Since gambling winnings are normally considered miscellaneous income for casual gamblers, they are not subject to self-employment tax. However, professional gamblers do incur self-employment tax on a gambler tax return. For additional information, see IRS Chief Counsel Memorandum on Professional Gambler’s Wagering Losses and Business Expenses.

Gambling income, unsurprisingly, is subject to income tax. This post is an overview of federal and Michigan treatment of gambling income and losses.

FEDERAL TAX TREATMENT OF GAMBLING INCOME & LOSSES

On your federal income tax return, you can take an itemized deduction for gambling losses, but only to the extent of gambling income (in other words you can’t claim an overall loss on gambling activity).

1. One of these areas is certain gambling prizes. Lottery winnings are subject to 25% federal tax withholding if the amount won is $5,000 (or more). Additionally, all income earned in the United States is subject to the income tax, unless Congress specifically exempted it. Gambling income has not been exempted.
2. If the amount is subject to self-employment tax, enter 1 in the SE Inc? To indicate 100 percent excludable gambling income, enter code 1 in the State Use field.

Example: John likes to play blackjack and had winnings of $40,000 in 2009. He also lost $90,000 in the same year. John has to report his $40,000 winnings as income, but he can only deduct $40,000 of his gambling losses because gambling losses are limited to gambling winnings. Excess gambling losses cannot be carried forward.

It should be noted that taxpayers must itemize to claim gambling losses.

Example: Joan won $4,000 in the lotto in 2009. She also lost $5,500 in other gambling activity during the year. If she does not itemize, she has to claim the $4,000 in income and cannot deduct the $5,500 in gambling losses—not a good result.

Even though the itemized deduction for gambling losses can offset gambling income, it is a below-the-line deduction (i.e., it is taken after computing AGI). AGI is used to calculate various phaseouts for credits and deductions. Therefore, gambling income may affect your phaseouts even though they are offset by gambling losses.

MICHIGAN TAX TREATMENT OF GAMBLING INCOME & LOSSES

In Michigan, gambling income is based on the amount of gambling winnings included in federal AGI (the bottom line of the first page of your Form 1040) without taking into account the itemized deduction for gambling losses. So, in the above examples, John has $40,000 in gambling income on his MI-1040 and pays $1,700 in tax and Joan has $4,000 in gambling income on her MI-1040 and pays $170 in tax even though both John and Joan had overall gambling losses.

To get around this unlucky result, the strategy is to use gambling losses to directly offset gambling income, rather than take gambling losses as an itemized deduction. There are two ways to do this:

* Special Rule for Slots and other Casual Gambling

* Becoming a professional gambler (harder than you think and will not be discussed here)

SPECIAL RULE FOR SLOTS AND OTHER CASUAL GAMBLING

Generally, gambling winnings and losses have to be determined on a wager-by-wager basis. For causal gambling (slots, poker, blackjack, horse racing, etc.) you can determine gambling winnings and losses on a net daily basis. By figuring gambling income on a daily basis (rather than wager-by-wager) gambling winnings are directly offset by gambling losses (and thus become excludable from Michigan income tax).

Example (wager-by-wager basis): Jimmy goes to the casino on Friday and buys $1,000 in tokens to play slots. He has $9,000 in winning spins and $6,000 in losing spins. He cashes out on Friday with $3,000. Jimmy wants to continue his winning streak on Saturday. He buys $4,000 in tokens. This time Jimmy has $1,000 in winning spins and $5,000 in losing spins. He leaves the casino with nothing.

On a wager-by-wager basis, Jimmy has $10,000 in winning spins over the two days and reports this amount as income. Jimmy has $11,000 in losing spins over the two days and deducts his losses as an itemized deduction (limited to the $10,000 in gambling winning). However, on Jimmy’s Michigan tax return, he must report the $10,000 as income, but cannot take a deduction for gambling losses.

Gambling Income Tax Return

Same Example (daily basis): Jimmy’s daily gambling winnings and losses are netted. Jimmy has overall income of $2,000 on Friday (Cash Out: $3,000 & Cash In: $1,000) and an overall loss of $4,000 on Saturday (Cash Out: $0 & Cash In: $4,000). On a daily basis, Jimmy had $2,000 of gambling winnings on Friday and $4,000 of gambling losses on Saturday. On his federal return, he must report $2,000 of gambling winnings and gambling losses of $2,000 (again, the itemized deduction for gambling losses is limited to gambling winnings). On his Michigan return, he only reports the Friday daily winnings of $2,000.

Income Tax Gambling Deductions

It is CRITICAL that gambling winnings and losses be properly documented. The following information should be maintained in a log:

1. the date and type of specific wager or wagering activity

2. the name and address of the gambling establishment

3. the names of other persons present with the taxpayer at the gambling establishment

4. the amount won or lost

If you need help with small business taxes,

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Reporting Gambling Income

Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

In March 2006, I wrote about Renato Medina, the principal owner of Lucky Chance’s. Lucky Chance’s is a cardroom located in Colma, just south of San Francisco. Mr. Medina and his niece and nephew were accused of tax evasion and conspiracy. At the time, they all stated their innocence. Mr. Medina’s attorney (then) said, “This is a simple tax case…[and Mr. Medina] asserts his innocence.”

Not anymore. As part of a plea agreement, Mr. Medina pleaded guilty to three counts of tax evasion (the remaining charges were dropped). He agreed to pay back the back taxes, penalties, and interest, which will likely total about $1 million.

Mr. Medina’s arrest and the charges stem from a corruption probe of the small town of Colma. The first victims were two former mayors of Colma, Philip Lum and Ronald Maldonado. Both were accused of accepting free airline trips to the Philippines from Mr. Medina but not disclosing the gifts on required disclosure forms.

Mr. Medina has also agreed, as part of his plea deal, to serve between 15 and 21 months at ClubFed. Additionally, under California law he must give up his 100% ownership of Lucky Chance’s. That had already been in the works, ostensibly for estate planning reasons, with the ownership transfer to his sons approved by both Colma and the California Gambling Control Commission.

Finally, Mr. Medina asked the government to drop the charges against his niece and nephew. The Department of Justice has yet to decide whether or not to do so.
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