Tax Rules for Amateur, Professional Gamblers

When the economy goes in the tank, some people react by trying their luck at gambling. While losses are the usual outcome, some folks do get lucky. And there are professional gamblers out there, too. So what are the tax rules? Read on for the answers.

The most important thing to know is you can only deduct gambling losses for the year to the extent of your gambling winnings for the year. This limitation applies to the combined results from any and all types of gambling (including playing the lottery, slots, poker, bingo, betting on the horses, and all the rest). For example, say you win a total of $1,500 in various gambling activities and lose a total of $2,000. You can generally deduct $1,500 of losses to offset your winnings. The $500 of excess losses goes up in smoke. Sorry.

After applying the losses-cannot-exceed-winnings limitation, the allowable loss amount for a person who is not a professional gambler is claimed as an itemized deduction on Schedule A of Form 1040. Unfortunately, if you don’t itemize, you’re out of luck in the gambling loss deduction game.

But there is some good news. Your allowable itemized gambling loss write-off is not subject to the deduction phase-out rule that applies to some other itemized deductions (that phase-out rule is scheduled to disappear in 2010 unless Congress extends it). And you can deduct your allowable itemized gambling loss in full under the alternative minimum tax (AMT) rules.

However, an amateur gambler can’t deduct any out-of-pocket expenses related to gambling activities (such as transportation costs). These expenses are considered nondeductible personal outlays.

What about winnings? You must report the full amount as miscellaneous income on page 1 of Form 1040. If your winnings for the year exceed your losses, you can’t subtract your losses from your winnings and report the net winnings on page 1. Instead, you have to report all your winnings on page 1, and all your losses on Schedule A (assuming you itemize). If losses exceed winnings, you still have to report all the winnings on page 1 and losses up to your winnings on Schedule A (assuming you itemize).

Over the years, quite a few court decisions have tried to define what it takes to be a professional gambler. The bottom line is you must devote substantial time to gambling on a regular basis, and you must depend on gambling winnings as a meaningful source of income. It also helps if you can prove that you conduct your gambling activities in a business-like fashion by keeping detailed records of wins and losses and developing and evaluating strategies.

The courts have agreed with the IRS position that the aforementioned losses-cannot-exceed-winnings limitation on deductible gambling losses applies equally to professional gamblers and amateurs. Also, a 2007 court decision confirmed that a professional tournament poker player’s losses were subject to the losses-cannot-exceed-winnings limitation. The taxpayer argued that playing in poker tournaments was not really gambling, and that her losses were therefore not subject to the deduction limitation. The Tax Court said no such luck.

When an individual can rightly claim to be a professional gambler for tax purposes, gambling winnings should be reported as business income on Schedule C of Form 1040, and gambling losses should be reported as a business expense on Schedule C. This treatment is favorable in years when you have losses, because it ensures that you can deduct enough losses to offset all your winnings. (For amateurs, there is no such guarantee because losses must be treated as itemized deductions.)

However, the seemingly benign rule that a professional gambler’s winnings and losses belong on Schedule C can have a big negative impact in profitable years, because net Schedule C income gets hit with the dreaded self-employment (SE) tax. In some cases, the SE tax issue can make claiming professional gambler status more expensive than being an admitted amateur.

What about a professional gambler’s out-of-pocket expenses to conduct the business of gambling (transportation, out-of-town meals and lodging, and so forth)? In 2008, the IRS conceded that these expenses do not have to be combined with gambling losses in applying the losses-cannot-exceed-winnings limitation. In other words, a professional gambler’s garden-variety expenses to conduct the business of gambling can be deducted on Schedule C, under the normal rules for business expenses, without regard to gambling winnings. This is good news, because it allows those out-of-pocket expenses to shelter income from other sources (from investments, retirement benefits and so forth) in years when gambling losses exceed winnings.

Remember: The losses-cannot-exceed-winnings limitation still applies to a professional’s actual gambling losses (as opposed to out-of-pocket expenses).

Whether you’re an amateur or a professional, you must document gambling losses to claim any deductions for them, and it certainly behooves you to do so. In theory, every loss must be accounted for separately, and every win must be reported as income. Beware: For most types of gambling at a legitimate gaming facility, you’ll be issued a Form W-2G (Certain Gambling Winnings) if you win $600 or more ($1,200 or more from slots or bingo; $1,500 or more from keno). The IRS gets a copy of Form W-2G, so you better report that income on your return. For more record-keeping tips, see IRS Publication 529 (Miscellaneous Deductions).