[IMGCAP(1)]It’s March and the college basketball tournament season is upon us. It is estimated that over $12 billion will be wagered on the NCAA tournament (compared with $10 billion on the Super Bowl).
The amount of entry fees received by daily fantasy sports (DFS or gaming) sites, where entrants create their own teams of actual athletes, might be even higher. Both DraftKings and FanDuel (two DFS sites) are valued at over $1 billion.
So with all those wagers and entry fees flowing from losers to winners, how do gamblers and players account for them tax-wise?
Bottom line is that all (potentially net) gambling winnings and prizes received from DFSs are taxable as ordinary income. The difference between gambling and DFS is in the details of how earnings and losses are reported to the gamblers and players, and how those individuals report those amounts on their tax returns.
Gambling winnings are reported on Form W-2G, in general. An office pool would generally be considered gambling, if the pool is merely a contest where each participant chooses a specific team to win and the winnings are based on how many players enter.
If you are participating in an office pool, the person paying out the winnings will have to submit a W-2G to the IRS, and send a copy to you, if your winnings are $600 or more and at least 300 times the amount wagered.
Even if the payer does not have to fill out a W-2G, your winnings are still taxable. Gross winnings are reported as “other income” on Form 1040.
You might be able to take advantage of your gambling losses. You can deduct your losses for the year, but only up to the amount of your winnings and only if you itemize your deductions. These gambling losses are considered miscellaneous itemized deductions, but they are not subject to the rule that bars most miscellaneous deductions unless they exceed 2 percent of your adjusted gross income (AGI).
Since the IRS only receives evidence of your income, and not expenses, you are responsible for keeping your own records of amounts wagered. That is the hard part.
If you entered an office pool, you probably didn’t receive a receipt showing your participation. And if you lost $100 at the slots in Vegas, you don’t have a receipt of that either. Lottery tickets and horse racing betting stubs are about the only receipts out there. The IRS has some guidelines for proving gambling losses, such as keeping a diary, but the burden of proof is on the taxpayer.
Winnings from DFS sites are not reported on Form W-2G. Instead, they’re reported on Form 1099-MISC as “other income,” assuming the net amount is greater than $600. The reason for this difference is that the players on DFS sites compete for a predetermined prize and their entry fees are not added to the pot. In addition, the DFS sites are designed to maximize the role of skill in determining the outcome.
Check a DFS’s website to see how it reports income on the 1099-MISC. One method of reporting is the net cumulative method, where income = prize winnings - entry fees from all games that a player entered + any site bonuses earned.
However, in a 2005 ruling, the IRS said that a taxpayer operating an online game-playing website should use the net method, where income = prize winnings - entry fees from each game where the player received a prize + any site bonuses earned. In that ruling, the IRS did not allow the taxpayer to use the net cumulative method.
Since this was a private letter ruling, DFS sites that were not party to the ruling are not bound by it. But this does indicate there is some uncertainty in how the IRS might want DFS sites to report.
One rub with DFS sites is the winner might also receive a 1099-K from his payment settlement entity (such as PayPal) if the number of transactions between the DFS and the player is greater than 200 and the total payments are greater than $20,000. The amount shown on the 1099-K might be different than the amount shown on the 1099-MISC because it will not be netted for entry fees. The player will have to keep good records to be able to reconcile these forms if the IRS were to ask.
How do you report losses from DFS sites? Just as the correct way for DFS sites to report net income is unclear, it is unclear which method players should use to net out income and losses from different DFS sites.
Suppose you receive a 1099-MISC from DFS1 for $1,000 because you paid a $1,000 entry fee and you won $2,000. You also tried your hand at DFS2, where you paid a $1,000 entry fee but did not win a game. So you do not receive a 1099-MISC from DFS2. How do you net these two transactions, if at all? There are potentially four ways.
One is to net the two on line 21 of Form 1040 and not report any “other income.” This would be similar to the way one DFS, using the net cumulative method described above, would report net earnings if the taxpayer entered two contests, paying a $1,000 entry fee for each contest and winning $2,000 at one and nothing at the other. Since the IRS disapproved the net cumulative method in the 2005 ruling, it might also disapprove of this method of reporting.
A second way would be to report $1,000 of income on line 21, and $1,000 as a miscellaneous deduction subject to the 2 percent AGI floor on Schedule A. The reasoning here is that the entry fee is an expense for the production of income, rather than a gambling loss.
A third would be to report $1,000 of income on line 21, and $1,000 as a miscellaneous deduction not subject to the 2 percent AGI floor (remember that gambling losses are not subject to the 2 percent floor).
The last would be to report both winnings and losses as part of a business on Schedule C. This presents two problems, though.
One is that to report on Schedule C, you must truly be engaged in a trade or business. This means you must spend extensive time on online gaming and conduct the activity in a businesslike manner, with the primary goal of profit rather than recreation. Each case turns on its individual facts and circumstances, so there are no hard and fast rules.
The second problem is that once you do report income on Schedule C, that income is subject to not only income tax but also self-employment taxes.
Because of the uncertainty of how to report losses, as well as the necessity of keeping good records in order to report losses, it is highly recommended that gamblers and gamers work with an accountant when they fill out their tax returns.
Note that this article doesn’t address the legality of gambling and gaming in any state. Regardless of legality, gambling and gaming winnings are taxable!
Michael Sonnenblick, J.D., LL.M., currently serves as an editor/author with Thomson Reuters Checkpoint with the Tax & Accounting business of Thomson Reuters. Michael holds a J.D. degree from Boston University School of Law and an LL.M. in Taxation from New York University Law School. A member of the New York Bar, Michael has 20 years of tax experience, including service with a major Wall Street bank and international law firms. In addition, he has represented clients before the IRS. Michael’s specialties include individual taxation and retirement planning.
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