Taxation Law (TA)

The recently amended Expanded Gaming Act[1] in Massachusetts provides additional clarity regarding certain tax rules associated with gambling income for recipients of Massachusetts source gambling income for Massachusetts residents and nonresidents. The Department of Revenue released Technical Information Release 15-14 in November, 2015 which provides some new Massachusetts tax rules and withholding and reporting requirements that apply to gambling income. It also adopts changed winning amount thresholds for gaming establishments to use when checking into unpaid child support or taxes prior to the payment of winning amounts to the taxpayer.

Expanded gaming in Massachusetts means the tax practitioner or preparer will have more clients with gambling winnings to report, and perhaps deductions that may be claimed against that income.  Especially with the holiday season coming to a close, (which tends to be “high season” for gaming establishments), and tax preparation season right around the corner, it may be helpful to review the key federal tax rules associated with gambling income and review the recent Massachusetts changes in this area too.

Federal Rules

Gambling winnings are taxable income and are included on line 21 (“Other Income”) on Form 1040.[2] Gambling losses may be deducted, but to do so, the taxpayer must itemize.  The amount of gambling losses allowed is limited to the amount of gambling income received[3] (so it isn’t possible to report a “net” gambling loss).  In addition, losses from one year may not be carried over into a subsequent year to offset winnings.[4]  Deductible gambling losses are shown on Schedule A, line 28 (“Miscellaneous Deductions). Such deductions are not subject to the 2% floor limitation. In addition, the net amount for the year should not be reported as income[5] but the gross amount should be shown on line 21 (with any deductions separately shown on Schedule A).

Documentation

Current IRS guidance is helpful in not only documenting the amounts reported on the taxpayer’s return, but also in advising taxpayers who gamble about what type of documentation to maintain and request from the gambling establishment in order to ensure proper required tax records exist for amounts reported each year.

Established IRS guidance[6] indicates that a diary, journal or other similar record should be regularly maintained by the taxpayer, which should include the following information.

•  ·       The date and type of specific wager (ie. taxpayer’s bet) or wagering activity, and the amount won or lost
• ·       The name and address of the casino or other gambling establishment
• ·       Names of any other persons present with the taxpayer at the casino or gambling establishment

In addition, the diary or journal should be supplemented by other verifiable information, which may include items such as Forms W-2G, Certain Gambling Winnings, Form 5754, Statement by Person(s) Receiving Gambling Winnings, cash window tickets, cancelled check images, credit records, bank statements and statements of winnings or losses issued by the gambling establishment.  In addition, where possible, the diary and journal should also be supplemented by corroborating information regarding the taxpayer’s visit to the gambling establishment. Such additional documentation may include hotel invoices, airline tickets or other travel receipts, or restaurant receipts from meals purchased within the gambling establishment.

 

Forms W2-G and 5754

Generally, the gambling establishment is required to issue Form W2-G to report a taxpayer’s gambling winnings in the following circumstances.

•  ·      Winnings of $1,200 or more from bingo or a slot machine
• ·       Winnings of $1,500 or more in a keno game
• ·       More than $5,000 of winnings in a poker tournament

 

Note that in calculating the above amounts, the amount won is not reduced by the amount wagered (ie. bet) by the taxpayer.  In addition, if there are multiple winners, the overall amount won by the winners collectively determines whether reporting requirements are met.  The amount won is not first allocated among the winners to determine if each winner meets these thresholds.

Form 5754 is used to allocate winnings among multiple winners of a single wager. This form is also used if the person receiving the winnings is not the winner who will report the winnings. This form serves to disclose the necessary tax identification information of each winner and the amount allocated to each. The gambling establishment will prepare individual Forms W2-G for each of the winners based on the amounts indicated on Form 5754.  

In addition, for winnings from gambling activities other than bingo, slot machines, keno or poker), Form W2-G is also generally issued in instances where the winnings are $600 or more and are at least 300 times the amount wagered by the taxpayer. Under this rule, it is up to the gambling establishment whether to reduce the amount of winnings by the wagered amount. 

