I named my tax firm Blackjack Tax Services, LLC because it’s my favorite card game. The idea came to me when sitting in my hotel room at the Palazzo in Las Vegas, Nevada. I like to read financial non-fiction books by Michael Lewis and Scott Patterson. A common theme among them is that they keep mentioning blackjack out of nowhere. It wasn’t until I discovered card counting that I understood why blackjack belonged in a book about finance and investing. I tried to teach myself card counting for months, but let’s just say I am better at taxes than blackjack.
This article is for the professional gambler, more specifically: the advantage player (AP). An advantage player is a professional gambler who uses statistical analysis techniques to gain an edge over the casino (the “house”). Over the long run, they can generate a profit by playing games with a positive expected value (EV ), which is the theoretical amount of money that can be won or lost for any given game of chance. If you are a professional AP, you own a business. It may not be a traditional business, but it is truly a business, nonetheless. A good AP is good at keeping detailed records of their sessions. That trait is good to have when it comes to tax compliance. I am sure tax compliance is the last thing on an AP’s mind. More about that later. However, there are some principals of taxation that any good AP should be aware of.
Gambling in the Internal Revenue Code (IRC)
IRC §61 – this provision defines gross income as “all income from whatever sourced derived,” including gambling winnings (“gross” means before deductions).
IRC §165(d) – “Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions. For purposes of the preceding sentence, in the case of taxable years beginning after December 31, 2017, and before January 1, 2026, the term ‘losses from wagering transactions’ includes any deduction otherwise allowable under this chapter incurred in carrying on any wagering transaction.”
This is one of the most important gambling provisions in the tax code. It is a provision that is unfavorable to the gambler, professional or otherwise, but its consequences are even worse for the professional gambler. For any other trade or business, a taxpayer is allowed to deduct all their ordinary and necessary business expenses. For the AP, that might include airfare, lodging, transportation, 50% of meals while traveling, supplies, equipment, and training. If a business’s expenses exceed its revenue, then the taxpayer would generate a net operating loss (NOL), which could be used to offset other income or be carried forward to be used in future years. §165(d) not only limits the amount of gambling losses you can deduct to the amount of winnings, but it also limits deducting business expenses to the amount of winnings. Here’s how this might look:
Winnings $50,000
Losses $40,000
Expenses $15,000
Deductions $50,000
Net $0
You can deduct only $50,000 of losses plus expenses, meaning all of your casino losses could be deducted, but only $10,000 of your expenses could be deducted. This would zero out your gambling income, but it would also leave you with $5,000 on nondeductible business expenses. A normal business would be able to take a ($5,000) loss on their tax return. So, not only does the AP need to overcome the house edge, but they also need to generate enough winnings to make up for any expenses related to gambling, in which case, they would need to pay taxes on those winnings – further reducing the return on investment for the AP. This provision is set to sunset in 2026, unless extended by Congress. I believe Congress should repeal §165(d) to make professional gambling on par with any other business, as it was prior to the Tax Cuts and Jobs Act of 2017.
What §165(d) taketh away, §1401 taketh even more.
IRC §1401 imposes a 15.3% self-employment tax (SECA tax) on net earnings from self-employment. This separate tax hits your income before ordinary income tax. While casual gamblers do not need to pay SECA tax on their gambling winnings, if an AP meets the definition of engaging in a trade or business, then they are required to pay the 15.3% SECA tax on their net income (after deductions).
Engaging in a Trade or Business
Commissioner v. Groetzinger, 480 U.S. 23 (1987) is one of the most important U.S. Supreme Court cases that affect the professional AP. Prior to this case, the IRS stubbornly refused to acknowledge any difference between APs and ploppies for tax purposes. The IRS believed gamblers, professional or otherwise, did not sell any goods or services, and thus they could not be engaged in a trade or business. The U.S. Tax Court and the U.S. Court of Appeals for the 7th Circuit ruled that the IRS was wrong, but it took the U.S. Supreme Court’s 6-3 ruling to get them to change their position.
Robert Groetzinger bet on greyhound races during tax year 1978, the year he was audited by the IRS. He spent 60-80 hours a week researching and wagering for himself. He had no other form of employment and conducted parimutuel betting with the main aim of making a living. He won $70,000 and lost $72,032 during the year. The Supreme Court developed a test called the Groetzinger Standard, which says “to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and … the taxpayer's primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement diversion does not qualify.”
Meeting this standard allows an AP to deduct wagering losses and ordinary and necessary business expenses on their tax return. Otherwise, amateur gamblers are only allowed to itemize gambling losses up to the amount of their winnings and are not permitted to take personal expense deductions. On the other hand, meeting this standard also subjects the AP’s net income to SECA tax. If an unsuccessful professional gambler claims no profits year after year, the IRS may also impose the IRC §183 hobby loss rules to prevent taxpayers from deducting ordinary and necessary business expenses.
