Taxes in the Back

Yesterday afternoon, New Jersey Governor Chris Christie signed into law Assembly Substitute for Assembly Bill No. 2578, which authorizes internet gambling in New Jersey. The Garden State is keeping pace with Nevada in the budding online gambling market in the United States.

The new law leaves many open questions that we should expect answers to over the next several months. Some include:

• What games will the Division of Gaming Enforcement authorize for iGaming? (Decisions on games are up to DGE.)
• How, if at all, will the State police non-iGaming “commercial enterprises” from making their premises “available for placing wagers at casinos using the Internet”? (See section 28 of the new law.)
• Will player-to-player transfers be authorized? (I doubt it at least initially, for reasons explained here.)
• What states will New Jersey enter into iGaming “reciprocal agreements” with?

David Rebuck, Director of the DGE, said earlier today initial regulations should be ready for iGaming “soon.” As for when the first live wager will be accepted, I’ve seen estimates range from six to eighteen months.

Although many iGaming aspects need to be hashed out before sites go live, the taxes imposed by the State on iGaming isn’t one of them. Some tax considerations do remain, however.

Operators

There are three tax components for operators:

1. License Fees. The issuance fee is $400,000 minimum. The renewal fee is $250,000 minimum. In addition, iGaming operators must pay $250,000 annually to compulsive gambling programs in the State.
2. Internet Gaming Gross Revenue. Operators pay an annual fifteen percent tax on “Internet gaming gross revenue.” IGGR is defined in section 6 as “the total of all sums actually received by a casino licensee from Internet gaming operations, less only the total of all sums actually paid out as winnings to patrons.”
3. Investment Alternative. Operators must “reinvest” two-and-a-half percent of annual IGGR through the Casino Reinvestment Development Authority. These funds are used in community and economic development projects in Atlantic City and around the State. If an operator fails to make the reinvestment, then the operator must pay an investment alternative tax at five percent of annual IGGR. In 1999, the Supreme Court of New Jersey upheld the constitutionality of the investment alternative tax. Read the court’s opinion here.

Consumers

Under the new law, anyone physically located in New Jersey may place wagers on sites licensed by the State. No, one does not have to be a resident of the State to play.

Federal tax laws apply to intrastate iGaming, of course, so consumers will be required to report on their federal income tax return all gambling winnings from iGaming activity in the State.

As I’ve previously discussed, there appears to be some gray area regarding when the federal tax information and withholding determinations should be made by iGaming operators. Whether or not the IRS issues guidance on regulated iGaming operations remains to be seen.

There is also state income tax. Unlike brick-and-mortar gaming, iGaming offers to the tax authorities easy access of all records of consumer activity. The iGaming regulations will almost certainly require operators to maintain detailed records of winnings and losses for all account holders. The regulations may also require operators to provide a summary form of these records to the NJ Division of Taxation.

Under New Jersey law, gambling winnings are subject to income tax in the State. Accordingly, all gambling winnings earned on iGaming sites in New Jersey are subject to income tax in the State, regardless of whether the consumer is a resident of the State. This means a nonresident may be required to file a New Jersey income tax return to report iGaming winnings.

Nonresidents shouldn’t take the reporting requirement lightly. What may happen if a nonresident with iGaming winnings in the State fails to file a New Jersey income tax return?

The NJ Division of Taxation could make at any time in the future an income tax assessment for the unreported iGaming winnings in New Jersey. If the taxpayer owes the State back taxes, it’s possible the taxpayer could be prohibited from continuing to place wagers on iGaming sites in New Jersey until the taxpayer is compliant with the State’s tax laws. It’s also possible the State could pursue criminal charges against the taxpayer for, among other things, tax evasion and failure to file a tax return.

A follow-up post is in store after the Division of Gaming Enforcement proposes iGaming regulations.

(Note: Credit to Joe Kristan for the phrase “Tax Roundup.”)

The last time I wrote about sports betting and New Jersey was last May, and I said the following:

Late last week, New Jersey Governor Chris Christie announced his State will proceed to take the steps necessary to offer sports betting at Atlantic City casinos and the State’s four horse tracks.

