Tax Implications of Staking Arrangements at the WSOP
In poker terms, a “staking arrangement” arises when someone backs up, or puts up, the funds for another player. This is commonly seen in tournament play. Typically, the “staker” contributes 100% of the entry fee, and is entitled to 50% of whatever winnings the “stakee” wins, in excess of the entry fee. To understand the tax implications of a staking arrangement, let’s work through a couple of scenarios.
Basic Facts: I see potential in your tournament play and stake you for the 2011 World Series of Poker Main Event, to be held at the Rio All-Suite Hotel & Casino in Las Vegas, Nevada, and run by Harrah’s. The entry fee is $10,000, and we agree on a 50-50 split of any winnings. Assume we are both U.S. residents.
Scenario 1: I could not have been more wrong about you. On the very first hand of the Main Event, you go all in preflop with 2-7 offsuit against aces and lose. I have a $10,000 gambling loss, and you have no tax consequences.
Scenario 2: The crystal ball says my instincts were right, because you place and win $100,000. We both have $45,000 of income ($100,000 less $10,000 entry fee, divided by two), taxable as gambling winnings. Where the gambling winnings are reported on each of our returns depends on whether we file as either as “professional” or “recreational” gamblers.
We should both receive a Form W-2G, Certain Gambling Winnings from the casino, because the winnings exceed $5,000. But, if we don’t tell the casino about our arrangement, the casino will just issue you a W-2G for $90,000. To properly allocate the income, the IRS created a form to address this exact situation: Form 5754, Statement by Person(s) Receiving Gambling Winnings. Complete and submit to the casino a Form 5754, and then the casino will issue to both of us W-2Gs for $45,000.
Well, not so fast. Back in 2007, tax practitioner Russ Fox discussed Harrah’s policy of not issuing Forms 5754 to backers of 2007 WSOP entrants. Harrah’s instead issued W-2Gs and prize winnings only to the actual winner of the prize.
2011 WSOP UPDATE: None, it seems. Earlier today, I placed a call to the General WSOP Information hotline. I explained to the gentleman this policy and asked for him to confirm whether or not it has changed. His response: “We do not recognize partnerships.”
How does this policy impact a backed gambler’s taxes? As Russ points out:
For the professional gambler who is backed, this is only an inconvenience. His accountant can, at year-end, create W-2Gs to correctly appropriate the winnings. However, for the amateur player this could be a lot more than an inconvenience.
The amateur gambler is now on the hook for the taxes on winnings that aren’t his. It’s even possible that the gambler will have to pay taxes on “phantom” winnings. Say that the gambler won $5000, but $2500 of it belongs to someone else. During the remainder of 2007, the gambler has losses of $3000. If the gambler completes his tax return without making any adjustments, he’ll show $5000 of winnings on line 21 (Other Income) and $3000 of an itemized deduction on Schedule A—he’ll pay tax on $2000 of income that he didn’t earn!
What can be done to allocate 50% of the winnings to the backer? The IRS should recognize this construct, because ultimately, 50% of the winnings are attributed to the backer. But what documentation will the IRS want to see before accepting the arrangement?
I like Russ’ suggestion: Put the staking arrangement in writing, signed by all parties, and have it dated sometime before the tournament starts. One suggested date is the date the WSOP accepts the player’s entry fee. That way the agreement will appear to have been entered into when the backer’s funds were used to enter the tournament. Also: Complete a Form 5754 even if the casino will not acknowledge it.
Russ explains what your accountant should then do with the W-2G the amateur gambler accepted and the Form 5754 completed by the backer:
The accountant then splits his winnings: his share remains as gambling winnings (line 21); the portion belonging to others is moved to a Schedule C as receipts (income) (and the accountant or the winner mails checks to the other participants). The accountant issues W-2Gs (or Form 1099-MISC’s) to the other participants; the total of these are listed as expenses. The net income from this “business” is zero (so there’s no self-employment tax owed).
Creative thinking by Russ, I must say.
If you back a player who places in the 2011 WSOP, consult a tax professional to make sure all documentation of the arrangement is in order and reporting is done properly before filing for the year.
In the basic facts, I purposefully mentioned that both the “staker” and the “stakee” are U.S. residents. That’s because gambling winnings of nonresidents may be subject to withholding. I’ll cover the tax implications of those situations another day.