Page 2 - Taxation of Gambling Income

■ Expertise of the taxpayer or his advisors as a return a percentage of the winnings. professional gamblers making payments
■ Time and effort expended by the tax- Such relationships can raise questions under staking agreements to foreign payees
payer in carrying on the activity regarding the gambler’s withholding and should withhold on such payments regard-
■ Expectation that assets used in the activ- reporting requirements, especially if the less of whether the games occurred within
ity may appreciate in value benefactor is a foreign individual. or outside the United States.
■ Taxpayer’s success in carrying on sim- A payment to a foreign individual or If the payee of the staking agreements
ilar activities entity is subject to a 30% withholding tax is also a professional gambler, he may be
■ Taxpayer’s history of income or losses if the payment is fixed or determinable able to claim that the payments are effec-
with respect to the activity annual or periodical income (FDAP) from tively connected with his U.S. trade or busi-
■ Amount of occasional profits, if any, that sources within the United States. The ness and thus exempt from withholding.
are earned Treasury Regulations broadly define Alternatively, the payee can claim that the
■ Taxpayer’s financial status FDAP, which courts and the IRS have held payments are subject to reduced or no with-
■ Elements of personal pleasure or recre- to include gambling winnings. A payor of holding based on an applicable income tax
ation. FDAP is treated as a withholding agent treaty between the United States and his
A professional gambler reports gambling and is required to file Form 1042-S, report- country of residence. In either circum-
income on Schedule C. In computing busi- ing withholding payments to each recipient, stance, the payments under the staking
ness income from gambling, the individual and Form 1042, summarizing all of its agreement may be exempt from withhold-
can net all wagering activity but cannot
report an overall wagering loss. In addition,
the individual can deduct any ordinary and
necessary business expenses, which can The tax consequences to an individual with gambling
include travel and meal costs, legal and
accounting fees, and subscriptions to gam- income and losses can vary significantly depending
bling magazines or services. In contrast to
the rule for recreational gamblers who are upon whether the individual participates in the
nonresident aliens, professional gamblers
who are nonresidents can deduct their gam- gambling activities on a recreational basis or
bling losses to offset their gambling win-
nings. as a professional gambler.
Prior to the TCJA, the Tax Court held
that a professional gambler with business
expenses in excess of net gambling win-
nings could report a business loss, which Forms 1042-S. Both forms must be filed ing if the payee provides the appropriate
would generate a net operating loss. The with the IRS for each calendar year by withholding certificate.
TCJA reversed this favorable treatment for March 15 of the following year.
tax years beginning after 2017 and before Payments made to a foreign person The Downside of Winning
2026. Under the TCJA, losses from any under a staking agreement would be treated The tax consequences to an individual
wagering transaction during those years as gambling winnings and thus subject to with gambling income and losses can vary
include any expenses incurred by the indi- withholding if sourced in the United States. significantly depending upon whether the
vidual in connection with the conduct of Payments made pursuant to these staking individual participates in the gambling
gambling activity. Accordingly, a profes- agreements for games played in the United activities on a recreational basis or as a
sional gambler with business expenses in States would be U.S.-source income gen- professional gambler. CPAs whose clients
excess of net gambling income would erally subject to 30% withholding. have gambling income and losses will
report a net profit of zero on Schedule C. Payments made under a staking agreement need to understand the specific manner in
for games played by a U.S. person outside which those clients engage in such activ-
Potential Withholding Issues the United States could arguably be ities and, in certain circumstances, whether
Certain professional gamblers—especial- sourced outside the United States and thus they have additional reporting and with-
ly poker players—will enter into “staking exempt from withholding; however, there holding requirements. ❑
agreements” with benefactors, in which the is no clear authority stating whether the site
benefactor financially sponsors the profes- of the game or the residence of the payor Eric Smith, JD, LLM, is counsel at
sional gambler and, in exchange, receives is the decisive factor here. Accordingly, Kostelanetz & Fink, LLP, New York, N.Y.

DECEMBER 2019 / THE CPA JOURNAL 83