New Jersey is far ahead of New York in the process, as Governor Christie signed a bill into law in January 2012 that authorizes professional sports wagering in NJ. New Jersey will likely encounter in the near future efforts by federal authorities challenging such legislation on the basis of the Supremacy Clause. NJ will argue PASPA is unconstitutional.

My prediction held true, sort of.

Last August, the NCAA and the four major professional sports leagues filed suit against NJ Governor Christie, et al., in an effort to prevent the expansion of legalized sports betting in the United States.

Then in December, U.S. District Court Judge Michael Shipp held that the leagues have legal standing to sue NJ over the State’s sports betting law.

About a month later, the U.S. Department of Justice filed papers to intervene as a co-plaintiff in the case and defend the constitutionality of the Professional and Amateur Sports Protection Act of 1992.

Since then, the parties exchanged and filed legal briefs outlining their positions, ahead of this Thursday’s oral argument on the merits before Judge Shipp in federal court in Trenton, NJ.

What will the parties focus on during oral argument?

The leagues and the DOJ will argue that PASPA is constitutional and thus NJ’s sports betting law violates PASPA. NJ, in turn will argue that PASPA is unconstitutional under any of three theories, as articulated in New Jersey’s brief filed on Friday:

1. PASPA Impermissibly Commandeers The Legislative Authority Of The States
2. PASPA’s Lack of Uniformity Exceeds Congress’s Commerce Clause Power by Depriving States of Equal Sovereignty
3. PASPA Violates Due Process and Equal Protection Rights

I find theory #1 the most compelling argument of the three. It’s clear NJ feels the same, as the substantial majority of its brief focuses on the commandeering issue.

What is commandeering? The 10th Amendment to the U.S. Constitution:

The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.

The U.S. Supreme Court has struck down federal laws as unconstitutional for violating the 10th Amendment only a handful of times. The basis for the findings was that the federal statutes in question commandeered the states to enforce them.

The issue narrows to, again: What is commandeering?

Unsurprisingly, the parties fiercely disagree on the answer to this question.

Does the 10th Amendment merely prohibit federal statutes that compel the states to take some affirmative action, as the DOJ argues? Or, as NJ argues, does it also extend to federal statutes that do not necessarily compel the states to do anything, but instead prevent them from taking some action?

In this case, that’s the billion dollar question.

NJ may have a tougher time prevailing on the issue merely because there is no Supreme Court case on point factually to support its interpretation of the 10th Amendment’s reach. But, the 10th Amendment cases decided by the Supreme Court are not even roughly analogous to this case, so that is the opening NJ is seeking to exploit.

In its brief, NJ comes out firing in the opening two paragraphs. Citing New York v. United States, the State emphasizes that under the Constitution, Congress lacks the power directly to compel the States to require or prohibit certain acts pursuant to a federal statute. And of course, argues the State, PASPA prohibits States from offering sports betting.

The entire brief is a worthy read, as the State picks apart the 10th Amendment characterizations presented by the leagues and the DOJ. In short, the State takes the position that the anti-commandeering doctrine has been applied to federal statutes that command the States to maintain a certain state of affairs.

There’s some great additional commentary on the commandeering issue in this Pokerati post and its comments.

No matter how Judge Shipp rules in this case, an eventual appeal to the U.S. Supreme Court seems inevitable. There’s simply too many dollars at stake for either the leagues or New Jersey to back down until the Supreme Court says to do so.

Yesterday, New Jersey Governor Chris Christie acted on the internet gambling bill sitting on his desk during the final moments of his forty-five day time-frame. He could have (i) taken no action, thus allowing the bill to become law, (ii) vetoed the bill, or (iii) conditionally vetoed the bill, recommending changes to the legislation that he would sign off on.

The Governor’s conditional veto has apparently generated little, if any, initial opposition. State legislators and other interested parties believe the proposed changes are non-issues and that internet gambling in New Jersey is going to happen.

