Tax Interplay of Gambling Winnings and Losses: Part II
When I think about this week’s post, I am reminded of a college calculus course. At first, the material is fairly straightforward, but is built upon later on to study more complex concepts. This notion explains the relationship between Parts I and II of the Tax Interplay of Gambling Winnings and Losses. I suggest rereading Part I before proceeding to today’s Part II, which is long and dense. Part II contains critical guidance necessary to understand how to approach the reporting position you will take on your tax return with respect to gambling winnings.
As discussed last week, losses from gambling sessions can offset winnings from gambling sessions. How are these offsets reflected on your tax return?
Today’s First Takeaway: “Professional” gamblers report gambling winnings and gambling losses on Schedule C, Profit or Loss From Business, of the Form 1040. The resulting net winnings amount, if any, is reported on line 12 of the 1040 as business income. “Recreational” gamblers report gambling winnings on line 21 of the 1040, and report gambling losses, up to the extent of gambling winnings, as itemized deductions on Schedule A of the 1040.
To be clear, each year a taxpayer who is reporting gambling winnings must decide whether he/she is filing either as a professional gambler or a recreational gambler. Before discussing the definitions for these types of gamblers, I will discuss the different tax consequences between being considered a professional or recreational player.
Under the tax code, the profession of professional gamblers is gambling. Sounds obvious. And it is. Professional gamblers are considered self-entrepreneurs who profit-seek on their own. Accordingly, professional gamblers are entitled to take certain business deductions for various costs associated with gambling.
The significant deduction for professional gambler is “ordinary and necessary” business expenses. Because there is a lot of commentary with respect to the types of expenses of the professional gambler that may be deductible, I will discuss at length in the near future.
Another significant aspect of reporting as a professional player is that the taxpayer is considered self-employed. Taxpayers who are self-employed must pay self-employment tax, which is a social security and Medicare tax primarily for individuals who work for themselves. It is similar to the social security and Medicare taxes withheld from the pay of most wage earners. Next week’s post will be dedicated to the self-employment tax.
While professional players net their gambling winnings and losses and report the net figure (if 0 or greater) on line 12 of the 1040 as business income, recreational players report gambling winnings and losses in separate places. The winnings are reported on line 21 as other income, and the losses are reported as itemized deductions on their Schedule A. As discussed last time, the losses reported cannot exceed the winnings reported.
The key differences for recreational players are that they cannot deduct ordinary and necessary expenses incurred in connection with gambling, and they do not report gambling winnings as self-employment income.
You are probably wondering if there is a straightforward answer to the question of whether a taxpayer pays Uncle Sam less as a professional or not. Each taxpayer’s situation is different, so you should seek assistance from a tax professional to make this determination. This brings us to the final discussion for week: What makes a gambler professional or recreational?
Today’s Second Takeaway: A “professional” gambler is considered engaged in the trade or business of gambling, while a “recreational” gambler is considered not engaged in the trade or business of gambling.
To be engaged in the trade or business of gambling, the taxpayer must gamble with continuity, regularity, and with the primary purpose of deriving a profit. The player need not actually have a reasonable expectation of profit, but instead have an actual and honest profit objective. These inquiries are fact specific. Typically, the facts make it fairly clear to ascertain whether the taxpayer is considered professional or recreational. Some situations, however, allow the taxpayer to make a choice. One common situation is the full-time college student.
The next couple of weeks will focus on the self-employment tax and the “ordinary and necessary” business expense deduction. If you might file as a professional player at some point, be sure to check in.