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Annette Nellen
Annette Nellen
Tax! Tax! Tax! — IRS proposal for taxing slot machine winnings

The IRS seeks comments on an optional method for determining gambling winnings or losses from “electronically tracked slot machine play.”

April 9, 2015
by Annette Nellen, Esq., CPA, CGMA

Your client, Tom, tells you he went to Las Vegas with $2,000 for gambling. He played the slots for two days at four casinos, used a few “player cards,” and came home with $3,200. Is this enough information for proper tax reporting? No. Should it be? This article reviews guidance on reporting gains and losses from slot machine play and summarizes and critiques a proposed IRS method for measuring Tom’s gains and losses. Proposed reporting regulations are also summarized. Both IRS proposals were motivated by changes in gaming technology.

Gambling taxation 101

Basics: Gambling (wagering) gains are included in gross income (Sec. 61). Losses from gambling are allowed to the extent of gambling gains, but only as an itemized deduction (Sec. 165(d), Regs. Sec. 1.165-10, Sec. 63, and Rev. Rul. 54-339). The amount spent to generate a gain (the winning bet) reduces the gain (Rev. Rul. 83-130 and Hochman, T.C. Memo. 1986-24). For example, a bet of $1 that produces a win of $10 results in gross income of $9, reported on the other income line of Form 1040, U.S. Individual Income Tax Return.

Tracking: The purchase of one winning raffle ticket or a single winning bet on a horse race is easy to track and report. Typical slot machine play, though, involves multiple bets of the original “investment” and usually also of the winnings. As the IRS and the courts have noted, tracking each play at a slot machine is “unduly burdensome and unreasonable” (AM 2008-011 (12/12/08)).

For slot machine play, guidance exists on the meaning of “wagering transactions” as used at Sec. 165(d). Per AM 2008-011, a casual gambler “recognizes a wagering gain or loss at the time she redeems her tokens.” The IRS offers an example of a gambler who starts with $100 at the slot machines and ends up with $300. The result is a wagering gain of $200, reportable as other income. It would not matter if during the course of play there were $1,000 of winning spins and $700 of losing ones.

Shollenberger, T.C. Memo. 2009-306, offers further guidance, including how an amount on Form W-2G, Certain Gambling Winnings, affects other income. In this case, the couple started their day of slot machine play with $500 and finished with $1,600. This play included one $2,000 jackpot for which they received a Form W-2G. They reported no winnings on their return and claimed the standard deduction. The couple stated they had over $2,000 of losses for the year. The IRS argued that the couple had $2,000 of unreported income. At trial, the IRS conceded that application of AM 2008-011 left the couple with winnings of $1,100 and no losses because they did not itemize. The court denied the couple’s argument to net all gains and losses for the year as that would defeat the rule to only allow losses as itemized deductions.

Documentation: Gamblers must be able to prove their winnings and losses (Sec. 6001). The IRS suggests records and documentation of at least the following (Rev. Proc. 77-29; also see IRS Publication 529, Miscellaneous Deductions):

1) Date and type of specific wager or wagering activity;
2) Name of gambling establishment;
3) Address or location of gambling establishment;
4) Name(s) of other person(s) (if any) present with taxpayer at gambling establishment; and
5) Amount(s) won or lost.

The IRS also suggests that individuals keep a “record of all winnings by date and time that the machine was played” (Rev. Rul. 77-29) and the machine number (Publication 529). Supporting documents might include wager tickets, bank withdrawal slips, and statements from the casino.

Many casinos offer “player” or reward cards to track a gambler’s activities that also allow gamblers to earn food discounts, free plays at the slot machine, points to accumulate for various discounts, and other benefits. These cards typically enable the holder to obtain a statement from the casino of wins and losses for the year. However, these are insufficient for tax purposes because there is no guarantee the holder used the card for all gambling activities (see Lutz, T.C. Memo. 2002-89). Casinos typically note that the statement is an estimate or a supplement to the gambler’s records (see, e.g., Rios, T.C. Memo. 2012-128, and Illinois Dept of Revenue IT 06-20 (11/16/06)).

Reporting: A win of $1,200 or more at a slot machine requires the payer to issue Form W-2G, without any reduction for the amount of the wager (Regs. Sec. 7.6041-1).

Casual versus professional: Gambling activities of some individuals might constitute a trade or business, which has the advantage of permitting reporting on Schedule C, Profit or Loss From Business, not as itemized deductions subject to the 2% floor. (See Groetzinger, 480 U.S. 23 (1987), and Mayo, 136 T.C. 81 (2011), acq. AOD 2011-06 (1/17/12).)

Proposed safe harbor for slot machine play

Notice 2015-21 (3/3/15) proposes a revenue procedure allowing an optional safe harbor method for individuals to determine a wagering gain or loss from “electronically tracked slot machine play.” Important for this method is “session of play,” defined as:

A session of play begins when a patron places the first wager on a particular type of game and ends when the same patron completes his or her last wager on the same type of game before the end of the same calendar day. … A session of play is always determined with reference to a calendar day (24-hour period from 12:00 a.m. through 11:59 p.m.) and ends no later than the end of that calendar day.