For a clear and concise read on the events surrounding the Governor’s conditional veto, be sure to check out this piece at Online Poker Report. The “short answer” on what Governor Christie wants changed:

• Taxes at 15%, not 10%
• License fees roughly double
• NJ Division of Gaming Enforcement takes the reigns of online gambling
• Online gambling regulation “sunsets” (expires) after 10 years (though nothing prohibits the legislature from renewing)
• More funding for problem gambling initiatives, including an annual report wrt the impact of online gambling on problem gambling

Online Poker Report also delves into a “longer answer” on the changes. There are a couple in particular that raise some interesting questions.

Authorizing Online Poker in New Jersey

I came across this thread on the TwoPlusTwo forums. The original poster wondered whether online poker would be authorized under the Governor’s proposed changes.

The conditional veto calls for this language to be deleted from the bill:

2. (New section) Any authorized game or authorized gambling game, as defined in section 5 of P.L.1977, c.110 (C.5:12-5), that is authorized to be played in a casino may, with the approval of the division, be offered through Internet gaming.

And to be replaced with:

2. Section 5 of P.L.1977, c.110 (C.5:12-5) is amended to read as follows:

“Authorized Game” or “Authorized Gambling Game” – Roulette, baccarat, blackjack, craps, big six wheel, slot machines, minibaccarat, red dog, paigow, and sic bo; any variations or composites of such games, provided that such variations or composites are found by the division suitable for use after an appropriate test or experimental period under such terms and conditions as the division may deem appropriate; and any other game which is determined by the division to be compatible with the public interest and to be suitable for casino use after such appropriate test or experimental period as the division may deem appropriate.  “Authorized game” or “authorized gambling game” includes gaming tournaments in which 6 players compete against one another in one or more of the games authorized herein or by the division or in approved variations or composites thereof if the tournaments are authorized by the division.  “Authorized game” or “Authorized gambling game” shall also include any game that the division may determine by regulation to be suitable for use for wagering through the Internet.

No, you don’t see the word “poker” anywhere, although other games are listed. What, then, is the authority for permitting online poker under this legislation?

The language proposed in the original bill says the Division of Gaming Enforcement may approve for internet gaming any games only already authorized to be played at New Jersey casinos. Since poker is authorized for play in NJ casinos, then the division may approve it for internet gaming.

The Governor’s proposed language (underlined portion above) takes a different approach. Instead, he wants the Division of Gaming Enforcement to decide pursuant to promulgated regulations the games that are suitable for internet gaming. From my reading, it appears that the division would not be limited to approving for internet gaming those games only already authorized for play in NJ casinos, but instead may approve for internet gaming any game the division so chooses.

The proposed change runs consistent with the Governor’s conditional veto statement, which makes clear his goal to grant the New Jersey Division of Gaming Enforcement “wide latitude and authority to establish a regulatory framework that provides for the most effective controls, monitoring, and supervision” of internet gaming.

What wouldn’t surprise me is if the division takes a cautious approach with poker. Games not against the house (i.e. player-against-player) raise various unique issues, such as collusion, that require special attention and consideration.

Poker will be a part of internet gaming New Jersey. Governor Christie is just giving the division the apparently unilateral power to figure out how to bring the game—any games, for that matter—online in the state.

Pooling Liquidity

Another proposed change pointed out at Online Poker Report:

Page 32, Section 33, Line 47: Delete “an interstate compact” and insert “a reciprocal agreement”

The phrase “interstate compact” is found in section 33 of the bill:

33.  (New section)  Notwithstanding any other provision of P.L.      , c.    (C.      ) (pending before the Legislature as this bill), wagers may be accepted thereunder from persons who are not physically present in this State if the Division of Gaming Enforcement in the Department of Law and Public Safety determines that such wagering is not inconsistent with federal law or the law of the jurisdiction, including any foreign nation, in which any such person is located, or such wagering is conducted pursuant to an interstate compact to which this State is a party that is not inconsistent with federal law.

Interstate compacts are agreements entered into between two or more states. Under the U.S. Constitution, interstate compacts require congressional consent.

Perhaps the Governor is anticipating possible legal challenges to agreements entered into with other states for internet gaming. If the iGaming law acknowledges that the agreement is an “interstate compact,” then the State is essentially admitting that the agreement is subject to Congressional approval under the compact clause. By labeling these possible future agreements as something else, the State at least leaves the question open as to whether the agreement is one subject to the compact clause.

