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Federal Judge: Offshore Online Gambling Accounts Are Reportable Foreign Financial Accounts

June 6th, 2014 No comments

A federal district court judge in California has ruled that FirePay, PartyPoker, and PokerStars online gambling accounts are subject to the foreign financial account reporting rules.

Ok, so who cares?

Any U.S. taxpayer who has or had offshore online gambling accounts. If a U.S. taxpayer’s total maximum balances in foreign financial accounts exceed $10,000 at any point during a tax year, he must file FinCEN Form 114, formerly known as the FBAR.

In the case United States v. Hom, the defendant had online gambling accounts with PokerStars, PartyPoker, and FirePay in 2006 and 2007. The defendant acknowledged that the aggregate amount of the funds in these accounts exceeded $10,000 in U.S. dollars during 2006 and 2007. But, he contended that they were not foreign financial accounts.

The judge disagreed. Because FirePay, PokerStars, and PartyPoker all functioned as banks, said the court, they fall within the scope of the definition for a reportable account. The judge granted the IRS’s motion to impose against the taxpayer FBAR penalties of $10,000 per account not reported per year.

We’ve discussed this issue before. I said:

1. It is possible Treasury could at some point view offshore online casino accounts as subject to FBAR disclosure, and

2. It is becoming more and more likely the IRS will have access to the records of offshore online casinos if and when offshore online casinos bring their operations to U.S. soil.

That was written two weeks before the Department of Justice seized the U.S. domains of Absolute Poker, Full Tilt Poker, and PokerStars on April 15, 2011.

As for (1):

Our judicial branch is tasked with interpreting the law. Our executive branch, including the Department of Justice, is tasked with enforcing the law. Will the DOJ suddenly allocate resources to penalize taxpayers who didn’t report offshore online gambling accounts because of this one decision?

Perhaps not, unless the violation also involves a serious offense such as tax evasion or it’s simply convenient to. Which brings us to (2):

I had suspected the federal government might obtain access to the records of offshore online gambling companies sometime in the future. Turns out I was correct, just for the wrong reason: Full Tilt Poker and PokerStars agreed to maintain all records relating to its business in the United States in connection with their domain seizures in 2011.

In order to retrieve funds on their offshore online gambling accounts that were frozen by the Department of Justice, some U.S. taxpayers had to provide their social security numbers. It’s clear the government can easily look into whether these U.S. taxpayers with larger balances filed FBARs. The questions remains of whether they will.

As Russ Fox notes, this is one court decision in one district. A federal district court decision is mandatory authority only on some lower specialized courts in that particular district. This case was decided in the Northern District of California. The court is headquartered in San Francisco and covers fifteen northern California counties.

If Mr. Hom appeals to United States Court of Appeals for the Ninth Circuit and the Ninth Circuit affirms the lower court’s decision, then the decision is mandatory authority on all district courts within the Ninth Circuit.

In all districts other than Northern California, the case is merely persuasive authority for now. This means all the other district courts may follow the decision but do not have to.

How should implicated U.S. taxpayers respond to the decision?

As I’ve said before, I don’t see the downside to playing it safe and filing the Form 114 going forward.

For taxpayers with prior years at issue, there are some options to consider. One is by coming forward through the IRS Offshore Voluntary Disclosure Program. This option may not be most appropriate for all taxpayers, as each taxpayer’s particular situation is different. A taxpayer should consult a tax professional to discuss specific facts and circumstances.

We’ll see if Hom decides to appeal or if the DOJ issues a statement on this…

Nonresident Gamblers Take a Step Closer to Equality

July 9th, 2013 No comments

Compared to U.S. resident gamblers, nonresident gamblers have had it far worse: Gambling losses are not deductible at all unless connected to a trade or business. Also, games like poker and slots are subject to thirty-percent withholding on a per-bet basis, as opposed to a per-session basis.

Until today, that is.

The District of Columbia Court of Appeals has ruled in Park v. Commissioner that a nonresident gambler may calculate gambling winnings or losses on a per-session basis.

To elucidate the practical significance of this holding, the court explained the tax outcomes when applying each method:

Consider two people. The first, a U.S. citizen, walks into a casino and sits down to play slots. The player first wins $100 but then loses the $100 before leaving the casino for the night. In that hypothetical, the U.S. citizen would have $0 in income to report because the IRS interprets the applicable provision of the Tax Code to cover only gains measured over a session of gambling.

The second person, a non-resident alien, also wins $100 and then loses $100. The non-resident alien is in the same financial situation as our U.S. friend. But according to the IRS, the non-resident alien has $100 in income to report (the $100 he won in the initial bet) because the IRS interprets the applicable provision to require non-resident aliens to pay taxes on gains from each bet.

Section 165(d) of the Internal Revenue Code states that a U.S. resident taxpayer may deduct losses from wagering transactions only to the extent of gains from such transactions. Section 871(a)(1)(A) requires nonresident taxpayers to include in income, among other things, “gains” received from sources in the United States.

