000 on Form 1040, U.S. Individual Income Tax Return, and $10,000 of his wagering losses on Schedule A in both 2017 and 2018. If G is a professional gambler, he could claim an NOL of $9,500 from gambling activities in 2017, as shown in the chart. However, under the amended Sec. 165(d), G may deduct his wagering losses and nonwagering gambling-related business expenses only to the extent of his gambling winnings, for a net zero income from gambling activities in 2018.

GAINS FROM WAGERING TRANSACTIONS

Amended Sec. 165(d) changes the definition of 'losses from wagering transactions' but not the meaning of 'gains from wagering transactions,' which may not always be clear. Courts generally have held that 'gains from wagering transactions' within the meaning of Sec. 165(d) must be the actual product of wagers entered by the taxpayer.

Gross income does not include the return of capital (Doyle v.Mitchell Bros. Co., 247 U.S. 179 (1918)). A gambler thus would be entitled to exclude the cost of a winning ticket from its associated gross winnings. Nevertheless, such recovery of capital could not include the cost of tickets that did not win (Hochman, T.C. Memo. 1986-24). In the past, courts have considered various items as gains from wagering transactions. The annual payments lottery winners receive are treated as their gambling winnings in the year the payments are received (Rusnak, T.C. Memo. 1987-249). However, an excess gambling gain in one year cannot be offset by an excess gambling loss in another year (Skeeles, 118 Ct. Cl. 362 (1951)).

The Fifth Circuit in Humphrey,162 F.2d 853 (5th Cir. 1947), held that wagering transactions include all gambling activities, regardless of whether they are legal or illegal, or whether they are business or personal. As long as the losses derive from wagering transactions, they could be used to offset gains from any such transaction.

It is not necessary for the wagering gains to be related in any way to the losses (Scott-Nickels Bus Co., T.C. Memo. 1956-120). For example, the taxpayer in Presley, T.C. Memo. 1979-339, an owner of an illegal casino, was allowed to use the losses from his other personal gambling activities to offset his gains from the casino (see also Jennings, 110 F.2d 945 (5th Cir. 1940), and Joseph, 43 B.T.A. 273 (1941)).

Gamblers could use gambling losses to offset the value of complimentary goods and services ('comps') they receive from a casino. Comps constitute gains from wagering transactions because the relation between the comps and the gambler's wagering is 'close, direct, evident, and strong' (Libutti, T.C. Memo. 1996-108).

INCOME THAT IS NOT GAINS FROM WAGERING TRANSACTIONS

In addition, courts have considered the following income sources to not be gains from wagering transactions:

Tokes

Traditionally, casino dealers receive 'tokes' from patrons who play at their tables, in the form of bets the patron places for the dealer's benefit. Tokes are considered compensation for the recipient's services and, thus, should be treated as ordinary income rather than either wagering gains or gifts (Bevers, 26 T.C. 1218 (1956); Allen, 976 F.2d 975 (5th Cir. 1992); Olk, 536 F.2d 876 (9th Cir. 1976); and Williams, T.C. Memo. 1980-494).

Take-offs

A take-off is the fee that the house charges card players to play poker at the casino. Because take-offs serve as seat rental charges, those the house receives are not gains from wagering transactions and cannot be used to offset the house's losses from such transactions (Nitzberg, 580 F.2d 357 (9th Cir. 1978)). Similarly, the taxpayer in Boyd, 762 F.2d 1369 (9th Cir. 1985), ran the poker room in a casino that awarded him a portion of the take-off collected in the card room. The contractual share of take-offs the taxpayer received was not his gains from wagering transactions and could not be offset by his losses from those transactions.

Theft income from stolen betting tickets

The taxpayer in Collins, T.C. Memo. 1992-478, aff'd,3 F.3d 625 (2d Cir. 1993), worked as a ticket seller at an off-track betting station. Without making any payment, he placed several personal bets that had a fair market value of $80,280 and resulted in winnings of $42,175 (for a net loss of $38,105). He returned the entire winnings to his employer and turned himself in at the end of the day. The Tax Court ruled that the taxpayer should recognize net theft income of $38,105. Further, the court held that the theft income from the stolen tickets was ordinary income and not gain from a wagering transaction. Therefore, the taxpayer could not use his losses from wagering transactions to offset his theft income.

LOSSES FROM WAGERING TRANSACTIONS

Professional gamblers can deduct business expenses against their gains from wagering transactions (again, subject now to limitation under the TCJA) even if illegal gambling activities are involved. For example, in Harbin, T.C. Memo. 1958-190, the owner and operator of an illegal lottery business was allowed to deduct gambling losses, business expenses, and the federal excise tax on gambling against his income from the gambling operations. When the losses from wagering transactions exceed the gains, the excess losses cannot be carried back to previous years (Estate of Todisco, T.C. Memo. 1983-247). Casual gamblers cannot claim a gambling loss deduction for nonwagering expenses, such as transportation, meals, and lodging (Whitten, T.C. Memo. 1995-508).

Courts have considered the following items losses from wagering transactions, such that their deduction is limited to wagering gains:

Unsold tickets

The taxpayer in Miller, 792 F.2d 392 (3d Cir. 1986), was a lottery dealer in the Virgin Islands, where the lottery distribution system did not allow dealers to return unsold tickets. The Third Circuit noted that the taxpayer retained the tickets and continued to buy more tickets than he could sell, indicating that he was betting that one or more of the unsold tickets would be drawn. Therefore, the cost of these unsold tickets should be treated as gambling losses rather than ordinary business expenses, the court held.