Documentation is Crucial
Every AP is trained on the importance of good documentation and recordkeeping, a practice which will serve them well in matters of tax compliance. The IRS typically recommends session-based reporting because tracking each bet or each transaction play by play is administratively burdensome. However, the definition for “session” is left open to some interpretation. In Advice Memorandum 2008-011, the IRS states “We think that the fluctuating wins and losses left in play are not accessions to wealth until the taxpayer redeems her tokens and can definitively calculate the amount above or below basis (the wager) realized.” This seems to correspond to play at a single slot machine during a day or play at a single table game during a day. One could also interpret this as play at a type of machine or type of table during a day, which would account for moving between slot machines or table games of the same type. The IRS has even issued guidance that appears to suggest that each buy-in at a poker tournament constitutes separate and distinct sessions, even if the poker play does not get up from their seat. Whichever definition you choose for your business, make sure it’s reasonable and consistent.
The important things to remember are to substantiate gambling losses by keeping a play journal that lists the type of game, property played, date and time played, and results – such as total buy-in and ending color-up/cash-out – and keep receipts and invoices of all business expenses. Aps are known to keep record that are much more detailed than that, but that is the minimum for tax compliance. Professional gamblers may be subject to increased scrutiny by the IRS due to the nature of their craft, but documentation is the number one way to win an audit.
Form W-2G, Certain Gambling Winnings
Blackjack players do not typically receive W-2Gs, except in rare circumstances, which we will cover. W-2Gs are common for slot machine players. The IRS Instructions for Form W-2G list the thresholds for receiving a Form W-2G if:
The winnings (not reduced by the wager) are $1,200 or more from a bingo game or slot machine;
The winnings (reduced by the wager) are $1,500 or more from a keno game;
The winnings (reduced by the wager or buy-in) are more than $5,000 from a poker tournament;
The winnings (not from the games mentioned above) reduced, at the option of the payer, by the wager are: (a) $600 or more, and (b) at least 300 times the amount of the wager; or
The winnings are subject to federal income tax withholding (either regular gambling withholding or backup withholding).
For blackjack, you would only have winnings of 300 times the amount of a wager if you won a side bet, since blackjack bets are only paid 1:1, 3:2, or 6:5 (hopefully, you are not playing 6:5).
The regular withholding rate under IRC §3402(q) applicable to winnings (less the wager) of $5,000 or more from sweepstakes, wagering pools, certain parimutuel pools, jai alai, and lotteries (formerly 25%) is 24%. Backup withholding is also 24%, but that only occurs when you do not provide the casino with a valid tax identification number (SSN, EIN, or ITIN). If you receive a noncash payment, you may be required to pay the casino the 24% in withholding required. If the casino pays the noncash payment withholding for you, then it would need to withhold at the higher rate of 31.58%.
Currency Transaction Reports
Since AP blackjack players are never are issued W-2Gs (because APs usually stay away from negative EV side bets), the only way for the IRS to readily know if you received income is from the filing of FinCEN Form 103, Currency Transaction Report by Casinos (CTR). These reports are filed with the Financial Crimes Enforcement Network (FinCEN) when you either cash-in or cash-out currency of more than $10,000 in a gaming day (31 CFR §1021.311). In cases of these reportable transactions, you will be required to show your identification to the casino. The most common transactions that trigger a CTR are the purchase or cash-out of chips. The casino must e-file the CTR within 15 days from the day after the reportable transaction, and casinos must keep a copy of all CTRs for five years from the date of report. CTRs are not to be confused with Suspicious Activity Reports (SAR).
State Income Tax Considerations
While professional gamblers are allowed to deduct their gambling losses (with certain limitations) on their Schedule C (Form 1040), not every state allows amateur gamblers to itemize/deduct their gambling losses. As of this writing, the following states require amateur gamblers to report all gambling winnings without deducting any gambling losses:
North Carolina (under reconsideration by legislature)
Rhode Island
Connecticut
Illinois
Indiana
Kansas
Massachusetts
Michigan
Ohio
Wisconsin (only losing sessions nondeductible)
For these states, they might aggressively challenge your status as a professional gambler if it is not clear. That may result in a large state tax liability if the challenge were to succeed. State income tax authorities are generally more aggressive than the IRS.
It should also be mentioned for the traveling AP that there are two things that determine whether you need to pay taxes to a state government: (1) your state of residence, and (2) the source of income or business “nexus.” Business nexus is the connection or link between a business and a taxing jurisdiction that establishes the legal authority for the jurisdiction to impose tax obligations on the business. For states that you have gambling winnings, provided you meet the filing threshold, you may require multiple state income tax returns in addition to your state of residence (assuming it has a state income tax).