The IRS has held the view that “gains” under 165(d) may be calculated over a series of separate plays or wagers. The IRS demonstrated some common sense when stating in 2008 that “fluctuating wins and losses left in play are not accessions to wealth until the taxpayer redeems her tokens and can definitively calculate” the amount realized.

The IRS demonstrated an equivalent lack of common sense interpreting “gains” under section 871 to mean a per-bet approach for gambling. In Park, the IRS argued that because losses aren’t deductible, then all winning bets are taxable.

This logic is backwards: We need to figure out how to calculate winnings and losses first, the court noted.

The taxpayer, Sang Park, played the slot machines. A lot. His case has been remanded to the U.S. Tax Court for the parties to calculate his proper tax liability.

For a summary of the U.S. Tax Court’s opinion that was reversed in part by the D.C. Court of Appeals, check out this post from Russ Fox. If Park’s gambling records are as poor as the Tax Court opinion indicates, he may not fare any better on remand.

Are there any other significant implications from the appellate court’s holding?

In general, payers of gambling winnings to nonresidents are required to withhold 30% of the winnings and issue the payee a Form 1042-S (exception: proceeds from a wager placed in blackjack, baccarat, craps, roulette, or big-6 wheel are not amounts subject to reporting).

Based on the IRS position in Park, theoretically U.S. casino operators should have been withholding (if appropriate) 30% on any winning bet subject to 1042-S reporting (such as slot machines and poker). As the decision notes, this reporting does not necessarily economically reflect the player’s gains from gambling per session.

Park essentially requires U.S. casino operators to make the Form 1042-S reporting and withholding determinations for slot machine play when the nonresident player seeks to cash out tokens or redeem a ticket.

Although this is how U.S. casino operators are also supposed to approach reporting and withholding determinations for slot machine play by U.S. residents, I believe there is inconsistent application of this rule. I’ve heard casinos issuing Form W-2Gs to U.S. residents when their slot machine pull results in a win exceeding $1,200. If a casino has been issuing W-2Gs on a per-bet basis in some situations now, I question whether Park would impact its approach for either U.S. residents or nonresidents.

Unfortunately, the decision does not attempt to further define what a gaming “session” means beyond slot machine play. There is little court precedent for what a gambling “session” is for other games, such as poker. In any event, since this case was about slot machine play, such interpretation would likely be considered dicta.

Nevertheless, the case is a victory for nonresident gamblers. Their treatment just became a bit more similar to resident gamblers for tax purposes.

Case: Park v. Commissioner, No. 12-1058 (D.C. Ct. App. 2013).

Intrastate iGaming: Interstate Compacts and Revenue Sharing

January 30th, 2013 No comments

One of the most not only fascinating but also critical issues for state-by-state iGaming legalization is whether states will let their virtual fences down and enter into iGaming compacts with other states. If so, how may states share tax revenue from gaming activity?

Interstate iGaming Compacts

Before evaluating tax revenue sharing possibilities, we must grasp some of the dynamics surrounding interstate compacts.

Look no farther than the State of Nevada, which appears poised to open its doors to intrastate online poker sometime in 2013. But with a population of approximately 2.76 million, Nevada presents profitability concerns for online poker operators offering its product only to customers physically present in the state. This viability issue is compounded many times over as more than a dozen companies have already received preliminary approval to operate in the state.

Sure, some committed poker players may move to Nevada to play online full-time, but it seems unreasonable to expect many recreational players to do so. Certainly not enough to make online poker in Nevada a robust business on its own. And interested parties know this.

In his 2013 State of the State address, Nevada Governor Brian Sandoval urged lawmakers to approve a bill authorizing him to enter into interstate iGaming compacts without first requiring federal legislation authorizing it.

Larger states, however, may not have as strong an incentive to negotiate compacts with smaller states. Consider California, for instance. With a population of over 38 million, the Golden State is larger than every country in Europe but eight.

The Internet Gambling Consumer Protection and Public-Private Partnership Act of 2012 did provide California legislators the alternatives to opt into a federal iGaming system or enter into compacts with other states. The problem with either alternative coming to fruition is that special interest groups in California are mightily struggling to get on the same page for iGaming. That’s why the bill failed to reach committee vote last year. And these groups may hold the belief that if the State reaches compacts for interstate online play, other smaller states would reap the benefits of the pooled liquidity far more than California would.

Another compact concern for California involves losing its residents to partner states. (Note: Expatriation is already a problem for California.) Suppose, however unlikely, that NV presented an attractive proposal to CA for pooling liquidity, such as NV giving CA a significant percentage of gross gaming revenue (“GGR”) generated by the NV players. Once the pooled sites go live, some CA players would move to establish residency in NV and thus avoid paying CA income tax. The analysis of this issue could narrow to whether the additional gaming revenue paid to CA as result of liquidity would exceed the lost income tax revenue from CA expats.

Even if states agree to share revenues based on location of players, as discussed below, there’s likely still an overall benefit to pooling liquidity. By substantially increasing the number of virtual players on a given site, a greater variety and quantity of tables become available for players to choose from. The challenge is figuring out how to distribute the increase in overall benefit so interstate compacting is agreeable to lawmakers and their supporters on all sides of the negotiating table.

