Gambling and Taxes: Part 2

 Part 2
Netting Wins and Losses

     In Part 1 we reminded our readers that all gambling wins are taxable and must be included on line 21 of Form 1040. We also pointed out that gambling losses are deductible - but only as itemized deductions on Schedule A and only up to the amount of winnings reported. If you won a thousand and lost two thousand  - too bad. You can’t deduct more than the $1,000 you won. 

     Taxpayers sometimes argue mistakenly that, to be fair, they should be allowed to net together their wins and losses and report the difference as income. Will the results be the same? No, they won’t. The example that follows will illustrate the difference. IRS regulations do NOT allow this netting, and we all know why. IRS is in the business of collecting as much as they can to run the government, and they would collect less tax if netting were allowed.

     To illustrate this difference, lets take the next step and crunch the numbers on a very simple tax return. You’ll see that the amount of tax you would pay will differ under these two systems -  using IRS’s rules vs netting gains and losses, the method that seems fairer to many filers. Most people have more complex tax situations than this basic return, but the principle is the same no matter how complicated the rest of your tax return is. 

     To keep the calculations as simple as possible, our hypothetical gambler will be 24,  a renter, and single with no dependents.  His only income reported by payers to the IRS for the 2014 year was $35,000 of wages on his W2 and a $4,000 jackpot reported by a casino on Form W2G.

     When he won his jackpot, the workers at the casino advised him to keep a gambling diary for the remainder of the year. He did. It shows another $1,000 income from totaling his other winning sessions and $3,000 of losses from his losing ones. These amounts were not reported to IRS, but he was told he should voluntarily report his winnings on his tax return. Casinos don’t report losses to the government, and they only report wins of over $1,200. - now. This may change soon. More later on this.

     For 2014 the standard deduction for our young filer is $6,200. This is more than his $3,000 of gambling losses. Since he has no other itemized deductions like mortgage interest, and property tax, and large charitable contributions, he can not find more to write off by itemizing than the $6,200 standard deduction. You should always pick the bigger number. Since he can’t write off more than $6,200, there is no way he can deduct his gambling losses. The $3,000 loss goes to waste. This is the bad news that tax preparers hate having to tell you.

     In most gamers’ minds, the FAIR amount of gambling income to pay taxes on would be $2,000. (The $4,000 jackpot reported to the IRS by the casino, plus the $1,000 other winnings not reported to the government by but which he included voluntarily, minus the $3,000 in losses substantiated by his gambling diary and the win/loss statement for the year by the casino). The IRS regulations, however, say he has to pay tax on $5,000 of gambling income. (The $4,000 reported on the W2G and the $1,000 of additional gambling income from his records.) 

     Taxes are figured for our filer by adding all his taxable income, subtracting the$6,200 standard deduction (or the total itemized deductions if larger), subtracting $3,950 personal exemption, and looking up the amount remaining in the tax table.

     If you do the math the IRS way, you have $29,850 to look up in the tax table and the total federal tax will be $4,043. If you had been allowed to net the gains and losses together and calculate the tax on the difference, you’d have $26,850 to look up the tax on and your total federal tax would have been $3,570.  The difference is $473. That’s $473 more tax you’ll have to pay.

     Here’s more bad news. No taxes were withheld when you won that casino jackpot. So, you will probably owe money when you file. That’s money you have to come up with somewhere. Maybe you could go back to the casino where you won the jackpot and try to win another one!

     And there’s still even more bad news. If you live in a state that has a state income tax (which is any state other than Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming -- or Tennessee and New Hampshire which only tax interest and dividend income) the amount of income your state tax is calculated on will be $3,000 more than if you had been allowed to net gains and losses. So not only will most people pay more federal tax, they will pay more state tax also.

     And another problem many will have - probably not the gamer in this example, but filers with children or who have certain deductions, credits, or exclusions based on  their Adjusted Gross Income - inflated AGI will reduce many of these benefits. Taxpayers who qualify for the Earned Income Credit, or Child Tax Credit, or Adoption Credit, or various other credits will find the extra income reported on their return reduces the amount of credit they qualify for.

     And it doesn’t get better when you are older. My husband and I are both over 65 and have higher standard deductions as a result. Instead of $12,400, our combined standard deduction is $14,800 so there is even less likelihood that we can itemize and deduct our losses. In addition, we have enough other income that we have to pay federal tax on much of our Social Security income. The portion of our Social Security that is taxed also rises with higher AGI.

     As you might expect, the taxpayers who benefit from itemizing and can deduct their gambling losses are the ones with the large mortgage interest and property tax payments exceeding their standard deductions. Isn’t it funny how so many tax breaks seem to help out the wealthier filers but not the middle class or struggling wage earners!

     IRS may do something about the unfairness of taxation on gambling income in the near future. They may make things worse. I will be posting news about proposed changes to the gambling regs in a few weeks after this year’s returns are filed. I’ll also be providing you with an address where you can mail your comments and suggestions if you have ideas for ways the system can be improved. Stay turned.