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.

Internet Probability Specialist

October 30th, 2012 No comments

Living in the NYC metropolitan area, I feel extremely fortunate to have survived Hurricane Sandy without losing power or sustaining flood damage. Thoughts and prayers to those less fortunate.

Stuck indoors all day yesterday, I watched the 2012 World Series of Poker Main Event final table reduce from nine to three. Play resumes tonight at 9:00 PM ET on ESPN (on a fifteen minute taping delay) until a champion wins the coveted bracelet. The winner takes home (before taxes) $8,531,853.

The current chip leader, Greg Merson, is a twenty-four year old American from Laurel, MD. According to this article in the Washington Post, Merson’s most recent tax filing stated he is an “internet probability specialist.” The article goes on to describe Merson’s ups and downs as he emerged in the poker world.

I’ve discussed on several occasions that a poker player reports gambling winnings as a professional or amateur gambler. Does filing instead as an “internet probability specialist” raise any issues? Maybe.

Merson began playing poker online while in high school. At 19 years old, he dropped out of college to play poker online full time. After “Black Friday” effectively eliminated the online poker market in the U.S. in April 2011, he moved to Toronto to continue playing online.

Playing live at this year’s World Series of Poker has already paid off big time for Merson. He won $1.1 million and the gold bracelet in the Six Max No-Limit Hold’Em Event in July, and stands to win at least $3,799,073 in the Main Event.

From the little I’ve read, it seems that Merson played minimal to no live poker prior to 2012. Let’s assume he in fact played no live poker prior to 2012. In that case, “internet probability specialist” is merely a euphemism for professional gambler. All of his gambling winnings and losses as an “internet probability specialist” would be reportable on Schedule C and he could deduct ordinary and necessary business expenses associated with the online poker play.

More interestingly, what if Merson also had live poker winnings and losses during a tax year for which he filed as an “internet probability specialist”? Could an “internet probability specialist” report online poker winnings as a professional and separately report live poker winnings as an amateur on the same return? Or must the live and online winnings be combined?

Because there is no case law or statutory authority to my knowledge that supports a bifurcation of gambling winnings between live and online play, I believe in that case filing as an “internet probability specialist” would be inappropriate.

The Internal Revenue Code does not distinguish between types of gambling for tax purposes. Whether a taxpayer’s winnings are from horse racing, live poker, online poker, etc., all of the gambling winnings are combined together and thus taxable either as a professional or amateur. There is no case law to support the position of a taxpayer claiming to be a “professional blackjack player” but also an amateur poker player at the same time. If the taxpayer is a professional of any type of gambling, then all the gambling should be considered part of the profession.

Of course, if Merson filed as an “internet probability specialist” and combined all his gambling winnings (live and online) on Schedule C anyway, then the tax law would seem to be applied correctly. Instead it’s just a labeling issue.

A final question to consider is whether one who files as an “internet probability specialist” is more likely to trigger an IRS examination. High income taxpayers are already at a high risk of audit, so I suppose not. Lower to moderate income taxpayers, however, may be asking for an examination by using an unfamiliar term for their profession. Then again, “professional gambler” is unfamiliar to many at the IRS anyway, so I’m not so sure the difference would be beyond marginal.

Good luck to the remaining three in tonight’s conclusion of the Main Event!

(Hat tip to @PokerScar for sharing the piece in the Washington Post.)

Lance Armstrong’s Race for Deductibility

October 29th, 2012 No comments

One week ago, the International Cycling Union took away Lance Armstrong’s seven Tour de France titles he had earned in successive years from 1999 to 2005. In addition, the ICU is requiring Armstrong to return up to $16 million he had received for winning the Tour de France over those years.

Armstrong is a U.S. citizen and thus was required to report and pay U.S. income tax on his winnings. Upon returning the winnings, is he entitled to any relief for the taxes already paid?

The answer is probably, but not necessarily entirely.

