For gamblers, the tax code offers unfavorable odds. Win, and you owe tax at your ordinary income rate, now as high as 35%. Lose….and you lose. There is no tax benefit.
However, savvy gamblers can offset taxable winnings with their losses if they can document those losses. The better your recordkeeping, the less tax youâ€™ll ultimately owe if you should happen to get lucky.
Casual gamblers (that is, persons not in the trade or business of gambling) should report any gambling winnings on line 21 of Form 1040 under â€śother income.â€ť Those winnings include money won at a casino or race track. Lotteries, bingo, raffles, etc., are all considered gambling, so you must report any success in those areas.
Example 1: Paul Sawyer wins $1 million in the lottery, payable over 20 years. In 2012, Paul sells the rights to his future payments for $400,000. On his 2012 tax return, Paul reports $400,000 of gambling winnings. (If Paul had chosen to receive $50,000 per year, he would report $50,000 on his 2012 tax return.) According to cases such as U.S. v. Maginnis, decided by the Court of Appeals for the Ninth Circuit in 2004, money received from such a sale is taxed as ordinary income, so sellers wonâ€™t get the favorable tax rate on long-term capital gains.
Youâ€™ll also owe tax if you win a prize instead of cash. Typically, the entity awarding the prize will put a fair market value on the car, trip, or other item and report that to the IRS on Form 1099. Youâ€™ll owe tax on the reported amount. If you think the value is overstated, you can report a lower amount, but you should be ready to support your claim to the IRS, if challenged. For example, make sure you can prove you sold the â€ś$2,000 flat screen TVâ€ť you won to an unrelated third party for $1,200 immediately after you received it.
Reporting and withholding
Tax payers are supposed to report gambling winnings, like all forms of income, in full. To help enforce compliance, the gaming establishment must report certain winnings to the IRS on Form W-2G. For example, winnings (not reduced by the wager) of $1,200 or more from a slot machine must be reported; the same is true for winnings (reduced by the wager or buy-in) of more than $5,000 from a poker tournament. In many cases, 25% will be withheld and sent to the IRS on winnings over $5,000.
Taxpayers who do not provide a Social Security number when requested may be subject to 28% backup withholding.
Regardless of whether anything was withheld, you must report all of your gross gambling winnings on line 21 of Form 1040. This is not where you net your gambling winnings and losses.
Listing your losses
In order to get any tax benefit from gambling losses, you must itemize deductions on Schedule A of Form 1040. If you take the standard deduction instead, youâ€™ll owe tax on the full amount of your gambling winnings.
On Schedule A, you can list all your gambling losses. In effect, this will trim the tax on your gambling winnings. You can claim losses up to the amount of gambling winnings you report. Keep in mind, though, the trade-off is not perfect because gambling winnings increase your adjusted gross income (AGI), and a higher AGI may reduce your ability to claim various tax deductions and credits.
Example 2: Joan Miller reports $10,000 of poker winnings on line 21 of her 1040. On Schedule A, Joan claims $6,000 of losses from poker, other table games, and horse racing bets. In effect, Joan winds up paying tax on $4,000 of gambling winnings.