With that said, is there any special significance with using the phrase “reciprocal agreement?” Perhaps. As fellow gaming attorney Bob Crawford noted on Twitter, it’s possible that a reciprocal agreement would require other states to accept NJ players, but an interstate compact might not.

We should continue to think on this issue. As I’ve previously discussed, how states seek to pool virtual liquidity may prove critical on how the internet gaming market thrives in the United States.

In the meantime, NJ Assemblyman John Amodeo said he is working “to get these [proposed amendments] passed by the Legislature as soon as possible and back onto the Governor’s desk for consideration.”

Yesterday’s conditional veto was a very significant step along the path towards regulated internet gambling in the United States.

A few months ago I received an e-mail from someone claiming to hold a Powerball ticket good for a seven figure sum. This someone, however, was seeking to claim the ticket anonymously, and wanted to know if I had any ideas.

I suspect this someone came across my post about an unclaimed winning lottery ticket in Iowa. In that case, the Iowa Lottery refused to honor the ticket unless the recipient came forward. In both situations, state law required the winner’s name and location to be made public information.

So I wrote back and said it could be considered fraud if someone other than the actual winner claims the prize. I added that I don’t have any viable courses of action to present, and thanked the person for the inquiry.

There are countless reasons why anyone would want to claim a lottery ticket anonymously. The primary reason, of course, is to avoid the public spotlight. Unfortunately, far too many times lottery winners have fallen victim to scam artists or physical harm.

New Jersey Assemblyman John Burzichelli believes lottery winners shouldn’t have to face the fame with their fortune. He recently introduced bill A2982, which would give New Jersey lottery winners the option of remaining anonymous for one year.

The NJ Lottery is likely to lobby against the bill as is. The State Lottery claims that “transparency gives taxpayers increased confidence that lottery games are fair and honest.” But I see a far more significant reason for its opposition: Lost publicity. No one is going to care about a press conference for a lottery winner a year after the fact.

Expect some sort of compromise, such as a prize amount threshold.

I don’t think we should preserve the publicity at the expense of continuing to expose lottery winners to evil. The states generate plenty of revenue from their lotteries and almost certainly could afford to take a small hit, if any. Plus, there are other ways to accomplish transparency.

Last week, the New York Post reported Sen. Tony Avella introduced a bill that would authorize wagering on professional sporting events in New York. Proceeds would be applied to education in the State.

This news isn’t surprising, considering last March Governor Cuomo reached an agreement with lawmakers to allow seven new casinos in the state.

For either new casinos or sports betting to have a chance to come to New York, a constitutional amendment is required.

To amend the New York Constitution, the proposed amendment must be adopted by two successive legislatures, and then approved by a public referendum. The current legislative session in New York has until June 21 to approve the measures.

The sports betting bill introduced by Avella, S.7401, would authorize

wagering on professional sporting events at betting facilities located at thoroughbred and harness racetracks operating in this state, in simulcast theaters operated by off-track betting corporations and in any constitutionally authorized casino facility, as may be prescribed by the legislature….

Under the current language of the bill, you could place bets on professional sporting events at any of New York’s five tribal casinos or nine racinos, as well as at any other NY racetracks or OTBs. And, if commercial casinos are approved in New York, then you could place bets there as well.

Wait, but isn’t sports betting illegal under federal law? In general, that is correct.

The Professional and Amateur Sports Protection Act (“PASPA”) is a federal statute enacted in 1992 that expressly prohibits states from operating a gambling system based on professional or college sports. Four states were exempted: Delaware, Montana, Oregon, and Nevada.

So how does S.7401 get around PASPA? Well, one day NYers might thank NJ for taking care of it.

Late last week, New Jersey Governor Chris Christie announced his State will proceed to take the steps necessary to offer sports betting at Atlantic City casinos and the State’s four horse tracks.

New Jersey is far ahead of New York in the process, as Governor Christie signed a bill into law in January 2012 that authorizes professional sports wagering in NJ. New Jersey will likely encounter in the near future efforts by federal authorities challenging such legislation on the basis of the Supremacy Clause. NJ will argue PASPA is unconstitutional.