Use of the S Corporation Strategy to Reduce SECA Tax
If I had to make a bet, I would put real money on the MIT Team and Church Team conducting business as an S corporation. If they didn’t, then they would have paid tens of thousands in SECA tax unnecessarily. S corporations work well for an AP team that includes investors, management, and players. The downside would be that players and managers would need to be paid as employees, and the team would need to run payroll. I would recommend live payroll rather than after-the-fact payroll for such as team. S corporations add administrative expenses to your P&L, such as unemployment tax and separate tax return preparation and filings. We are talking about a minimum of $2,000 extra expenses per year depending on the size of the team. Therefore, you want to make sure that your annual AV is high enough for the team to exceed its breakeven point. SECA tax savings has to outweigh S corporation expenses.
Would an S corporation work well for a small informal team and a solo AP? The answer is yes, provided that each player nets more than the breakeven point mentioned above. A solo AP would need to net at least $60,000 in Hawaii to exceed breakeven. I use Hawaii as an example because I am familiar with its state payroll requirements, even though Hawaii is one of only two states that has a blanket ban on gambling. The other state is Utah, of course, but at least they have Nevada as a neighbor state. For a small team, I would operate as a partnership with each AP owning an interest in the partnership using their own S corporation. For solo APs, they would simply operate as an S corporation. There is a gray area in tax law about whether an AP personally earns income or whether their S corporation earns income. The IRS tends to lean in the direction that results in more money in the US Treasury, so you would need to accept that risk. I wrote an article that explores, in depth, about whether the “assignment of income” doctrine applies to licensed professionals, such as real estate agents. I believe the same set of facts apply to APs, so I would encourage an AP exploring the possibility of operating as an S corporation to read and understand that article.
Here's how an S corporation can save an AP on tax. When you operate as a sole proprietor using Schedule C (Form 1040), then you will pay SECA tax on all your self-employment earnings. Technically, it’s 92.35% of self-employment earnings, but let’s assume that it covers 100%. That means that a self-employed AP who nets $100,000 would need to pay 15.3%, or $15,300, in SECA tax. And that’s before paying ordinary income tax, state income tax, blah, blah, blah. It’s significant. In an S corporation, business income is not subject to SECA tax because it’s not considered self-employment earnings. However, the one big rule is that a shareholder who materially participates in the S corporation’s business activity needs to pay themselves “reasonable compensation.” Such compensation means that the shareholder-employee needs to be paid wages, subject to payroll tax. The payroll tax is called FICA, and it includes the same Social Security and Medicare tax, at the same tax rate, that is in SECA. FICA and SECA is the same tax, different name. That S corporation can deduct those wages from its business income. So under the same circumstances as before, the S corporation has $100,000 in business income, minus $40,000 in reasonable compensation, you are left with $60,000 in income not subject to SECA. FICA will still need to be paid for the $40,000 in wages. The savings are 15.3% of $60,000 = $9,180. Subtract an average of $2,000 in administrative expenses and the net savings are $7,180. Talk about positive EV. That’s how the S corporation strategy works: by splitting income into two different streams that are treated differently for tax purposes.
Tax Evasion vs Tax Avoidance
I want to address the elephant in the room right here. I am aware that the tax code is not kind to professional gamblers. I am also aware that the nature of the business makes it easy to not report earnings on your tax return. Yes, the professional gambler is probably the profession that can most easily evade income tax, short of drug dealing. Cash and casino chips are difficult to trace. But I want to advise the AP that there is a difference between tax evasion and tax avoidance. The former is illegal, while the latter is legal. Conducting business in all cash is not 100% foolproof for the IRS. Cash transactions more than $10,000 require a CTR with your name in it. Such transactions may be common at banks or in casinos. The IRS does not need to trace cash income to the taxpayer to conduct a successful audit. Tax enforcement laws allow the IRS to look at your lifestyle and compare the cost it would take to maintain it to what you report on your income tax.
I understand that everything in an AP’s life is an EV calculation. You need to include the back taxes, monetary penalties, interest, and even jail time into that calculation. Not filing an income tax return has no statute of limitations. An unfiled tax year is open to audit forever. You cannot forget about IRC §6501(e)(1)(A), which applies when a taxpayer omits more than 25% of gross income from their tax return. In such cases, the IRS has six years from the date of filing to assess taxes, rather than the standard three years.
If you want a retirement account. If you want to own stocks and bonds. If you want to live a lifestyle of a successful person. If you want to own a house. If you want to be a contributing member of American society, then I highly encourage you to adhere to the same tax laws that apply to all of us. Blackjack Tax Services, LLC wants APs to avoid taxes, LEGALLY.