Samuel D. Brunson, Assistant Professor of Law at Loyola University Chicago School of Law, explains in this paper titled Lance Armstrong and the Race for Deductibility.

Reid-Kyl Federal Online Poker Bill

October 19th, 2012 No comments

A draft bill for federal online poker said to come from the offices of Senators Harry Reid and Jon Kyl was leaked to the media earlier today. Read the full text of the bill, titled “Internet Gambling Prohibition, Poker Consumer Protection, and Strengthening UIGEA Act of 2012,” here.

Gaming attorney Ian Imrich has offered his initial comments on the bill. I’ll post some thoughts after combing through its seventy-three pages.

Updates

September 27th, 2012 1 comment

You may have noticed a slowdown in the quantity of content here over the past few weeks. The reasons are twofold.

First, a family scare. Early last week my older brother (I’m the middle sibling) was hospitalized with a serious intestinal infection that ultimately required surgery. The surgeon informed us that had he gone untreated for a few more days, my brother could have went into septic shock.

I’ve looked up to my brother all my life. He’s the one person who I could say has been through more than me as a sibling. So when I first learned of his hospitalization and the seriousness of his condition, my world came to an abrupt pause. I couldn’t bear the thought of possibly losing him so prematurely. I was afraid of losing a part of me.

After the news settled in, I found myself stepping into his shoes in an effort to provide the immediate family the emotional strength we’re accustomed to seeing in him. Naturally, my mother did not take the news well. As my father said on the day of the surgery, “You can’t get your mom out of that hospital with a bulldozer.”

I hadn’t spent as much time in a hospital all my life as I have since my brother was hospitalized. This period of time has forced me to temporarily live outside of life’s daily routine. It has reminded me to always appreciate the time you spend with the people most important to you. We just don’t know what tomorrow brings, good or bad.

I’m happy to report he is recovering as well as expected to this point. There’s a long road ahead, and a better qualify of life awaits.

Second, I’ve been in the process of slightly shifting the blog’s focus. I will continue to highlight tax issues relevant to the gaming industry. Going forward, however, I plan to also write more about gaming law developments in general, and scale back a bit of the non-gaming tax pieces. Feel free to suggest topics of interest.

Yes, I am a tax lawyer. And as I continue to chart the path of my career, I further realize that my long-term place is likely somewhere in gaming. The gaming industry will continue to evolve and present challenging and stimulating legal issues. I’ve learned a lot from the many sharp and engaging individuals that the community has to offer. I also hope I’ve shared with you an interesting concept or two.

Now’s a perfect time to queue up a very cheesy 80s tune that, well, sort of captures the moment:

 [youtube=http://www.youtube.com/watch?v=8qrriKcwvlY]

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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.

Anonymous Lottery Winner Bill Introduced in New Jersey

September 6th, 2012 No comments

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.

NY Cigarette Wholesalers Violate CCTA

August 28th, 2012 1 comment

The battle between New York and its federally recognized tribes over the taxation of cigarettes continues.

In the most recent development, other players involved were on the losing end of a recent ruling in federal court. The judge held that wholesalers failed to collect New York City cigarette tax on the sale of millions of cigarette cartons to tribal retailers located on reservations in New York. The New York Times estimates the wholesalers could have to pay penalties up to $15 million to New York City.

New York City brought this action alleging that the wholesalers violated federal law. The Contraband Cigarette Trafficking Act prohibits persons from selling “contraband cigarettes,” which are defined as “a quantity in excess of 10,000 cigarettes, which bear no evidence of the payment of applicable State or local cigarette taxes in the State or locality where such cigarettes are found, if the State or local government requires a stamp, impression, or other indication to be placed on packages or other containers of cigarettes to evidence payment of cigarette taxes.”

Defendant wholesalers Mauro Pennisi and Gutlove & Shirvint each sold from May 2008 to January 2011 more than 10 million cartons to Indian retailers mostly on the Poospatuck Reservation, where fewer than 500 people live. Although cigarette packs sold to tribal members on reservation are exempt from NY cigarette tax, packs sold off-reservation in NYS are taxable.

