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Frozen Online Poker Funds and the Casualty Loss

Almost a month and a half has passed since the Department of Justice seized the U.S. internet domains of three major offshore online gambling companies.  To date, only one of the three “Poker Companies,” PokerStars, has been returning to U.S. customers funds frozen upon the seizures.  Earlier today, we learned that the first Full Tilt account belonging to the site’s co-founder was unfrozen by the DOJ.  Absent from that news, however, was an update on when, if at all, Full Tilt customer’s funds will be returned.  There has been little to no rumblings from the other company, Absolute Poker, since it reached an agreement with the DOJ.

Suppose at some point either Full Tilt or Absolute Poker declares it will *not* return player funds.  Although the news would be extremely unfortunate for many, the Internal Revenue Code may lessen the blow incurred via the casualty loss.

Section 165(c)(3) allows a taxpayer to take a deduction for a loss arising from a “fire, storm, shipwreck, or other casualty” incurred with respect to property that is not used in a trade or business.  Losses incurred with respect to property used in a trade or business, such as in the trade or business of gambling, are deductible under (c)(1) or (2), do not require a casualty, and may be reported on Schedule C.  (Note that there may be significant tax reasons, beyond the scope of this post, why a loss to property used in a trade or business caused by a casualty should be treated as such.)

So what is a casualty?  Neither the Internal Revenue Code nor the regulations define “casualty,” so it’s up to the IRS and the courts to decide.  “Casualty” has been defined by the IRS as “the damage, destruction, or loss from property resulting from an identifiable event that is sudden, unexpected, or unusual.”  A straightforward example of a casualty is a home permanently destroyed by the tornado recently ripping through the small town of Joplin, Missouri.  My deepest sympathies to all those impacted.

As far as I know, the issue of whether permanently frozen online poker funds may qualify as a casualty loss under the Internal Revenue Code would be one of first impression.  My position would be they do qualify, because of the sudden and unexpected action from the DOJ directly resulting in frozen customer funds.  Regarding the “unexpected” component, it’s important to note the U.S. Tax Court has said foreseeability of a casualty does not necessarily prevent taxpayers from deducting the resulting loss.  It must be emphasized, however, the casualty loss cannot be claimed until after some announcement is made confirming permanence of customer fund seizure.  This hasn’t happened, yet.

To claim a casualty loss, a taxpayer must attach a Form 4684 to the tax return for the year the loss occurred.  The recreational gambler completes the personal use property section of Form 4684, and claims the resulting casualty loss as an itemized deduction on line 20 of Schedule A.  Note that there is a $100 deductible for casualty losses, and a casualty loss is deductible only to the extent it exceeds 10% of the taxpayer’s adjusted gross income.

As stated earlier, a professional gambler may simply claim the loss on a Schedule C.  An alternative may be to claim a casualty loss under the business property section of Form 4684.  Ascertaining those tax consequences could get very messy if one considers that course of action, and one certainly should consult a tax professional.

At this point, this discussion is entirely academic.  However, with each passing day, the general consensus for the likelihood of players seeing their funds again gradually lessens.  At least taxpayers know a deduction may arise in the event the dreaded news becomes a reality.

  1. May 27th, 2011 at 13:49 | #1

    “…a casualty loss is deductible only to the extent it exceeds 10% of the taxpayer’s adjusted gross income.”

    This could be brutal. I have a hunch quite a few recreational online poker players would have kept online bankrolls of less than 10% of their AGI for the year, depending on the frequency of their play.

    Hopefully it won’t come to that, though! Thanks for the info, and I reluctantly am bookmarking this entry for possible later use…

  2. Nicholas Barnett
    June 9th, 2011 at 00:33 | #2

    If you declare your play as a business (as i do), I treat deposits as expenses and withdrawals/transfers as the moment ‘income’ is realized. Therefore, the ‘loss’ due to non-payment is non-existent (theoretically) as the ‘income’ i worked so hard to obtain never gets ‘realized’…….fwiw

    • June 9th, 2011 at 09:36 | #3

      Mr. Barnett,

      The Internal Revenue Code does not equate deposits with gambling losses and withdrawals with gambling winnings. It’s not that simple. Regarding deposits, if the funds simply sit in the account and are never wagered, then there is no viable gambling loss deduction. The deductions arise, if at all, upon sustaining a loss from a gambling “session.” Regarding withdrawals, the income is considered earned under the doctrine of constructive receipt when sustaining winnings from a gambling “session,” as long as the funds can be withdrawn at that time. See this post for a more detailed discussion of constructive receipt as applied to online gambling accounts.

  3. June 30th, 2011 at 11:11 | #4

    To add an additional wrinkle….

    If I declared income in 2010 for my online accounts, but never withdrew the money, how do I get credited for the the taxes I paid on that income?

    Do I refile 2010?

    • July 1st, 2011 at 09:08 | #5

      I’m not sure I fully understand your question. This post may clarify the issue you’re getting at.

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