With the above in mind, how would states seek to share tax revenues pursuant to interstate iGaming compacts?

Revenue Sharing Pursuant to Interstate Compacts

States that have or are considering legalized online gaming are including their own licensing and taxation regimes in the legislation. We should expect any state’s iGaming legislation to permit an operator to operate in the state only if licensed in the state. In other words, foreign operators in general seem unlikely, at least in the early stages of this emerging industry.

The natural progression to interstate iGaming compacts would seem to involve an operator licensed in more than one state to pool its liquidity among those states. But it’s not necessarily a smooth ride to get there.

New Jersey’s pending iGaming bill, for instance, requires all iGaming servers to be located in Atlantic City in order to comply with the New Jersey State Constitution. If PokerStars is licensed in both NV and NJ and pools its liquidity, for example, then PokerStars would have to ensure all servers running virtual tables with NJ players are located in Atlantic City. If NV players were on these tables as well, would such conduct run afoul of the NV interactive gaming laws? I suspect this type of issue would need to be addressed in the interstate compacts themselves.

As an aside, the notion of requiring operators pursuant to an interstate compact to be licensed in each state it seeks to operate ironically defeats another purpose for compacts: Avoiding paying license fees in multiple states.

With the above considerations in mind, how would states share gaming revenue pursuant to an iGaming compact? Let’s assume, as discussed, that each state will have in place its own gaming taxation model. The result is that operators could be required to apply more than one state’s taxation model to activity taking place on the same online poker table.

Suppose again that PokerStars is licensed in both NV and NJ. NV’s tax is 6.75% of GGR. The pending NJ iGaming bill calls for a 10% tax on GGR. If liquidity is pooled between the states, there could be both NV players and NJ players on the same PokerStars cash game tables. Gaming revenue to PokerStars would be the collected rake for each hand played.

The question then becomes, how do the two state’s gaming taxation models apply to each online poker hand played? A few possible approaches:

  1. The rake is subject to tax in both states;
  2. The rake is subject to tax in the state that the winning player of the hand resides; or
  3. A proportion of rake is subject to tax in state “A” based on the ratio of total wagers made by players in state “A” to total wagers made by players in both states “A” and “B.”

Approach #1 obviously requires modification, otherwise operators would pay GGR tax of the full amount to both states. Operators could be entitled to some tax credit for GGR paid to another jurisdiction. The states would need to negotiate the mechanics of the tax credits as applied to each state.

Approach #2 would seem to be the easiest to implement. Operators would already be required to know the location of all of its players, so the added step of attributing a location to rake collected for each hand does not seem too burdensome. Of course, split pots present more complex situations, but are likely far from insurmountable.

An interesting issue arises with Approach #2, however. States themselves would then be biased with respect to the outcome of each hand in favor of its own residents. The more its own residents win over nonresidents on the pooled tables, the more overall gaming revenue to the state. The bias would be more pronounced with poker tournaments, as the prize distributions are more skewed. Clearly, states themselves should not have preferred winners for quantifiable reasons in games they are regulating.

Approach #3 would be more complicated to implement than #2, but it removes the state bias issue. Let’s try an example for #3 to clarify the mechanics.

Suppose there are three NJ players and three NV players at the same online poker table with a rake of $5 for each hand played. At the conclusion of one hand of Texas Hold’em, player 1 (NJ) wagered $5, player 2 (NJ) wagered $0, player 3 (NJ) wagered $10, player 4 (NV) wagered $25, player 5 (NV) wagered $25, and player 6 (NV) wagered $10. Player 4 won the hand. NJ players wagered a total of $15, and NV players wagered a total of $60. The percentage of rake attributable to NJ would be 15/(15+60), or 20%. Percentage of rake attributable to NV would be 80%. For this hand, $1 of rake would be subject to the 10% GGR tax in NJ, and $4 of rake would be subject to the 6.75% GGR tax in NV.

Any of the three above approaches are viable if each state has a similar GGR model. How would states share revenue if one state taxes gaming revenue based on GGR and another imposes a deposit tax? I will leave that question open for us to think about.

I’m very interested in hearing reactions to this post. Does anyone envision a different path to pooling virtual liquidity in the U.S.? Are there more efficient or agreeable ways that states could seek to share revenue? Consider contributing your thoughts at the LinkedIn group U.S. Internet Gaming: Tax Considerations.

I plan to revisit this topic sooner than later. In about one week, we’ll learn whether iGaming becomes legal in New Jersey. If it does, I’ll cover that next time. If not, I’ll delve into state income tax considerations for both iGaming operators and players.

Intrastate iGaming: State Gaming Taxation Models

January 23rd, 2013 No comments

It’s no secret the chief aim for most—if not all—states to legalize Internet gambling is to generate tax revenues. This “Intrastate iGaming” series now turns to how states may seek to attain that goal.

Gaming Taxation in the United States – Gross Gaming Revenue

A convenient iGaming tax model for states to adopt is that used to collect gaming tax revenues from licensed brick and mortar casinos in their particular state. Among the twenty-two states with commercial casinos, most tax casinos based upon Gross Gaming Revenue (“GGR”).