Losses by shills

Typically, casinos engage persons referred to as 'shills' to whom they agree to provide a certain sum of money or chips to play. The casino will absorb any loss, but gains are split between the shill and the casino. The Tax Court in Nitzberg, T.C. Memo. 1975-228, held that when shills' losses were greater than their winnings, the net loss was deductible as the casino's ordinary and necessary business expense under Sec. 162. However, on appeal, the Ninth Circuit (Nitzberg, 580 F.2d 357 (9th Cir. 1978)) reversed the ruling, noting that shills acted on the casino's behalf when placing bets and, therefore, the casino's losses were losses from wagering transactions.

State tax assessment

A state income tax assessment on gambling income of an individual in the trade or business of gambling is tied directly to a taxpayer's gambling activities and, hence, is subject to the limitation of Sec. 165(d) (Estate of Todisco, 757 F.2d 1 (1st Cir. 1985)).

Buy-in and rake

Tournament poker players are required to pay the tournament organizer a 'buy-in,' or entrance fee. The casino retains a portion of this amount as an administrative fee, and the remainder goes directly into the prize fund 'pot' that will be paid out to the tournament's winners. The Tax Court in Tschetschot, T.C. Memo. 2007-38, considered tournament poker a wagering activity and treated poker players' loss of the buy-in as losses from wagering transactions. However, the IRS in Hom, T.C. Memo. 2013-163, conceded that poker entry fees and rake fees (charged per hand to play poker online) were business expenses of a professional gambler. While the Tschetschot and Hom cases are inconsistent, this inconsistency is irrelevant under amended Sec. 165(d). Regardless of the nature of buy-in and rake fees, both are subject to the Sec. 165(d) limitation under the TCJA.

Takeout

In horse-race betting, 'takeout' refers to the share of the entire betting pool that the event manager (the track) is specified to receive. The track uses the takeout to pay its expenses, such as purse money for the horse owners, taxes, license fees, and other state-mandated amounts, and keeps any remaining amount as its profit. As a professional gambler, the taxpayer in Lakhani, 142 T.C. 151 (2014), aff'd, Nos. 14-72576, 14-72577 (9th Cir. 5/10/18), argued that his pro rata share of the takeout the track remitted to the state and local tax authorities constituted his business expense and was not a loss from wagering transactions. The Tax Court noted that the taxes, license fees, and other expenses discharged from the takeout were expenses imposed upon the track, not the bettors. Therefore, the taxpayer was not allowed to deduct his share of the takeout.

POTENTIAL ISSUES

Taxpayers should be aware of the following potential issues, some of which may require more clarification by either courts or the IRS:

Treatment of 'fee to play'

The courts treat the 'fee to play' inconsistently, as it may be referred to as take-off, buy-in, or rake. The Ninth Circuit in Boyd held that take-offs the casino received or awarded to a contract player were not gains from wagering transactions. The Tax Court in Mayo implied that take-offs gamblers paid were nonwagering business expenses. On the other hand, the Tax Court in Tschetschot considered poker players' losses of the buy-in as losses from wagering transactions, while in Hom, rake was treated as a business expense.

This inconsistency raises two issues. First, there is no statute or theory to support the different tax treatments of the entry fees based simply on whether the taxpayer is the recipient or the payer. Second, for professional gamblers, the inconsistency between the Tschetschot and Hom cases does not matter under Sec. 165(d) as amended by the TCJA. For casual gamblers, however, this inconsistency has created chaos. Naturally, casual gamblers prefer to follow the Tschetschot case and treat their fees to play as losses from wagering transactions, as they are not allowed to deduct any gambling-related nonwagering expense.

Gambling Deductions Tax Reform 2020

Treatment of tokes

Are tokes that dealers receive considered the giver's winnings and losses? The courts have held that tokes are not dealers' gains from wagering transactions, as noted above. However, there is no precedential ruling with respect to the giver's treatment of the toke. As a toke belongs to the giver until the bet is won (Bevers, 26 T.C. at 1219), theoretically, the loss or winning of the toke should be considered the giver's gambling loss or winning.

Reportable gambling winnings

In Regs. Sec. 1.6041-10, the definition of 'reportable gambling winnings' for information-reporting purposes depends on the type of game. In bingo and slot machines, the amount of the reportable gambling winnings includes the amount wagered. Conversely, it is reduced by the amount wagered for keno. Taxpayers should be aware of this difference when they receive Form W-2G, Certain Gambling Winnings.

AN END TO NOLs

Before the TCJA, under the Tax Court's holding in Mayo, professional gamblers were allowed to fully deduct their nonwagering business expenses beyond wagering gains. By amending Sec. 165(d) in the TCJA, Congress reversed Mayo, allowing professional gamblers to deduct their wagering losses and nonwagering business expenses only to the extent of their gambling winnings, and no longer allowing them to generate an NOL from their gambling activities. Although, under the TCJA, the amendment to Sec. 165(d) is scheduled to expire at the end of 2025 along with most of its other provisions affecting individual taxpayers, Congress may extend it further. In the meantime, professional gamblers' winning streak apparently has come to an end.

About the authors

Wei-Chih Chiang, CPA, DBA; Yingxu Kuang, DBA; and Xiaobo Dong, Ph.D., are all associate professors of accounting in the School of Business Administration, University of Houston—Victoria at Katy, Texas.

To comment on this article or to suggest an idea for another article, contact Paul Bonner, a JofA senior editor, at Paul.Bonner@aicpa-cima.com or 919-402-4434.

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Gambling Deductions Tax Reform Rules

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Gambling Loss Deduction Tax Reform

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