Play that stops and resumes at a single gaming establishment in the same calendar day is considered the same session of play if it is all electronically tracked.

Playing a slot machine from 10 p.m. to 2 a.m. is at least two sessions of play because it spans two days. If a player moves from one casino to another, a new session of play begins.

Key points:

  • The safe harbor would apply only to “electronically tracked slot machine play” where the gaming establishment records the gambler’s bets and wins, such as with a player card.
  • A session of play results in a wagering gain if the dollar amount of payouts exceeds the dollar amount of the wagers for that session; a wagering loss occurs when total wagers exceed total payouts for the session.
  • Gains and losses from separate sessions of play may not be netted.
  • The safe harbor must be consistently used for all plays at the same “gaming establishment” throughout the year, or not used for any plays at that establishment for the year.
  • The safe harbor would be available to both casual and professional gamblers.
  • To adopt this method, a taxpayer must note “Revenue Procedure 2015-X” on line 21 of Form 1040 (different lines apply for nonresident aliens).
  • The normal documentation requirements remain.

The IRS seeks comments on the proposed safe harbor method by June 1, 2015. See Notice 2015-21 for eight specific questions for which the IRS seeks input.

Example: From 6 p.m. to 8 p.m. on June 1, Mary wagers $300 in electronically tracked slot machine play at Casino X and loses it all. From 11 p.m. June 1 to 1 a.m. June 2, Mary wagers another $200 in similar play at the same casino. At 1 a.m., Mary quits and has $450. If Mary uses the safe harbor, she has two sessions of play: (1) June 1 from 6 to 8 p.m. plus 11 p.m. to 11:59 p.m., and (2) June 2 from midnight to 1 a.m. Mary will need to determine her position at 11:59 p.m. to know her wagering gain or loss for June 1 and June 2. If she continues electronically tracked slot machine play at X on June 2, she must combine it with the play from midnight to 1 a.m. If Mary also has slot machine play at X that is not electronically tracked, it is not included in the electronically tracked play sessions.

Note that under the proposed safe harbor, the timing of Mary’s play over the two days affects her tax result. For example, assume she plays at one machine from 11 p.m. June 1 to 1 a.m. June 2. She starts with $200 and notes that at 11:59 p.m., she has $50, for a wagering loss of $150 for June 1 (wager of $200 less payout of $50). When she stops at 1 a.m., she has $350, for a wagering gain of $300 for the June 2 session (payout of $350 less wager of $50). If this were all of Mary’s gambling for the year, she would report $300 as other income and claim $150 as an itemized deduction (or nothing if she claims the standard deduction). If Mary’s session had instead started 61 minutes earlier, she would have $150 of other income and no loss ($350 of payout less $200 of wager).

Critique

The proposed safe harbor provides limited guidance as it only applies to electronically tracked slot machine play. A few observations:

  • Why is the safe harbor limited to electronically tracked play? For consistency, why not allow use of the safe harbor “session of play” definition for other slot machines?
  • Why limit “session of play” to a 24-hour day, particularly for individuals who gamble over limited consecutive days, such as while on vacation? Why not only require a split for play from Dec. 31 to Jan. 1 or for individuals who engage in play for a specified number of days during a year (to allow for respect of the loss rule as noted in Shollenberger)? Play that continues through midnight may be difficult to separate between the two days.
  • How is a session of play measured if an individual uses multiple player cards at the same time at the same casino?
  • What is a “gaming establishment”? Many casinos have common ownership and may use the same player cards.
  • How do noncash benefits obtained from use of some player cards factor into the measure of payouts or wagers?

Information return proposal

The IRS also released proposed regulations under Sec. 6041 for winnings from bingo, Keno, and slot machines (REG-132253-11 (3/4/15)), to replace Regs. Sec. 7.6041-1. The proposed regulations use the same definition of electronically tracked slot machine play as used in Notice 2015-21. Reporting varies depending on whether the winnings are from electronically tracked machines. For electronically tracked machines, the amounts of wagers for that session are considered to determine if the filing threshold is met. The IRS also seeks comments on whether current reporting thresholds should be reduced to $600, which is consistent with other reporting thresholds.

Looking forward

The proposed safe harbor for gamblers and proposed changes to information reporting for payers are good signs that the IRS acknowledges the need for guidance and that technology may justify new options. Additional work is needed though, to address a broader range of gambling activities and ensure simple and feasible reporting approaches. Good luck!

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Annette Nellen, Esq., CPA, CGMA, is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, ABA, and California State Bar. She is a member of the AICPA Tax Executive Committee and Tax Reform Task Force. She has several reports on tax policy and reform and a blog.