GGR is characterized as a profit-based model. In general, GGR consists of total wagers made by customers less the winnings paid back to its customers. The GGR base may be further reduced by other expenses. The tax is a percentage of GGR, from a low of 6.75% in Nevada to a high of 55% on slot machines in Pennsylvania.

The GGR model has already been adopted to tax iGaming operators at the state level. In Nevada, the first state to promulgate iGaming regulations, gross revenue received by an interactive gaming operator is subject to the same license fee “as the games and gaming devices of the establishment, unless federal law otherwise provides for a similar fee or tax.” (NV Gaming Comm’n Reg. 5A.170(1)) In other words, the State will generally tax iGaming operators the same as its brick and mortar casinos.

Delaware is the only other state with an iGaming law on the books, titled The Delaware Gaming Competitiveness Act of 2012 (“DGCA”). Delaware’s iGaming framework is different from Nevada’s because it is under the control and operation of the Delaware Lottery. Furthermore, it authorizes not only internet poker like in Nevada, but also traditional lottery games and table games over the internet.

Similar to Nevada, Delaware generally taxes iGaming based on GGR. Under the DGCA, gross revenue from iGaming, less winnings paid to players, are required to be placed in a special account called the “State Internet Lottery Fund.” After an appointed Director pays administrative and operation fees out of the account, the first $3.75 million of proceeds for a given fiscal year must be transferred to the State Lottery Fund for the benefit of the state. Remaining funds from internet lottery and table games are to be distributed pursuant to the provisions under section 4815 of the Delaware Code.

Alternative Model – Deposit Tax

Another iGaming taxation model is the deposit tax. Instead of taxing gross gaming revenues, the deposit tax is imposed on a percentage of funds a player deposits with an operator. A volume-based model, deposit tax rates around the world on iGaming are generally much lower than GGR rates.

It’s notable that of the three federal bills containing tax schemes for regulated iGaming in the U.S. (here, here, and here), all of them called for a deposit tax. The Internet Gambling Regulation and Tax Enforcement Act of 2010, for example, sought to impose a two percent tax on deposits made by customers on licensed iGaming sites.   

Comparing the Models

GGR may be viewed as relatively low-risk for operators since the tax is based on profits from gaming. Plus, it’s the model many future iGaming operators will be most comfortable with at the outset, since GGR is the most common model to tax commercial casino gaming in the United States.

Applied to iGaming, the GGR model has some kinks. When are payouts to customers in the iGaming space deemed to be made? When a winning wager is credited to a customer’s account or when the customer withdraws the funds from the account? The answer impacts the timing of the deduction from the GGR base. In addition, some GGR models have different tax rates depending on the game played. This structure adds complexity to the accounting measures operators must have in place to properly remit the GGR tax to the State.

Licensing jurisdictions would seem to favor a deposit tax for iGaming because the tax is collected up front, when the customer deposits funds on the iGaming site. And unlike GGR, the deposit tax does not depend on the type of game played, so it is game-neutral. An across the board tax would make implementation far easier for iGaming operators.

One issue with the deposit tax is that it may apply regardless of whether an iGaming customer actually uses the deposited funds to engage in wagering activity. Theoretically, customers could deposit funds and then immediately request withdrawal without placing any wagers. Such activity presents no benefit to the operator, who would have to pay a tax without the opportunity to earn revenue.

Finding a Happy Medium

At least initially, states seem keen on carrying gaming taxation models from brick and mortar to iGaming. It’s not a surprise considering operators are already accustomed to GGR. Jurisdictions should bear in mind the deposit tax offers potentially much simpler implementation. But what about the deposit tax issues?

To address the deposit and immediate withdrawal situation, states could permit operators to charge early withdrawal fees. Another idea is to allow operators to take a tax credit for withdrawn funds that are not returned to players, thereby imposing the deposit tax only on wagered funds. Such a credit makes the deposit tax more akin to a profit-model like GGR while maintaining game-neutrality.

The gaming taxation model is crucial for determining how a state will generate revenue from iGaming. Each state must carefully consider the implications of each proposed model for operators and customers and ultimately determine which is in the best interests of the State in order for the iGaming industry to thrive in the United States.

Next time, we will highlight some tax considerations for states entering into interstate iGaming compacts.

Intrastate iGaming: Federal Wagering Tax

January 16th, 2013 No comments

So far, we’ve discussed how federal withholding and reporting obligations and the Bank Secrecy Act may be implicated with intrastate internet gaming activity in the U.S. This time we examine the possible applicability of another type of tax imposed by the Internal Revenue Code (“IRC”), the excise tax on wagers made under section 4401.

The federal wagering excise tax may apply for bets accepted on U.S. internet gambling sites. For accepted wagers authorized under state law, the excise tax is 0.25 percent of the wager amount and is paid by the entity accepting the wager. For all other wagers (i.e. wagers not authorized by state law) the tax jumps to two percent.

