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Safe Bet: IRS Won't Get Gambling Winnings

By Kay Bell

Picked the Super Bowl winner yet? As the game nears, millions of Americans are choosing, and betting on, their favorite to take home the Vince Lombardi Trophy this year.

Many are just friendly wagers -- a dollar in the office pool or a good-natured bet with the neighbor who's jumped on that overcrowded Patriots' bandwagon.

But other football fans are taking the game more seriously and handing over big bucks to bookmakers, both legal and not-so-legal. All these Super Bowl wagers spotlight a persistent Internal Revenue Service problem: tracking and taxing gambling winnings.

It's a challenge the agency faces daily, because many people don't realize that gambling winnings are taxable. Of those who do, a good portion simply choose to ignore the law.

Admittedly, the IRS is playing catch-up here. While the U.S. income tax is a 19th century creation, gambling has been around at least since man was able to record his activities. Dice almost identical to those used on today's gaming tables have been recovered from Egyptian tombs, and the Chinese, Japanese, Greeks and Romans all were known to play games of chance as early as 2300 B.C.

Nowadays, in addition to the well-publicized offerings of Las Vegas, Reno and Atlantic City, betting is commonplace throughout the United States. The choices range from off-track betting parlors to tribal bingo games to riverboat casinos to state-operated lotteries.

Online gambling down, but not out
Then there's online gaming. A June 1999 Washington Post article reported "at least 140 Web sites now offer some form of wagering to online users -- an expansion in recent years that has alarmed opponents and put increased focus on the laws that govern Internet gambling." By 2005, research firm Christiansen Capital Advisors estimated that nearly 23 million people gambled on the internet, with approximately 8 million of those gamblers from the United States.

It's easy to see why the numbers have grown so much. Type "online gambling" into any Internet search engine and within seconds you'll have a list of hundreds of thousands of potential gambling sites. This is in spite of the Unlawful Internet Gambling Enforcement Act, which was passed without much fanfare and signed into law in late 2006 in an effort to restrict U.S. gamblers' access to these typically foreign-based Web sites. It is now a federal crime for U.S. banks and credit card companies to process Internet-bet payments.

But even before the law was enacted, U.S. law enforcement officials argued that Internet gambling was illegal under the 1961 Wire Act. In recent years, many credit card issuers already had halted such transactions, citing risk factors if the cardholder disputes or refuses to pay the charges.

The latest antigambling law and associated enforcement efforts are getting mixed reviews and equally mixed results.

Some companies have curtailed their U.S. betting operations. Following the arrest in July 2006 of its CEO, the once ubiquitous BetOnSports.com halted its U.S. operation, which accounted for around three-quarters of its business, closing offices in Costa Rica and Antigua, which was the base of its American service. Other legal troubles subsequently shut down the entire company. But that victory by anti-gambling forces was tempered by the World Trade Organization ruling against the United States in a dispute over Internet gambling operations based in Antigua.

"America's prohibition in the provision of gambling services from other countries violates the U.S. commitments to the WTO," said the Caribbean island's representative Mark Mendel. Since the 2006 law allows online wagers on horse and dog racing, Antigua successfully argued that the statute unfairly forbids international companies from competing in the U.S. market.

Meanwhile, U.S. officials are just getting around to creating rules to implement the Unlawful Gambling Enforcement Act passed in 2006. The regulatory goal is to block online gambling by disrupting the credit card payment process. The Treasury Department and Federal Reserve Board issued a first draft last October. The comment period ended in mid-December, with most finding the proposed rules wanting.

A common problem cited by reviewers was the vagueness of what constitutes gambling. Many noted that various U.S. governments, federal as well as many states, recognize and even support or operate gambling enterprises, ranging from state lotteries to tribal casinos.

And as the international legal and domestic regulatory wrangling continues, online gambling sites and their cyberpatrons are adapting. Some sites have introduced dedicated debit cards and alternative, although circuitous, e-payment and electronic wallet services. It's a good bet that millions of U.S. customers will be utilizing them Super Bowl Sunday, the biggest global betting day of the year.

So many events, so many bets
Combine all these gambling options with Americans' love of athletics, and betting on sporting events has arguably become the true national pastime. If you want to keep your sports wagering domestic, legal betting on athletic events is allowed only in Nevada.

Las Vegas alone draws millions of visitors each year expressly for that purpose. Clark County, Nev., in which the world-famous Vegas Strip is located, reported that in 2006, visitors spent $10.6 billion on gambling, ranging from casino games to bets on professional and collegiate competitions.

The Super Bowl is the single biggest one-day sports betting event of the year, with the men's collegiate basketball championship each spring always a close second in gambling activity. Worldwide, over 200 million individuals are expected to wager more than $10 billion on Super Bowl XLII.

In the United States, Pregame.com president RJ Bell expects "over 50 percent of all adult Americans will risk money on Super Bowl XLII."

The greater-than-usual interest, says Bell, comes from having a team seeking a perfect record facing a team from New York, the nation's No. 1 market. That's likely to set a betting record of more than $100 million in Nevada alone; the record is $94.5 million for Steelers-Seahawks in January 2006.