Christie’s comments all but ensure an imminent showdown:

“We intend to go forward,” the Republican governor said. “If someone wants to stop us, then let them try to stop us. We want to work with the casinos and horse racing industry to get it implemented.

“Am I expecting there may be legal action taken against us to try to prevent it? Yes,” the governor said. “But I have every confidence we’re going to be successful.”

Christie has a reputation of actually doing what he says he’ll do. This is already a great story, and the best is likely yet to come. I’ll address the merits of the legal arguments in a future post.

Some Atlantic City casinos just became richer. It’s not because of a massive losing streak from its patrons, however. Instead, it’s because of a recent tax-appeal settlement cutting property values of three casinos by 35 percent.

Atlantic City has agreed to give $26.96 million back to Caesars Entertainment Corp. From 2009 to 2011, Caesars had paid property taxes for Bally’s Atlantic City based on the property being valued at $1.5 billion.

The Atlantic City Council agreed to settle the appeal filed by Caesars by reducing the Bally’s property valuation to $700 million.

Previously, property values for casinos were based on their land and buildings. Since the economic downturn, the casinos opted to take financial performance into account.

Atlantic City Mayor Lorenzo Langford claims the change to how casino properties are valued for purposes of the property tax is not fair:

“If the state of New Jersey really wants to assist the city, they should mandate that the casinos be assessed in the same way and manner as residential properties,” Langford said. “Property taxes are not reduced on the residential side if a property owner suffers a reduction in income or mismanages their financial affairs. Why should casinos be treated differently?”

Because the casinos are now paying less property tax, a budget shortfall is expected. The ultimate losers of these settlements may be the other local property owners.

Discussion about the possible legalization of online gambling in the U.S. has been gaining more and more traction for some time. An update here on the current legislative developments is long overdue.

California: In late February, Senate Bill 1463 was introduced. The bill would legalize online poker in California, and has a goal of raising $200 million for the state general fund. The bill is co-authored by Senate President Pro Tem Darrell Steinberg. According to the complete bill history for Senate Bill 1463, the bill may be acted upon on or after March 26.

Iowa: This past Thursday, Iowa House Speaker Kraig Paulsen said the State House does not plan to take up Senate File 2275, which would legalize intrastate online poker in Iowa. The State Senate had recently approved the bill in a 29-20 vote. The bill is all but dead.

Mississippi: In late February, House Bill 1373 was introduced. The bill would have legalized online gambling within the state. The bill is now dead.

Nevada: Nevada is far ahead of any other state in this area, having legalized intrastate online poker late last year. In January, the Nevada Gaming Control Board finalized the Technical Standards for Gaming Devices, and the Minimum Internal Control Standards were finalized in February. At this time, it is unclear when online operators will be permitted to accept real-money deposits. Some speculate late 2012.

New Jersey: In early February, Senate Bill 1575 was introduced. The bill would legalize online gambling within the state. Just over a year ago, Governor Christie vetoed a bill that would have legalized intrastate online gambling, citing constitutional concerns. Current bill sponsor Senator Lesniak believes he has addressed these concerns. The bill failed to advance through the legislature during the final voting session this past week, however, so it may not be subject to a vote for at least six more weeks.

Over the weekend I came across this “Biz Brain” article from NJ.com. It addresses the question whether New Jersey lottery winnings are subject to New Jersey income tax. The answer: Maybe.

For taxable years beginning on or after January 1, 2009, New Jersey lottery winnings are subject to New Jersey income tax only if the prize amount exceeds $10,000. The prize amount is the determining factor.

For example, in 2011 if you win the $25 million New Jersey PowerBall and score a $5,000 win from a Pick 4, only the PowerBall winnings are subject to New Jersey income tax. Of course, all $25,005,000 is subject to federal income tax.

What the article doesn’t address is the question whether the $10,000 minimum prize threshold applies to all gambling winnings in New Jersey. The answer is no. All other gambling winnings in New Jersey are fully subject to the state’s income tax. See this N.J. Technical Bulletin for more details.

Furthermore, as I’ve written before, if an out-of-state resident travels to Atlantic City and wins big playing blackjack, he may be on the hook for paying income tax to both his state of residence and New Jersey.