To determine whether the tax may apply to intrastate iGaming, the first question we must ask: What is a taxable wager under the statute?

IRC section 4421 provides taxable wagers include those placed:

  1. on a sports event or contest with a person engaged in the business of accepting such wagers;
  2. in a wagering pool on a sports event or contest conducted for profit; or
  3. in a lottery conducted for profit.

As an aside, any wager placed in a sweepstakes, wagering pool, or lottery which is conducted by an agency of a State acting under authority of State law is exempt from the tax. So if a state or an agency of a state operated an iGaming site, then the federal wager tax wouldn’t apply to wagers accepted on the site.

In general, the federal wagering tax applies on wagers accepted by race and sportsbook establishments in the U.S.

Online horse wagering exists today, and operators are required to collect and remit the tax on wagers placed. (Note: Parimutuel horse race wagers pursuant to state law are exempt.) Online sportsbooks at this time are not authorized under any state law, so those accepting wagers would be required to pay the tax at the higher two percent rate.

Does the tax apply to offshore online sportsbooks accepting wagers from U.S. customers? Probably not, unless the party accepting the wager is a U.S. citizen or resident.

IRC section 4404 provides that the tax applies only to wagers:

(1) accepted in the United States, or

(2) placed by a person who is in the United States (A) with a person who is a citizen or resident of the United States, or (B) in a wagering pool or lottery conducted by a person who is a citizen or resident of the United States.

This provision extends the wager tax to cross-border wagers accepted by American bookies. If the bookie located offshore is not a U.S. citizen or resident, then the tax should not apply. If, however, the bookie is located in the U.S., then the wager placed is taxable regardless of where the person placing the wager is located.

What types of bets may fall under the third type of a wager subject to the tax, “a lottery conducted for profit?”

Treas. Reg. 44.4421-1(b)(1) states “lottery” includes the numbers game, policy, and similar types of wagering. A lottery conducted for profit

includes any scheme or method for the distribution of prizes among persons who have paid or promised a consideration for a chance to win such prizes, usually as determined by the numbers or symbols on tickets as drawn from a lottery wheel or other receptacle, or by the outcome of an event.

Poker may be considered a lottery conducted for profit.

The regulation at least implies that the game must be one of chance. In IRS Revenue Ruling 57-521, the Service considered whether a puzzle contest was a lottery conducted for profit. Because “the element of skill rather than that of chance determines the winners” in the puzzle game, the IRS stated, the puzzle contest was not considered a lottery. Applying the skill versus chance analysis to poker, there is at least an argument that poker is not a lottery conducted for profit, especially in light of the recent Dicristina decision.

Even if poker falls within the definition of a lottery conducted for profit, it may nevertheless be exempt from the wager tax.

IRC section 4421(2)(A) provides that the term lottery does not include any game of a type in which usually the wagers are placed, the winners are determined, and the distribution of prizes or other property is made in the presence of all persons placing wagers in such game. Treas. Reg. 44.4421-1(b)(2) applies the exemption to card games and concludes, “no tax would apply in the case of card games.”

It’s clear that in-person poker cash games and tournaments are exempt. It’s far from clear, however, that we can deduce the same conclusion with respect to online poker wagers.

One can argue that the standard for “in the presence of all persons” is not merely physical presence, but also extends to virtual presence on the same online poker table.

Some slightly bad news: In Rev. Rul. 79-146, the IRS applied a physical presence standard to certain types of keno games. We shouldn’t place too much emphasis on this particular revenue ruling, however, because it was written well before virtual poker tables were around.

Another possible argument is online poker wagers are placed in “coin-operated devices,” as the wagering tax does not apply on any wager placed in a coin-operated device. Treas. Reg. 44.4402-1(b)(2)(v) says the following is an example of a coin-operated device:

A coin-operated machine that displays a poker hand or delivers a ticket with a poker hand symbolized on it that entitles the player to a prize if the poker hand displayed by the machine or symbolized on the ticket constitutes a winning hand.

Of course, nobody is putting coins into their computers to play online poker. (Note: Bitcoin enthusiasts may disagree.) But there have been indications the definition of a “coin-operated device” is not strictly construed to require actual insertion of coins to play poker, giving rise to an argument for regulated online poker wagers in the U.S. to fall under the exemption.

As you can see, intrastate iGaming in the U.S. raises more questions than answers for purposes of the federal wagering tax. Next time we will shift the tax discussion from federal to state by examining some gaming taxation models that states may consider adopting.

Intrastate iGaming: Bank Secrecy Act and Player-to-Player Transfers

January 9th, 2013 No comments

Last week we discussed some federal withholding and reporting considerations for intrastate iGaming. The Internal Revenue Code is not the only federal law implicated in this emerging area, of course. This time we examine the applicability of the Bank Secrecy Act (“BSA”).

The BSA is aimed at preventing and detecting money laundering and other financial crimes. Because casinos handle large amounts of cash, they are prone to serving as a vehicle for illicit activity. In order for the government to monitor notable money movement, Congress enacted rules requiring casinos that fall under the definition of a “financial institution” to report certain financial transactions.

