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Poker and Taxes: 2011 Year in Review

January 8th, 2012 No comments

2011 was anything but a boring year in the poker world. With tax season approaching, it’s time to review some noteworthy events during the year that may impact items on a poker player’s 2011 U.S. income tax return.

Mayo Decision

In general, the tax code is very harsh towards gamblers. In January, however, the U.S. Tax Court issued a pro-gambler decision. In Mayo v. Commissioner, the court held that a professional gambler may deduct “ordinary and necessary” business expenses beyond the extent of a taxpayer’s “net” gambling winnings.

Here’s a simple example to illustrate. Suppose during 2011 I had $50,000 of gambling winnings, $70,000 of gambling losses, and $20,000 of ordinary and necessary business expenses incurred in connection with my gambling activity. Section 165(d) of the Internal Revenue Code limits the deductibility of my gambling losses to $50,000, producing “net” gambling winnings of $0. Because of Mayo, I may further deduct the $20,000 of business expenses, producing a $20,000 business loss, which may be applied against other income.

If there was any concern over the IRS appealing the decision, it’s now gone. In a recent Action on Decision, the IRS explicitly acquiesced to the tax court’s Mayo opinion. Victory for professional gamblers.

For more comprehensive commentary on the case, click here.

Black Friday

On April 15, the Department of Justice seized the internet domains of Absolute Poker, Full Tilt Poker, and PokerStars. At the time, players’ funds on each of these sites were also frozen and inaccessible. To date, only PokerStars has repaid its customers. Absolute Poker is in bankruptcy, and may or may not repay customers. Full Tilt has agreed to forfeit its assets to the U.S. Department of Justice, and French investment firm Groupe Bernard Tapie is currently in the process of purchasing the assets from the DOJ. It has been reported that the DOJ will repay Full Tilt’s U.S. customers, but nothing has been finalized.

With 2011 behind us and a lot of uncertainty remaining, it’s no surprise the number one tax question on poker players’ minds is how to treat the frozen funds on their tax returns. Of course, PokerStars customers have been fully repaid, so the tax treatment of its customers’ gambling winnings is no different this year. With respect to Absolute Poker and Full Tilt accounts, however, the current state of affairs warrants careful consideration of a couple of tax principles.

  1. Constructive Receipt

As I discussed back in April, the doctrine of constructive receipt sometimes requires cash method taxpayers to include an item in income even if no cash, services, or property are actually received in hand during that year. When are some of those times? A taxpayer has constructive receipt of income in the taxable year during which it is:

  • credited to the taxpayer’s account;
  • set apart for the taxpayer; or
  • otherwise made available such that the taxpayer may draw upon it during the taxable year if notice of intention to withdraw had been given.

Now, if an online casino maintains segregated accounts for each customer, as in the case of PokerStars, then it’s pretty clear that constructive receipt is triggered when a customer earns winnings on the site, and not when the funds are actually withdrawn. But what if an online casino pays its customers through a general operating account? Further, what if that casino’s operating account balance is far less than the total amount owed to players? According to the amended civil complaint filed against Full Tilt Poker, that was precisely the case: At the end of March 2011, Full Tilt owed $390 million to its players but had less than $60 million in its bank accounts. Does constructive receipt still apply?

I would argue that it doesn’t. Constructive receipt does not apply if the taxpayer’s control of its receipt is subject to substantial restrictions or limitations. Gambling winnings in Full Tilt accounts on April 15, 2011 were, in my view, subject to substantial limitations because Full Tilt didn’t have the money to pay the balances. With the Department of Justice alleging in a press release that Full Tilt was operating a “massive Ponzi scheme” against its own players, it would be rather inconsistent for the IRS to then assert that winnings in Full Tilt player accounts not actually received in 2011 are still taxable.

Although we have less evidence to make the same case for winnings in Absolute Poker player accounts, a pending bankruptcy without the return of player funds seems like a strong argument for no constructive receipt.

  1. Claiming a Loss for Unpaid Funds

May a poker player write off unpaid Full Tilt and Absolute Poker funds? For 2011, the answer is no. I covered this issue in detail back in May. What has changed? Now there’s a pending sale of Full Tilt assets by the DOJ to Groupe Bernard Tapie. It seems more likely players will be repaid.

Ultimately, because it’s still possible Absolute Poker and Full Tilt will pay its players back, no loss may be realized. I suspect sometime in 2012 we’ll learn the final fate of unpaid accounts.

  1. Possible IRS Examination of Online Poker Players

Back in April, I explored the possibility of the IRS examining U.S. customers of Absolute Poker, Full Tilt Poker, or PokerStars. To my knowledge, the IRS has not pursued these individuals.