The dollars add up because there are countless ways to get a piece of the action. The Patriots are 11-to-13 point favorites, but wagers aren't just placed on the eventual winner. You can bet on who will catch the first pass, who will rush for the most yardage (team and individual), who will get the first sack. Known as prop bets, short for proposition bets, there are approximately 300 unique ways to gamble on the big game.

Essentially, if it happens (or could happen) in a football game, the Nevada sports book operation will take a bet on it.

But casino bets aren't a real concern for the IRS. The tax man has a way to track legal athletic wagering. In fact, it was IRS rules requiring taxpayer data that helped the horse racing industry discover a scheme to illegally claim $3 million in Breeders' Cup payouts back in 2002.

It's a dicier tax-collection proposition, however, when it comes to bets placed at increasingly popular offshore sports-betting operations, dollars dropped into friendly office pools and illegal wagers handled by bookies. These bets, according to the American Gaming Association, represent more than 99 percent of all sports betting nationwide. The National Gambling Impact Study Commission estimates that translates to as much as $380 billion annually in illegal wagers.

Why the bells go off
Legal betting operations -- state lotteries, casinos and horse racing tracks -- are regulated. One of the government agencies that has a say in these operations is the IRS.

"That's why the bells go off when you hit the slots," says John Shelk, a former executive with the American Gaming Association. "So someone can get there to get your tax information."

In some cases, Uncle Sam even gets his cut (25 percent on most winnings) before you get your payout. That's the case for winnings of more than $5,000 from any sweepstakes, wagering pool or lottery; withholding also is collected on proceeds that are 300 times or more the amount of the bet. Gambling winnings from bingo, keno and the slots are not generally subject to withholding, but you're still required to provide your tax ID. If you refuse, the casino can assess backup withholding of your jackpot at a 28-percent rate.

And beginning this March, the IRS will require all poker tournament sponsors to report tournament winnings of more than $5,000. The new reporting requirement (Rev. Proc. 2007-57), aimed at poker tournament sponsors, including casinos, will help the IRS ensure that card game winners are including their winnings on their annual tax returns.

Those poker tourney winnings, along with your jackpots from the casino or horse track or lottery dealer, will be recorded on a Form W-2G showing how much you won and how much, if any, was withheld for federal taxes. And like all other income reporting forms, a copy will go to the IRS.

But, Shelk notes, there's a distinction between what's reportable and what's taxable. All gambling winnings -- regardless of the amount -- are taxable. But it's ultimately the winner's responsibility to let the IRS know how much was won, even if the casino doesn't have to file a W-2G. This reliance on the gambler's tax-law compliance is where the IRS frequently gets shortchanged.

How tempting is it to assume the IRS won't miss a small jackpot? Apparently pretty darn appealing.

"On a trip to Vegas, I won $146 at a slot machine," admits a chagrined economics professor who, because he teaches at a church-financed university, asked that his name not be used, "and I didn't report it on my tax return."

Making a bad day at the track pay off
The professor's tax reporting inclination is one shared by many gaming winners, but not all.

IRS analysis of 2005 returns, the latest year for which data are complete, shows 1.8 million taxpayers reported almost $25 billion in gambling income; compared to 2004, that's a slight increase (5.8 percent) in the number of returns reporting gambling income and an almost 9 percent hike in dollars won. This includes winnings from casinos and horse tracks, lottery and raffle jackpots, as well as the fair market value of cars, houses and other noncash prizes.

As for how many taxpayers didn't bare all about their betting at tax time, the IRS won't even venture a guess. "We can't tell you what we don't know," says an IRS spokesman.

But the IRS has a tax break for conscientious taxpayers who report their gambling income on line 21 of their Form 1040. They can subtract any gambling losses from winnings if they itemize. For many, that's a good deal. Just over 1 million gamblers in 2005 made their good luck less taxing by claiming slightly more than $16 billion in bad bets.

Losses to reduce gambling winnings don't have to be from the same game. If you go to the race track every weekend and drop $1,000 but then win $3,000 on the World Series, those losing horse betting slips can reduce the amount of baseball winnings on which you'll owe tax.

There are a couple of ground rules to keep in mind here. First, you can't claim more in losses than you've won. And, as with any tax deduction, you need to keep records of your losses that will satisfy the IRS if you're ever audited.

Good records are the best bet
Your best bet is to keep track of gambling losses as you go through the year so you're not scrambling to reconstruct them if you do hit it big.

Such reconstruction efforts not only are difficult, they aren't likely to pass IRS scrutiny. Tax professionals recall a horse race fanatic who went to tax court with bags full of losing betting slips to support his large deduction against his winnings.

It didn't work; almost every ticket was covered with footsteps of the other bettors who tossed the tickets when their horses didn't win. He ended up paying the extra tax -- and penalties.

"It's not a tax myth, but it is an old story," says Don Roberts, who saw similar actions when he was an IRS agent in Saratoga, N.Y.

"And if you don't have a big win to offset," Roberts adds, "then the receipts can be your ticket to Gamblers Anonymous."