In addition, the taxpayer is required to report all gambling income on line 21 of Form 1040 (regardless whether all amounts have been reported on Form W2-G).

 

Tax Withholding

Generally, regular gambling withholding is a flat rate of 25%.  Any amount of tax withheld is also shown on Form W2-G. The rules regarding withholding that a gambling establishment is generally required to follow is summarized as follows.[7]

 ·      Regular gambling withholding does not apply to bingo, keno, or slot machine winnings or to amounts of winnings that are $5,000 or less (when reduced by the amount of the taxpayer’s wager) but does apply to such amounts greater than $5,000

 ·       Withholding is required for winnings (minus the taxpayer’s wager amount) greater than $5,000 from pari-mutuel pool gambling such as horse racing, or other wagering pools.

 ·      The 25% flat amount of regular gambling withholding is calculated as 25% of the entire winning amount (reduced by the taxpayer’s wagered amount); it does not get calculated on only the amount above $5,000.[8]

Another type of withholding that may apply is backup withholding. Both backup and regular withholding should not apply to the same amount. Backup withholding generally applies if the taxpayer does not provide an accurate TIN to the gambling establishment and regular withholding is not used. The backup withholding rate is 28% and applies to the same winning amounts from bingo, keno, slot machines, and pari-mutuel bets as the guidelines above for regular gambling withholding.

Foreign persons (such as a nonresident alien or foreign entity) do not receive Form W2-G.  Instead, gambling winnings to foreign persons are subject to a flat 30% withholding under the rules for tax withholding for nonresident aliens.[9]  The amount of withholding is generally reported on Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and Form 1042-S, Foreign Person’s U.S. Source income Subject to Withholding. Forms 1042 and 1042-S are completed and filed by the gambling establishment as withholding agent. According to the IRS, nonresident aliens are not subject to withholding or reporting requirements for winnings arising from blackjack, baccarat, craps, roulette, big-6 wheel, love dog or horse racing in the U.S. from legal wagers placed outside of the U.S. in a pari-mutuel pool.[10]

Note that for cash winnings in excess of $10,000, the casino is generally required to complete a FinCen Form 103, Currency Transaction Report by Casinos, which is electronically filed with the Financial Crimes Enforcement Network.[11] This identifies the winner(s) and generally must be completed for amounts either received or paid out in excess of $10,000 during any single gaming day.

Calculation Methodology for Wins and Losses

On December 5, 2008, IRS Chief Counsel advice was provided[12] “about a recurring issue in litigation.” The issue involved how a casual gambler determines gains and losses from slot machine play. The case involved a taxpayer who properly substantiated gabling gains and losses and who attended a casino to play slot machines on 10 occasions during the year. On each visit, she exchanged $100 of cash for $100 of tokens.  On five of the occasions, she lost her entire $100 in tokens before terminating her slot machine play.  On each of the other five occasions, she redeemed her remaining tokens for $20, $70, $150, $200 and $300 respectively.

At issue in the Chief Counsel Advice Memorandum was the language of IRC §165(d) which indicates that “losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” At issue was the meaning of the word “transactions”. While a literal reading of “transactions” could mean every single individual play or wager made, this would require the taxpayer to separately calculate the gain or loss on every individual play or bet, recomputing basis through the transactions to arrive at the result of each play.  The CCA Memorandum noted that the Tax Court has considered that questions and found this approach unduly burdensome and unreasonable.[13]

The CCA Memorandum noted the use of the plural form of “transactions” in §165(d), taking this to imply that gain or loss may be calculated over a series of separate plays or wages. The CCA Memorandum concluded that the “better view” was to consider the taxpayer as recognizing a gain or loss at the time the tokens were redeemed, with fluctuating winds and losses during play not considered accretions to wealth leading to recognizable tax events).[14]

Accordingly, the CCA Memorandum concluded that this taxpayer’s gains and losses should be calculated as follows.