With reports that the DOJ may handle the repayment process of Full Tilt funds to U.S. players, it’s not far-fetched to speculate that some tax examination process will take place. Players may have to apply to the DOJ to obtain unpaid funds. The DOJ or IRS may very well take a look at applications of taxpayers claiming significant balances, perhaps $10,000 or greater.

Another possible alternative is the DOJ offering an amnesty program to poker players who have unpaid balances and are not in compliance with U.S. tax laws. We’ve seen similar programs far greater in scope. In 2011, for example, U.S. taxpayers with certain unreported foreign financial accounts may have came forward under the 2011 Offshore Voluntary Disclosure Initiative.

World Series of Poker

In November, Pius Heinz took home $8,715,638 after capturing the 2011 World Series of Poker Main Event bracelet. And I say “took home” in the literal sense. Because Mr. Heinz was a resident of Germany, he was able to take advantage of the U.S.-Germany Tax Treaty, which exempts from U.S. income tax gambling winnings earned in the U.S. by German residents.

For a complete breakdown of how much tax each of the Main Event’s final nine players had to pay, be sure to check out Russ Fox’s article.

Legislative Developments

In December, the Department of Justice released a memorandum opinion taking the position that the Wire Act applies only to sports wagering. Not exactly a tax event, but an event worth mentioning nonetheless. Although the opinion itself addresses only online state lotteries, states now have been shown a green light for intrastate online gaming. Although player liquidity issues remain for online poker under an intrastate regime, state compacts combining player pools is a realistic possibility. Because of the opinion, legislative developments for U.S. online gaming in 2012 became far more interesting.


Postscript:

I must remind all readers that it is impossible to offer comprehensive tax advice on the internet. Information I write on this blog is not legal advice, and is not intended to address anyone’s particular tax situation. Should you seek such advice, consult with a tax professional to discuss your facts and circumstances.

IRS Circular 230 Notice:

To ensure compliance with requirements imposed by the IRS, I inform you that any U.S. federal tax advice contained in this blog is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this blog.

Frozen Online Poker Funds and the Casualty Loss

May 27th, 2011 5 comments

Almost a month and a half has passed since the Department of Justice seized the U.S. internet domains of three major offshore online gambling companies.  To date, only one of the three “Poker Companies,” PokerStars, has been returning to U.S. customers funds frozen upon the seizures.  Earlier today, we learned that the first Full Tilt account belonging to the site’s co-founder was unfrozen by the DOJ.  Absent from that news, however, was an update on when, if at all, Full Tilt customer’s funds will be returned.  There has been little to no rumblings from the other company, Absolute Poker, since it reached an agreement with the DOJ.

Suppose at some point either Full Tilt or Absolute Poker declares it will *not* return player funds.  Although the news would be extremely unfortunate for many, the Internal Revenue Code may lessen the blow incurred via the casualty loss.

Section 165(c)(3) allows a taxpayer to take a deduction for a loss arising from a “fire, storm, shipwreck, or other casualty” incurred with respect to property that is not used in a trade or business.  Losses incurred with respect to property used in a trade or business, such as in the trade or business of gambling, are deductible under (c)(1) or (2), do not require a casualty, and may be reported on Schedule C.  (Note that there may be significant tax reasons, beyond the scope of this post, why a loss to property used in a trade or business caused by a casualty should be treated as such.)

So what is a casualty?  Neither the Internal Revenue Code nor the regulations define “casualty,” so it’s up to the IRS and the courts to decide.  “Casualty” has been defined by the IRS as “the damage, destruction, or loss from property resulting from an identifiable event that is sudden, unexpected, or unusual.”  A straightforward example of a casualty is a home permanently destroyed by the tornado recently ripping through the small town of Joplin, Missouri.  My deepest sympathies to all those impacted.

As far as I know, the issue of whether permanently frozen online poker funds may qualify as a casualty loss under the Internal Revenue Code would be one of first impression.  My position would be they do qualify, because of the sudden and unexpected action from the DOJ directly resulting in frozen customer funds.  Regarding the “unexpected” component, it’s important to note the U.S. Tax Court has said foreseeability of a casualty does not necessarily prevent taxpayers from deducting the resulting loss.  It must be emphasized, however, the casualty loss cannot be claimed until after some announcement is made confirming permanence of customer fund seizure.  This hasn’t happened, yet.

To claim a casualty loss, a taxpayer must attach a Form 4684 to the tax return for the year the loss occurred.  The recreational gambler completes the personal use property section of Form 4684, and claims the resulting casualty loss as an itemized deduction on line 20 of Schedule A.  Note that there is a $100 deductible for casualty losses, and a casualty loss is deductible only to the extent it exceeds 10% of the taxpayer’s adjusted gross income.

