The taxation of gambling winnings is widely misunderstood (or at least widely not followed). Gambling gains are included in gross income, reported on “other income” on form 1040. Losses from gambling are allowed to the extent of gambling gains, but only as an itemized deduction. The amount spent to generate any win reduces the win. For example, a single one dollar bet that wins twenty dollars results in $19 of income reported on the front of form 1040. If the gambler has up to nineteen $1 dollar bets that were losers, the $19 of lost bets can offset the income, but this assumes that the taxpayer itemizes deductions. Additionally, the myriad of tax limitations that are based on adjusted gross income are increased by the gambling winnings reported as other income, but not offset by the Schedule A deduction.
The courts and the Internal Revenue Service (“IRS”) acknowledge that tracking each play at a slot machine is “unduly burdensome and unreasonable”. The IRS requires a diary of gambling activity that is way more detailed than the typical player keeps (of course, most players keep no meaningful records at all). Consequently, the only records that usually exist involve individual wins of $1,200 or more, which requires the payer (casino) to issue Form 1099-G.
Realizing the lax (at best) reporting of gaming winnings, the IRS proposed new regulations that are rattling the casino industry. IRS Notice 2015-21 provides for mandatory electronic player tracking for tax reporting using player loyalty cards and considers lowering the winnings threshold from $1,200 to $600. Importantly, the proposal mandates a “session” of play which requires separate tracking, as follows:
“A session of play begins when a patron places the first wager on a particular type of game and ends when the same patron completes his or her last wager on the same type of game before the end of the same calendar day. … A session of play is always determined with reference to a calendar day (24-hour period from 12:00 a.m. through 11:59 p.m.) and ends no later than the end of that calendar day.”
The American Gaming Association (“AGA”) is the national trade association which represents licensed Tribal and commercial casino operators and gaming suppliers. Not surprisingly, the AGA has objected to these new regulations. Some of its objections include:
- New tax information reporting rules fail to consider the diversity of the gaming establishments serving the marketplace, including high-end gaming centers, regional markets, largely local markets and riverboats.
- Some of these entities may not have the financial resources to implement these requirements.
- Existing controls were not designed with this type of compliance in mind.
- Proposed mandatory slot tax information reporting based on electronic casino player tracking will hurt industry revenues.
- The machines will have to go offline upon a $1,200 win in order to gather needed information, i.e. the casino industry will be forced to take assets out of production in order to be compliant with reporting requirements.
- The association between customer loyalty cards and tax tracking will have a “chilling effect” on the use of loyalty cards, a “crucial casino marketing tool”.
- A reduction from $1,200 to $600 for the reporting threshold would result in a dramatic increase in required reporting (calculated by AGA members as ranging from 113 percent to 550 percent), resulting in increased labor costs coupled with additional time that slot machines are required to be offline. Notably since the $1,200 threshold has been in place for 38 years, the AGA reports inflation would suggest an increase to $4,700 is more appropriate than any reduction.
- The fact that most players are in a losing position at year end suggests that the additional paperwork will not yield sufficient additional tax revenues after losses are offset.
Reporting systems and an associated system of internal control designed with one purpose in mind are not necessarily sufficiently stringent or effective for another purpose. The AGA calls the current tracking “an unaudited estimate that is given to customers as a courtesy”. An important aspect of assessing the appropriateness of the strength of internal controls is to understand the materiality of a potential error. The risk of improper tax reporting is far greater than the risk of improperly compensating a patron through a reward program. For instance, the existing controls do not adequately prevent multiple members of a family from playing on one loyalty card in order to amass “comps” or someone from playing on a card misplaced or left behind in a machine such that a card improperly accrues wins or losses.
But, the real issue is that gamblers’ slot machine activities will likely change if one actually had this type of reporting to the IRS. The ability to market to casino patrons and the type and rate of play will likely be affected by the proposed changes as they currently stand.