 

	Basis	Proceeds	IRC §165(d) Gain or Loss Amount (Proceeds – Basis)
Five occasions where $100 in tokens were entirely lost	$500	$0	($500)
Occasion with $20 token redemption	$100	$20	($80)
Occasion with $70 token redemption	$100	$70	($30)
Occasion with $150 token redemption	$100	$150	$50
Occasion with $200 token redemption	$100	$200	$100
Occasion with $300 token redemption	$100	$300	$200

The taxpayer’s total losses amount to $610 (the aggregate of the $500, $80 and $30 losses).  The taxpayer’s total gains amount to $350.  Accordingly, the taxpayer must report $350 of losses, and she may deduct $350 of the $610 loss amount under §165(d) if she itemizes.

 

Professional Gamblers

IRC §165(d) limits the deduction of gambling losses up to the amount of gambling gains. While the Code makes no distinction between a “casual” and “professional” gambler, courts have held that professional gamblers are not entitled to net gambling loss deductions. However, gambling expenses other than wagering losses are not subject to the IRC §165(d) limitation if the gambler is a professional gambler.[15]

Additionally, the Supreme Court has concluded that “if one’s gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business…”[16]

If the gambler’s activity in gambling may appropriately be classified as a bona fide trade or business, their gross winnings each year should be reported on Schedule C instead of Form 1040, line 21 as “Other Income.” Expenses may be fully deducted, with the only exception being the gambling losses which are still limited by IRC §165.

 Recent Massachusetts Guidance

Massachusetts enacted the Expanded gaming Act on November 22, 2011 to provide for up to three “destination resort casinos” in the Commonwealth to further economic development.  The Act divides the Commonwealth into three regions, and one casino in each region is authorized.[17]  The relevant statute associated with the Massachusetts Gaming Commission, including the licensing of the new casinos and administrative requirements, is found at MGL c. 23K.[18]

Recognizing the need to clarify certain tax issues associated with the reporting of gambling income in the Commonwealth, the DOR released Technical Information Release (TIR) 15-14 on November 20, 2015. TIR 15-14 serves to allow a deduction for certain losses, adopts new tax withholding and reporting requirements for certain types of gambling income, and increases the dollar threshold at which a gambling establishment is required to check for outstanding child support obligations or outstanding tax liabilities prior to the payment of winnings. The highlights of each of these changes is discussed in turn.

Allowed Deduction for Losses

A Massachusetts resident must include in gross income any gambling winnings that are includible in gross income under federal rules. Income is included in Massachusetts income whether the gambling income was received by a gambling establishment within Massachusetts or outside of Massachusetts.  Since a nonresident must include income on their Massachusetts return that arise from Massachusetts sources, the nonresident must report gross income from winnings from any establishment located in Massachusetts, including winnings from a pari-mutuel wager paid by a Massachusetts racetrack or simulcast center. In essence, the nonresident must include winnings that represent Massachusetts source income that is considered effectively connected with the participation in any lottery or wagering transaction in Massachusetts.

While TIR 15-15 acknowledges the deduction and limitation provided at the federal level under IRC §165(d), it does not adopt this federal Code provision for Massachusetts purposes.  Instead, Massachusetts adopts a new deduction from income available against certain gambling winnings. The new Massachusetts deduction allows a loss, incurred at a gaming establishment licensed under MGL c. 23K, to be deducted only against winnings received from a MGL c. 23K-licensed establishment.  The amount so deducted is limited to the amount of such winnings.

This is the only deduction available to a Massachusetts taxpayer reporting gambling income (unless the taxpayer’s gambling activity is a bona fide trade or business).  This new Massachusetts deduction is available for the 2015 tax year and subsequent years.

TIR 15-14 indicates that Massachusetts adopts the federal calculation methodology that uses the “per occasion” basis described in Rev. Proc. 77-29 (discussed previously).  Moreover, following the federal rule, Massachusetts gamblers may not simply report their “netted out” winnings as gross income, but must separately report the entire gross income amount from gambling and any allowable deduction claimed under the new deduction rule.