As stated earlier, a professional gambler may simply claim the loss on a Schedule C.  An alternative may be to claim a casualty loss under the business property section of Form 4684.  Ascertaining those tax consequences could get very messy if one considers that course of action, and one certainly should consult a tax professional.

At this point, this discussion is entirely academic.  However, with each passing day, the general consensus for the likelihood of players seeing their funds again gradually lessens.  At least taxpayers know a deduction may arise in the event the dreaded news becomes a reality.

DOJ (Finally) Reaches Agreement with Absolute Poker

May 12th, 2011 No comments

The deafening silence has ended.  Yesterday, the Department of Justice issued a press release announcing an agreement entered into with Absolute Poker to facilitate the return of funds to U.S. players.  Read the actual agreement here.  The announcement comes just less than a month after the DOJ seized the U.S. domains of Absolute Poker, Full Tilt Poker, and PokerStars.

Unlike the agreements the DOJ reached with Full Tilt Poker and PokerStars, this agreement does not expressly allow for Absolute Poker to utilize its U.S. domain to facilitate the return of player funds.  Instead, the U.S. Attorney’s Office provides “all necessary assurances” to third-party entities engaged with Absolute Poker that these third-party entities may work with Absolute Poker to facilitate the return of funds to U.S. players.  Because the U.S. domain of Absolute Poker has not been restored, it appears that players will not be able to request withdrawal of funds directly through Absolute Poker, but instead via some third-party site.  Whether or not this structure makes it more or less likely Absolute Poker players will ever see their funds returned, I cannot say.  I suspect poker bloggers Grange95, Billrini, or F-Train to weigh in on this issue in the near future with quality insight.  These gentlemen possess as strong an understanding of the online poker industry as anybody.

One common aspect among all three agreements is the “Records Preservation” clause.  It is paragraph 3 in the Absolute Poker agreement.  The wording of this paragraph is unsurprisingly identical (besides the name of the companies, of course) in all three agreements.  Last night, I discussed various possible purposes of this paragraph with @AgentMarco on the live QuadJacks radio show.  In my opinion, there are two primary purposes:

  • 1) The DOJ doesn’t want the companies to start shredding documents that may contain incriminating evidence pertaining to the allegations in the indictments;
  • 2) The DOJ wants to leave open the possibility of handing these records over to the IRS.

Regarding #2, I explored the likelihood of this possibility at length by comparing the Poker Company case to a recent tax evasion case involving a giant offshore bank and many of its account holders.  My stance on the issue hasn’t changed since then, not that much time has passed.  While I haven’t heard of any online poker players recently receiving audit letters from the IRS, it’s still probably too soon to expect any that relate to the indictments.

As I say time and time again, the IRS typically treats taxpayers far more favorably when they voluntarily come forward to declare previously unreported income as compared to the IRS making that discovery.  Keep in mind that just because frozen online poker funds have not yet been withdrawn does not necessarily mean the funds are not considered income that tax should have already been paid on.  If a taxpayer has frozen funds that should have been reported as income in prior years, he/she should strongly consider consulting a tax professional experienced in the area to discuss particular facts and circumstances.

DOJ Reaches Agreement with Full Tilt and PokerStars

April 20th, 2011 No comments

Earlier today, the Department of Justice issued a press release announcing domain-name use agreements entered into with Full Tilt and PokerStars.  Read the respective agreements here and here.  The agreements restore access to these two sites to U.S. players only for purposes of facilitating the return of money that was frozen by the DOJ last friday.

This is great news for U.S. poker players who have funds frozen in accounts on these sites.  Although there hasn’t been any guarantee of fund retrieval, the news, at least on the surface, can’t be relatively any better, considering the state of affairs last Friday.  It’s looking much more likely the funds will be returned.

I say “on the surface” because of possible implications from the agreements.  In particular, observe paragraph 4 in each, entitled “Records Preservation.”  Essentially, Full Tilt and PokerStars are required to maintain all records relating to its business in the U.S.  Because the return of player funds will be overseen by a “Monitor” pre-approved by the DOJ, it is clear the DOJ will have access to these records of consumer activity on these sites.  Whether or not the DOJ decides to scrutinize the records or hand them over to the IRS, we probably won’t know for some time.

What’s also particularly interesting from the press release is the loud silence from the third offshore poker company whose domains were seized in the U.S., Absolute Poker.  The DOJ press release indicates that the same agreement offer was extended to Absolute.  I strongly suspect the reasons behind the delay of the agreement or rejection of the offer will emerge within the upcoming days.

All in all, a partial rebound from what my fellow Tweepers describe last friday as: #PokerPanic.

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