New York City asserted that the cartons sold by the wholesalers were trafficked into New York City without payment of the New York City cigarette tax and re-sold. The judge ruled that New York City met its burden of proof to establish that the wholesalers should have known the vast majority of the untaxed cigarettes sold to the tribes were re-sold to non-tribal members.

This case will only further encourage tribes located in New York to manufacture their own cigarettes. Whether or not NYS will again seek to stop such activity remains to seen.

Last Two Dollars in State Supreme Court?

August 27th, 2012 1 comment

Last October I wrote about operators of the Napa Valley Casino refusing to pay a $2 card room admissions tax. The city of American Canyon, CA, approved the measure in 2010, yet it has delivered exactly $0 in tax dollars to date, as Napa Valley Casino is the only entity subject to the tax.

The parties ended up in court after the city filed a criminal complaint against the casino’s operators, and the operators countered with a civil suit of their own.

Earlier this month a Napa County Superior Court panel decided in favor of the city, according to the Times-Herald. The operators are seeking review of the decision by the state Supreme Court, but the court is not obligated to hear the case.

The Superior Court panel upheld the constitutionality of the tax, noting that local governments have broad powers to regulate gaming establishments located within their jurisdictions.

I don’t see a reversal here. The operators are asserting that the tax is on private citizens entering into a private business. Problem is, it’s not that straightforward.

To the Left Behind Law Graduates

August 20th, 2012 6 comments

People like to say timing is everything. I’m often tempted to call out this remark by suggesting that the cliché is merely a reactionary observation. I try to consider myself a forward-thinker, so it’s not an adage that offers me any guidance in life.

I could say, for example, that my decision to enroll in law school in Fall 2006 was awful timing. Graduating in Spring 2009, my class was one of the first to enter the legal market following the burst of the U.S. housing bubble.

Far too many of my colleagues graduated without legal jobs. Far too many others begrudgingly accepted low paying positions just to have a legal job. It wasn’t what they signed up for.

The classes of 2010, 2011, and 2012 haven’t had it any better. Actually, it has probably been even worse for them. Yet, for the past few years, law school tuition around the nation has steadily increased. (UPDATE 8/21/2012: According to this article, the average tuition for law school this fall will rise by more than double the rate of inflation.) It doesn’t add up.

We’re looking at another bubble. Others intimately closer to the situation than I am have written extensively about it. University of Colorado Law School professor Paul Campos launched Inside the Law School Scam. Wash U. in St. Louis Law School professor Brian Tamanaha published Failing Law Schools.

Change to the system is coming. Good change, for example, that prevents schools from disguising employment statistics in order to convince naïve college seniors into believing that law school is a still a golden ticket.

Hopefully, these changes will generate a far higher overall utility for those involved in law school education going forward. Unfortunately, the classes of 2008, 2009, 2010, 2011, 2012, and likely 2013, 2014, and 2015 are left behind.

Wait, so timing is everything, right?

Wrong.

Accept the reality of the situation. We can’t give our degrees back. And we’re not getting our money back. Law school is no longer a golden ticket, simple as that.

Back to the first sentence of this post. Timing is something, but not everything. Those who often put themselves in a position to capitalize on seemingly fortuitous opportunities know that there’s much more to their success than timing.

Those struggling to find quality legal jobs need to consider approaching the matter more unconventionally. There are hundreds of others equally as qualified and jobless or underemployed. Continuing to follow the conventional methods will produce the same lack of intriguing opportunities.

Problem is, I haven’t come across substantial commentary on how the left behind can work towards creating these opportunities. I wrote some initial thoughts a couple of months ago. It’s a start, but much remains to be said.

No one has all the answers. Collaboration is key. Whether it commences here, on a far more popular blog, on Twitter, or at Reddit, it doesn’t matter. I’d be happy to share ideas with people willing to listen and offer critical insights. Let’s get this going.

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