As much as we attorneys don’t like to acknowledge it, let’s face it: Some of us are crooked. Perhaps none are more crooked than Thomas Frey of Edison, NJ.

Frey had attempted to collect legal fees from various individuals, including two police officers, to handle an IRS investigation. What Frey didn’t tell them, however, was that he fabricated the entire matter. Last week, a federal grand jury indicted Mr. Frey with multiple charges. He’s now facing up to 140 years in prison if convicted on all counts. The Department of Justice press release is here, and the indictment is here.

Frey’s co-conspirator communicated to the victims that IRS agents approached him at a property owned by one of the victims as part of a criminal investigation. To corroborate the story, Frey showed to the victims business cards of the IRS agents, claiming he received them during the questioning. According to the indictment, Frey had obtained these cards while representing another client in an unrelated tax matter many years prior.

Frey set up the plot, and sought to score. He told the victims (again, who were police officers) that if they each paid him $10,000, he could utilize a “special relationship” with one of the IRS agents in order to have the criminal investigation converted to a mere desk audit. Frey also represented that a family member of his is an IRS employee who would enable Frey to obtain a more favorable outcome. Under the direction of law enforcement, one of the victims provided to Frey the $10,000 in a tape recorded meeting.

Frey’s alleged conduct is unethical on so many levels. First, fabricating a story to obtain funds for legal services is obviously grounds for immediate and permanent disbarment. Second, if the story were true, he’d be conspiring with a government employee to reach a more favorable outcome for his clients.

When I read a story like Mr. Frey’s, I find myself dumbfounded. Mr. Frey dedicated at least three years of his life to obtain a legal education, and earned the right to practice law after passing the New Jersey bar exam. He’d been practicing law since 1989.

Why risk throwing away all of the hard work for roughly fifty grand? There had to be another way out of whatever mess Mr. Frey got himself involved in. Whatever valuable experience and sound judgment Mr. Frey had accumulated over the years, if any, it certainly wasn’t on display here.

To my attorney readers, please don’t try this at home. To those who seek to hire an attorney, be careful whom you choose.

High-stakes blackjack player Don Johnson recently walked away from Atlantic City casinos $15 million richer over a five month period. Before taxes, that is. A resident of Pennsylvania, he’s now well-aware how the Garden State’s jock tax leaves a large chunk of those winnings in the state’s coffers:

[Johnson] said the state’s reaction to his winning spree could put a chill on high-roller betting in New Jersey. He said he’s being told to pay New Jersey income taxes on his winnings even though he has never lived, owned property or done business there.

“That would be a precedent that might just kill off New Jersey gaming,” he said. “I can’t imagine any big player going there knowing that if he does hit them big, he might have a tax liability to them even though he’s paying taxes in his home state.”

He said he was being asked to pay under a provision tied to the introduction of gambling in New Jersey in the 1970s.

“It made sense when you had no other states surrounding New Jersey that had gaming,” he said. “Now you have all these competitors involved. It becomes a nightmare for a player who wins big and plays in multiple states. He has to figure out what his P&L is in every state. It’s ridiculous.”

Johnson explained further.

“Let’s say you won $1 million in New Jersey for the year, but you lost $2 million between Pennsylvania and Vegas. You had an overall net loss of $1 million. You lost money for the year, but the state of New Jersey may still come after you to try to require you to pay for what you won from them. That’s where this doesn’t work. The math doesn’t work on that.”

While the math may not “work,” he’s right about New Jersey imposing tax on the $1 million in his example. It’s a killer particularly because New Jersey has one of the highest income tax rates of all states. What Johnson doesn’t point out, however, is that as a resident of Pennsylvania, he may be able to take a credit on his Pennsylvania tax return for taxes paid on his gambling winnings to New Jersey. The significance is that he’ll pay only the higher of the two state’s tax rates (in addition to the federal rate, of course).

Despite the possibility of the credit, he makes a fair observation about how the state’s jock tax may hurt the New Jersey gaming industry, with casinos across the state border in close proximity. If Johnson won the $15 million in Pennsylvania casinos instead, he’d pay far less in state income tax because Pennsylvania’s personal income tax rates are much lower than New Jersey’s.