Poker and Taxes: 2011 Year in Review
2011 was anything but a boring year in the poker world. With tax season approaching, it’s time to review some noteworthy events during the year that may impact items on a poker player’s 2011 U.S. income tax return.
In general, the tax code is very harsh towards gamblers. In January, however, the U.S. Tax Court issued a pro-gambler decision. In Mayo v. Commissioner, the court held that a professional gambler may deduct “ordinary and necessary” business expenses beyond the extent of a taxpayer’s “net” gambling winnings.
Here’s a simple example to illustrate. Suppose during 2011 I had $50,000 of gambling winnings, $70,000 of gambling losses, and $20,000 of ordinary and necessary business expenses incurred in connection with my gambling activity. Section 165(d) of the Internal Revenue Code limits the deductibility of my gambling losses to $50,000, producing “net” gambling winnings of $0. Because of Mayo, I may further deduct the $20,000 of business expenses, producing a $20,000 business loss, which may be applied against other income.
If there was any concern over the IRS appealing the decision, it’s now gone. In a recent Action on Decision, the IRS explicitly acquiesced to the tax court’s Mayo opinion. Victory for professional gamblers.
For more comprehensive commentary on the case, click here.
On April 15, the Department of Justice seized the internet domains of Absolute Poker, Full Tilt Poker, and PokerStars. At the time, players’ funds on each of these sites were also frozen and inaccessible. To date, only PokerStars has repaid its customers. Absolute Poker is in bankruptcy, and may or may not repay customers. Full Tilt has agreed to forfeit its assets to the U.S. Department of Justice, and French investment firm Groupe Bernard Tapie is currently in the process of purchasing the assets from the DOJ. It has been reported that the DOJ will repay Full Tilt’s U.S. customers, but nothing has been finalized.
With 2011 behind us and a lot of uncertainty remaining, it’s no surprise the number one tax question on poker players’ minds is how to treat the frozen funds on their tax returns. Of course, PokerStars customers have been fully repaid, so the tax treatment of its customers’ gambling winnings is no different this year. With respect to Absolute Poker and Full Tilt accounts, however, the current state of affairs warrants careful consideration of a couple of tax principles.
- Constructive Receipt
As I discussed back in April, the doctrine of constructive receipt sometimes requires cash method taxpayers to include an item in income even if no cash, services, or property are actually received in hand during that year. When are some of those times? A taxpayer has constructive receipt of income in the taxable year during which it is:
- credited to the taxpayer’s account;
- set apart for the taxpayer; or
- otherwise made available such that the taxpayer may draw upon it during the taxable year if notice of intention to withdraw had been given.
Now, if an online casino maintains segregated accounts for each customer, as in the case of PokerStars, then it’s pretty clear that constructive receipt is triggered when a customer earns winnings on the site, and not when the funds are actually withdrawn. But what if an online casino pays its customers through a general operating account? Further, what if that casino’s operating account balance is far less than the total amount owed to players? According to the amended civil complaint filed against Full Tilt Poker, that was precisely the case: At the end of March 2011, Full Tilt owed $390 million to its players but had less than $60 million in its bank accounts. Does constructive receipt still apply?
I would argue that it doesn’t. Constructive receipt does not apply if the taxpayer’s control of its receipt is subject to substantial restrictions or limitations. Gambling winnings in Full Tilt accounts on April 15, 2011 were, in my view, subject to substantial limitations because Full Tilt didn’t have the money to pay the balances. With the Department of Justice alleging in a press release that Full Tilt was operating a “massive Ponzi scheme” against its own players, it would be rather inconsistent for the IRS to then assert that winnings in Full Tilt player accounts not actually received in 2011 are still taxable.
Although we have less evidence to make the same case for winnings in Absolute Poker player accounts, a pending bankruptcy without the return of player funds seems like a strong argument for no constructive receipt.
- Claiming a Loss for Unpaid Funds
May a poker player write off unpaid Full Tilt and Absolute Poker funds? For 2011, the answer is no. I covered this issue in detail back in May. What has changed? Now there’s a pending sale of Full Tilt assets by the DOJ to Groupe Bernard Tapie. It seems more likely players will be repaid.
Ultimately, because it’s still possible Absolute Poker and Full Tilt will pay its players back, no loss may be realized. I suspect sometime in 2012 we’ll learn the final fate of unpaid accounts.
- Possible IRS Examination of Online Poker Players
Back in April, I explored the possibility of the IRS examining U.S. customers of Absolute Poker, Full Tilt Poker, or PokerStars. To my knowledge, the IRS has not pursued these individuals.
With reports that the DOJ may handle the repayment process of Full Tilt funds to U.S. players, it’s not far-fetched to speculate that some tax examination process will take place. Players may have to apply to the DOJ to obtain unpaid funds. The DOJ or IRS may very well take a look at applications of taxpayers claiming significant balances, perhaps $10,000 or greater.
Another possible alternative is the DOJ offering an amnesty program to poker players who have unpaid balances and are not in compliance with U.S. tax laws. We’ve seen similar programs far greater in scope. In 2011, for example, U.S. taxpayers with certain unreported foreign financial accounts may have came forward under the 2011 Offshore Voluntary Disclosure Initiative.
World Series of Poker
In November, Pius Heinz took home $8,715,638 after capturing the 2011 World Series of Poker Main Event bracelet. And I say “took home” in the literal sense. Because Mr. Heinz was a resident of Germany, he was able to take advantage of the U.S.-Germany Tax Treaty, which exempts from U.S. income tax gambling winnings earned in the U.S. by German residents.
For a complete breakdown of how much tax each of the Main Event’s final nine players had to pay, be sure to check out Russ Fox’s article.
In December, the Department of Justice released a memorandum opinion taking the position that the Wire Act applies only to sports wagering. Not exactly a tax event, but an event worth mentioning nonetheless. Although the opinion itself addresses only online state lotteries, states now have been shown a green light for intrastate online gaming. Although player liquidity issues remain for online poker under an intrastate regime, state compacts combining player pools is a realistic possibility. Because of the opinion, legislative developments for U.S. online gaming in 2012 became far more interesting.
I must remind all readers that it is impossible to offer comprehensive tax advice on the internet. Information I write on this blog is not legal advice, and is not intended to address anyone’s particular tax situation. Should you seek such advice, consult with a tax professional to discuss your facts and circumstances.
IRS Circular 230 Notice:
To ensure compliance with requirements imposed by the IRS, I inform you that any U.S. federal tax advice contained in this blog is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this blog.