A casino or “gaming establishment” (including, for example, a card room) is considered a financial institution if:

  • (a) its gross annual gambling revenue exceeds $1 million; and
  • (b) it is a licensed casino or gaming establishment under federal or state law.

It seems clear iGaming sites regulated pursuant to state law would be considered financial institutions under the BSA. What types of transactions on iGaming sites may operators be required to report? Qualifying financial institutions are required to file with the Financial Crimes Enforcement Network:

  1. Currency Transaction Report by Casinos (FinCEN Form 103); and
  2. Suspicious Activity Reports by Casinos and Card Clubs (FinCEN Form 102).

A casino must file Form 103 for each transaction involving either currency received or currency disbursed of more than $10,000 in a gaming day. Among other things, the form includes the name, address, and social security number of the individual making the transaction. So, if I open an account on a U.S. regulated iGaming site that is a qualifying financial institution and make an initial deposit over $10,000, the site would be required to file Form 103.

Money launderers may seek to avoid triggering the Form 103 filing requirement by making two or more smaller deposits under the $10,000 threshold. This is a no-no.

The practice of conducing financial transactions in a specific pattern with the purpose of avoiding a Form 103 filing is called “structuring,” and is illegal under the BSA. One may go to jail for structuring.

Financial institutions are on the lookout for “structuring” activity. A U.S. iGaming site, for example, must treat multiple transactions as a single transaction if the iGaming site has knowledge that:

  • (a) they are made by or on behalf of the same person, and
  • (b) they result in either Cash In or Cash Out by the casino totaling more than $10,000 during any one gaming day.

If I deposited $6,000 in the beginning of the day and then another $6,000 later in the day on the same site, that iGaming operator would probably have to treat the transactions as a single transaction for purposes of determining whether Form 103 would have to be filed.

A single deposit of $9,999 might seem harmless on its own because Form 103 wouldn’t have to be filed, but such activity may instead require an iGaming operator to file Form 102, Suspicious Activity Reports by Casinos and Card Clubs.

An iGaming site would be required to file Form 102 if a transaction involves or aggregates at least $5,000 in funds or other assets, and the site knows, suspects, or has reason to suspect that the transaction (or a pattern of transactions of which the transaction is a part):

(i) Involves funds derived from illegal activity or is intended or conducted in order to hide or disguise funds or assets derived from illegal activity (including, without limitation, the ownership, nature, source, location, or control of such funds or assets) as part of a plan to violate or evade any federal law or regulation or to avoid any transaction reporting requirement under federal law or regulation;
(ii) Is designed, whether through structuring or other means, to evade any requirements of 31 CFR Chapter X or of any other regulations promulgated under the Bank Secrecy Act, Public Law 91-508, as amended, codified at 12 U.S.C. 1829b, 12 U.S.C. 1951-1959, and 31 U.S.C. 5311-5332;
(iii) Has no business or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage, and the casino knows of no reasonable explanation for the transaction after examining the available facts, including the background and possible purpose of the transaction; or
(iv) Involves use of the casino to facilitate criminal activity.

Institutions must file these forms pursuant to the BSA E-Filing System. With respect to the BSA, the challenge for iGaming operators in the U.S. will be how to implement practices to ensure compliance.

These practice standards may also be required by state gaming commissions before an iGaming operator is approved for accepting real money deposits in a specific state. Nevada, the only state with internet gaming regulations at this time, requires iGaming operators to comply with the BSA pursuant to NV Gaming Comm’n Reg. 5A.080:

Each operator shall implement procedures that are designed to detect and prevent transactions that may be associated with money laundering, fraud and other criminal activities and to ensure compliance with all federal laws related to money laundering.

We should expect similar minimum standards from other states promulgating iGaming regulations in the future.

Player-to-player transfers

A major part of the game of poker that you don’t see on the table: Staking. As I’ve discussed before (here and here), a “staking arrangement” arises when the “staker” backs up, or puts up, the funds for another player, the “stakee.” The staker and stakee share the winnings, if any, by some predetermined agreement. Given the popularity of staking, iGaming operators have strong incentives to explore the feasibility of making staking easy for its players.

The more straightforward aspect to staking in the iGaming space is handling the distribution of winnings among the staker and stakee. The IRS is aware that gamblers sometimes share winnings, and created Form 5754 to allow for allocation of winnings among multiple recipients for reporting and withholding purposes. If I won $20,000 in an online poker tournament and my U.S. resident backer collects $10,000 of the winnings, we could theoretically submit a completed 5754 to instruct the U.S. iGaming operator to issue two W-2Gs for $10,000 each instead of one W-2G for $20,000 to me. Whether the operator actually acknowledges the form is another story.

The more difficult consideration involves how the “staker” could supply the initial funds to the “stakee” to engage in gambling activity on a U.S. iGaming site. The most convenient method, of course, would have the “staker” transfer funds from his online poker account to the account of his “stakee.” Player-to-player transfers are permitted on the most popular online poker site in the world, PokerStars. PokerStars, of course, is not licensed and regulated in the U.S. If it were, would player-to-player transfers take place between U.S. customers?

