Intrastate iGaming: Federal Reporting and Withholding Tax Obligations
It’s no surprise Senator Harry Reid could not attach his rumored internet poker bill to must-pass legislation during the lame-duck session in Congress. Now “iGaming” in the United States is likely to emerge over the next few years by state-by-state legalization. Delaware and Nevada have already cleared the initial legalization hurdle, and are carefully taking their next steps in an effort to establish industry standards before permitting operators to accept real money deposits. With an iGaming bill merely awaiting Governor Christie’s signature, New Jersey may not be far behind.
Unless federal oversight legislation is passed, states will have to adapt the current federal laws, including the Internal Revenue Code, to their intrastate iGaming operations. Intrastate iGaming in the U.S. presents a variety of interesting tax considerations for operators, consumers, and third-parties. Of course, I cannot adequately address them in one post. Instead, I begin here a series of posts with the minimum goal of raising awareness and ideal goal of exploring possible approaches to the trickier issues. I also plan to analyze new iGaming legislation signed into law in light of these considerations.
I welcome and encourage topic suggestions, questions, comments, constructive criticisms, etc. Do not hesitate to send me an e-mail (brad[at]taxdood[dot]com) or engage me on Twitter @taxdood. If you are on LinkedIn, consider joining the group U.S. Internet Gaming: Tax Considerations to observe or participate in additional discussion.
Federal Reporting and Withholding Tax Obligations
Regardless of state-specific legislation, internet gambling operators will have to comply with the current federal withholding and reporting obligations under the Internal Revenue Code. In general, brick and mortar casinos determine whether a tax information form (usually either a W-2G or 1042-S) must be issued and withholding is required when a winner seeks to cash out chips or redeem a winning ticket.
In the online space, it may not always be as clear when the tax information and withholding determinations should be made. Let’s assume an iGaming operator would have the taxpayer’s identification information (e.g. taxpayer identification number, or “TIN”) upon establishing a consumer’s online account. (Note: How operators will adequately verify the identification of iGaming consumers is beyond the scope of this post.)
“Closed-universe” situations, such as poker tournaments, are more straightforward. When a U.S. resident wins more than $5,000 (less the buy-in) in a poker tournament, the casino is required to issue a W-2G to the winner. Technically, operators are also required to withhold twenty-five percent of the winnings pursuant to Rev. Proc. 2007-57. Section 6 of the Revenue Procedure, however, provides a safe harbor for operators that do not withhold in this situation:
The IRS will not assert any liability for additional tax or additions to tax for violations of any withholding obligation with respect to amounts paid to winners of poker tournaments under section 3402, provided that the poker tournament sponsor meets all of the requirements for information reporting under section 3402(q) and the regulations thereunder.
In other words, if the sponsor reports the winner to the IRS, then the IRS is okay with no withholding. I should note this IRS safe harbor is not binding law. It remains possible for a court to rule that a poker tournament falls within the definition of a “wagering pool” and thus withholding would be required under section 3402(q) of the Internal Revenue Code.
Onto a potentially more problematic situation: Cash games. In general, gambling winnings are reportable on a W-2G if the amount paid with respect to a wager is $600 or more and the proceeds are at least 300 times the wager; withholding is required if the amount paid is $5,000 or more and at least 300 times the wager.
Let’s apply the rules to No Limit Texas Hold’em. Assume a table seats no more than the usual maximum of ten. In general, the most one can win on a given hand is ten (10) times the amount wagered. This outcome occurs when every player at the table bet at least as much as the winner did. As a result, the withholding and reporting obligations thresholds for U.S. residents would not be triggered for poker cash games in the iGaming space. Well, not so fast.
Some casinos pay bad beat jackpots to the highest hand that doesn’t win. For example, Commerce Casino pays a bad beat jackpot under the following circumstances:
If you lose with a hand of aces full of Ten’s (10’s) or better to a four-of-a-kind or better in Hold’em games, you will receive 60% of the posted jackpot; the winning hand will receive 20% and the other players at the table will split the remaining 20%. The jackpot in an average $3-$6 per Hold’em game might amount to as much as $15,000.
One possibility is to bet $30 in a $3-$6 Hold’em game and win 60% of a $15,000 jackpot, or $9,000. The casino would be required to issue a W-2G in that situation because the jackpot amount is 300 times the amount wagered and more than $600. Withholding would be required as well.
Time will tell whether online poker sites in the U.S. pay bad beat jackpots.
What is a wager?
In the Hold’em context, we assume a “wager” is defined by the sum of all bets made by a player during the course of one hand. What if, in the online space, “wager” is interpreted as all bets made with deposited funds by a player while seated at a Hold’em table? Or even more broadly, all bets made with deposited funds by a player while logged into an account? These interpretations give rise to the possibility of a player leaving a Hold’em table or logging out of an account after winning more than 300 times amount wagered. These possible outcomes, however unlikely, mean the iGaming operator’s software may have to be programmed to detect when these situations occur.
In my opinion, wager should be defined by the sum of all bets made by a player during the course of one hand. As a result, winnings of U.S. residents for the substantial majority—if not all—of poker cash games would go unreported to the IRS.
Would Congress take action to change this result? Probably.
H.R. 2230, Internet Gambling Regulation and Tax Enforcement Act of 2011, for example, sought to require “Internet gambling licensees” to report to the IRS, among other things, the “net Internet gambling winnings” for the calendar year of each person placing a bet or wager with the licensee. Such a requirement would maximize the reporting to the IRS. But would it be prohibitively costly for iGaming operators to not only document but also report the net winnings of all persons placing wagers, including nominal amounts (e.g. less than $100)?
At the outset, intrastate iGaming will likely be offered only to those who are physically present in a state regulating iGaming. This group could include individuals who are not U.S. residents. How are the above considerations different with respect to nonresident aliens?
In general, gambling winnings of nonresident aliens are subject to thirty percent withholding and the payee is issued Form 1042-S. Again the issue is raised: When would the iGaming operator make the reporting and withholding determinations? After each hand played? After each table session? After a player logs out? At year’s end?
iGaming operators must also consider how to handle claims of treaty benefits made by nonresidents. An applicable tax treaty between the U.S. and a treaty partner may reduce the withholding rate or eliminate it altogether. Claimants must provide the operator Form W-8BEN or Form W-8ECI to obtain treaty benefits.
If operators do not put mechanisms in place to accommodate such claims, the nonresident alien’s recourse could be to file Form 1040NR and claim a refund for the withheld funds. This alternative is far from ideal for the player, however, because the 1040NR is not filed until after year’s end. Withholdings from January, for example, would probably not be returned to the player until far more than a year later.
Next time we’ll examine applicability of the Bank Secrecy Act to intrastate iGaming operations, including implications of player-to-player account transfers.