Withholding Rules

TIR 15-14 indicates that generally, the Massachusetts tax withholding rules are aligned with the federal withholding rules mentioned earlier under IRC §3402(q). However, the TIR outlines changes made to the Massachusetts gaming tax withholding rules found in MGL c. 62B, §2. These changes result in the following withholding rules in Massachusetts (with a withholding rate of 5% applying to any required withholding under these rules).

 

Type of Winnings	Withholding Rule	Reporting Rule (Using Form W-2G)
Lottery	Required for winnings of $600 or more[19] (regardless of recipient’s residency).  Total proceeds are subject to withholding (not just the excess over $600).  Same federal rule is followed for multiple winners; Form 5754 is used.	Required on Form W-2G for winnings of $600 or more.
Slot machines  at c. 23K licensed establishments	Only required if federally required.  IRC §3402(q)(5) does not require withholding for slot machine winnings.	Required for winnings of $1,200 or more.  Taxpayer’s wager is not subtracted from the gross proceeds for threshold determination.
Table games  at c. 23K licensed establishments	Only required if federally required. IRC§3402(q)(3)(A) requires withholding on winnings of more than $5,000 if such proceeds are at least 300 times the amount wagered.  Withholding applies to the total gross proceeds amount (not just the amount over $5,000).	Required whenever withholding is required.
Pari-mutuel wagering (horse and dog racing)	Only required if federally required. IRC§3402(q)(3)(C)(ii) requires withholding on winnings of more than $5,000 if such proceeds are at least 300 times the amount wagered.  Withholding applies to the total gross proceeds amount (not just the amount over $5,000). This includes simulcast races.	Required if winnings are $600 or more (if at least 300 times the amount wagered).
Keno or bingo at c. 23K licensed establishments	Required if federally required. Federal rules exempt these forms of winnings from withholding under IRC §3402(q)(5).	Not required.

 

Massachusetts generally follows the federal withholding rules that apply to gambling winnings for nonresident aliens under IRC §1441(a). This general rule requires a flat 30% to be withheld for federal purposes, and where required, an additional Massachusetts 5% will be withheld. Note that there are some exceptions to the federal withholding requirement, such as the existence of a superseding term in a tax treaty between the U.S. and the winner’s country. Countries that currently exempt U.S. gambling winnings from U.S. tax withholding are: Austria, Belgium, Bulgaria, Czech Republic, Denmark, Finland, France, Germany, Hungary, Iceland, Ireland, Italy, Japan, Latvia, Lithuania, Luxembourg, Netherlands, Russia, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Tunisia, Turkey, Ukraine, and the United Kingdom.  In such cases, Massachusetts 5% withholding will not apply.  Reporting is only required where withholding is required.

 

Child Support and Tax Debt Checks by Gaming Establishments in Massachusetts

MGL c. 23K, §51 requires a Massachusetts gaming establishment to first check information provided by the DOR and DOR Child Support to determine if the winner has any unpaid child support or tax debts (where winnings are in excess of an applicable threshold). If such debts exist, the winnings are first paid to satisfy the winner’s unpaid obligations before any payment is made to the winner.

As a result of amendments made to these rules, the applicable threshold necessary to trigger the gaming establishment’s obligation to check these debts has been increased from the former flat $600 to the dollar level at which reporting will be required under the reporting rules for the various types of gambling income discussed earlier.

Conclusion

It is likely that Massachusetts tax practitioners and preparers will be seeing increased instances of taxpayers receiving gambling income in various forms. This summary of the applicable federal rules, Massachusetts rules (including recent amendments promulgated through TIR 15-14) will ensure practitioners have the appropriate rules needed for proper federal and Massachusetts reporting. It is likely the Expanded Gaming Act will continue to evolve, with further amendments as the Massachusetts Gaming Commission monitors the Act’s impact on our Commonwealth.

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