My guess is probably not at the outset, for various reasons. One major obstacle is how would an iGaming operator adequately monitor whether player-to-player transfers are for a legitimate purpose such as staking or for something illicit?

As discussed above, casinos must file a Suspicious Activity Report (FinCEN Form 102) if it suspects that a transaction involves or aggregates at least $5,000 has no business or apparent lawful purpose. Will iGaming operators put themselves in a position to have to make that determination each time a transfer request of such amount occurs? Perhaps the “business or apparent lawful purpose” standard could be met if the transfer recipient was required to wager a certain amount of the funds on the iGaming site before being permitted to cash out the funds.

In Nevada, player-to-player transfer issues are academic at this time. NV Gaming Comm’n Reg. 5A.120(9) reads, “An operator shall not allow an authorized player to transfer funds to any other authorized player.”

I spoke with a Nevada lawyer regarding this provision. Although regulators and potential operators are well aware of the attractiveness of player-to-player transfers, regulators don’t want to deal with this difficult issue upon opening the State’s doors to iGaming. After some time of successful operations, perhaps Nevada will soften its stance on the issue and begin to permit player-by-player transfers under limited and controlled conditions.

To learn more about financial transaction considerations for iGaming in the U.S., be sure to check out fellow gaming attorney Stuart Hoegner’s draft paper Cash Is Not King: Thoughts on Financial Transactions in Internet Gaming.

Next time we return to the Internal Revenue Code to examine the possible applicability of the federal wagering tax to intrastate iGaming activity.

Intrastate iGaming: Federal Reporting and Withholding Tax Obligations

January 2nd, 2013 No comments

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.)

Poker Tournaments

“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.

Cash Games

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)?

Nonresidents

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.

Tweetbag: Withholding Gambling Winnings of U.S. Nonresidents

September 17th, 2012 4 comments

Today I received the following inquiry:

“[L]ooking for some info why 30% was tak[en] out of an $83 winning in poker at a NY state casino when most states tax after 5k.”

The casino in this case was the Seneca Niagara Casino, located in Niagara Falls, NY.

To evaluate the issue, we need to know whether the taxpayer is a U.S. resident. That’s because the rules for withholding and informational reporting of gambling winnings under the Internal Revenue Code depend on the residency status of the taxpayer.

It turns out this taxpayer is a resident of Canada. In general, gambling winnings paid to foreign individuals are subject to 30% withholding, assuming the income is not effectively connected with a U.S. trade or business. Proceeds from a wager placed in blackjack, baccarat, craps, roulette, or big-6 wheel, however, are not amounts subject to reporting.

Here, it seems that Seneca properly withheld thirty percent of the $83 winnings, as poker is not exempt from nonresident withholding.

Note that an applicable tax treaty between the United States and a treaty partner may reduce the amount withheld by Seneca Niagara. The United States-Canada Tax Treaty, however, offers no such relief.

Is there any other relief? Suppose the same taxpayer enters in only one other poker tournament during the year paying an $83 entry fee, and loses. Now the taxpayer has net $0 of gambling winnings for the year, yet approximately $25 was withheld on the $83 win. One shouldn’t pay $25 in U.S. tax on net zero gambling winnings. To possibly obtain a refund, the taxpayer could file a Form 1040NR to claim the winnings and losses for the year and the amount withheld.

Keep in mind that the withholding and informational rules discussed above are pursuant to federal law, not state law. Again, U.S. casinos are required to withhold 30% and issue a Form 1042-S to nonresidents unless an exception applies.

Of course, some states have their own separate informational and withholding rules for state income tax purposes. But they are not in lieu of federal law, which still must be followed, but are in addition.

The comment that “most states tax after 5k” is likely a reference to the federal rule that requires all U.S. casinos to issue a Form W-2G to U.S. residents who win more than $5,000 in a poker tournament, net of the entry fee. Note, however, whether a W-2G is actually issued has no bearing on whether the actual winnings are taxable, as all gambling winnings of U.S. residents are taxable, regardless of the amount.

Inadequate Gambling Records Lead to Foreclosure

June 8th, 2012 1 comment

Time after time after time I have emphasized the importance of maintaining a diary of gambling activity for tax purposes.

In a recent case out of Minnesota, the failure to do so by taxpayers Eugene and Brenda Rivetts has resulted in a nightmarish result: Home foreclosure.

Over the years the taxpayers regularly played slots at casinos in Illinois, Indiana, Minnesota, and Wisconsin. When you play slots regularly for an extended period, chances are you will win some jackpots. A casino is required to issue to you (assuming you are a U.S. resident) and to the IRS a Form W-2G each time you win $1,200 or more from a slot machine.

In 2001 and 2002, the taxpayers had some big slot machine wins, but they failed to file their income tax returns. So, the IRS prepared for them substitute for returns, and then sent notices for the balances due. Interest and penalties continued to accrue, and as of January 31, 2012, the taxpayers owed $200,066.34 for 2001 and $2,197.15 for 2002.

In court the taxpayers argued, among other things, that they incurred gambling losses during these years, but they were not reported to the IRS. The burden of proof to demonstrate such losses exist is on the taxpayer. Unfortunately, the taxpayers admitted to not maintaining an accurate record of gambling winnings and losses for each of the years in question (1999, 2000, 2001, 2002, and 2005). Although the taxpayers offered to provide the court an estimate of the losses, the court said a request to discount five years of tax documents implies they were not candid in filing their taxes.

The Government commenced the action seeking to reduce the tax assessments to judgment and foreclose tax liens on the taxpayer’s property in Minnesota. The court granted the Government’s motion for summary judgment. In other words, the Government now may take steps to order a foreclosure sale of their home in order to collect on the outstanding liabilities.

It’s extreme for the government to seek foreclosure on a home to collect on a tax liability. In general, the IRS has 10 years to collect on outstanding liabilities. The IRS typically won’t strongly consider foreclosure unless the 10 year period is close to expiring. Before the IRS may proceed with foreclosure, a court will exercise judicial discretion on such efforts by taking into account “both the Government’s interest in collecting delinquent taxes and the possibility that innocent third parties will be unduly harmed by the collection effort.”

In this case, the taxpayers share their home with several family members, including a son, a daughter, a granddaughter, and a niece. In addition, the husband taxpayer’s parents live nearby, and the family regularly helps attend to his father’s health problems. Despite these circumstances, the court held in favor of the Government, noting that “being removed from one’s home can carry with it an inherent indignity and inequity,” but “[t]hat indignity and equity, though, is not sufficient to tip the scales in favor of Defendants and their family.”

It’s not clear from the opinion what efforts the taxpayers took to address their outstanding liabilities before the foreclosure action commenced. An Installment Agreement, Offer in Compromise, or other collection alternative could have prevented this unfortunate result.

Had the taxpayers kept good records as required, this outcome possibly could have been avoided.

Case: United States v. Rivetts, Civ. No. 11-556 (RHK/LIB) (D. Minn. 2012).

Pro Gambler’s Refund Request Denied

April 22nd, 2012 No comments

Sometimes an audit of a tax return concludes in the taxpayer’s favor. “No change” are the magic words in the tax controversy world.

What could be a better result than “no change”? A change resulting in the taxpayer having paid too much in tax. To receive the overpayment, a taxpayer must make a claim for refund. Claims for refund have expiration dates, however.

In a recent case before the Wisconsin Tax Appeals Commission, taxpayer Dennis Spear’s claim for refund from his 2004 tax year was not timely.

Dennis Spear was a professional gambler in Wisconsin. His 2004 through 2007 tax returns were audited by the Wisconsin Department of Revenue, who challenged his status as a pro gambler for 2005 through 2007. He filed as an amateur in 2004. The amount of tax and interest at stake during his pro years was $149,901.17.

Wisconsin is known as a “bad” state for amateur gamblers because one cannot deduct gambling losses for state tax purposes, but professional gamblers can to the extent of winnings. Clearly, the state tax consequences between filing as a pro or amateur in Wisconsin can be very significant.

Spear submitted 225 pages of documentation to establish his status as a professional gambler. The Department agreed to cancel its assessment for the 2005 through 2007 tax years. The only remaining issue was whether Spear was entitled to a refund from his 2004 year.

Spear sought to apply a different method than originally used to calculate his total gambling winnings for the 2004 year. Apparently, the method he originally used was inappropriate. Applying the appropriate method would have resulted in less total income tax. The different method was the “session method,” which involves netting gambling gains and losses on a daily or per session basis rather than bet-by-bet.

As an aside, I’ve written about gambling sessions before. The tax code does not define a gambling session. In the two U.S. Tax Court cases referenced in Spear, the taxpayers were entitled to treat all gambling activity during a day as one gambling session.

Those cases do not necessarily imply all gamblers may treat a day as one gambling session. In each of those cases, the taxpayers played exclusively on slot machines. If, however, a taxpayer throughout one day plays slots, blackjack, and roulette, he is almost certainly required to treat the gain or loss from each type of game as separate gambling sessions.

In this case, the taxpayer could not change to the “session method.” The reason was because his request to make the change was untimely.

Under the Wisconsin tax code, a taxpayer may make a request for an income tax refund if the claim is filed within four years of the original due date of the tax return. (Note: Under the Internal Revenue Code, a taxpayer may make a request for an income tax refund if the claim is filed within three years of the original due date of the return or within two years of the overpayment, whichever is later.)

Spear’s 2004 tax return was due April 15, 2005. His claim for refund was made on May 17, 2010, more than a year after the four year period expired on April 15, 2009.

Spear argued that the four year statute of limitations should have been extended in his case. The problem was that the plain language of the statute establishing a four year period is clear. A court won’t rule against plain language in a statute unless the statute is unconstitutional.

Ultimately, a small price to pay for an otherwise victorious result for the taxpayer.

Case: Spear v. Dep’t of Revenue, Docket No. 11-I-140 (Wis. Tax App. Comm’n Mar. 16, 2012).

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