On-line poker winnings

A reader (who wishes to remain anonymous and who is NOT a VITA client) writes:

I have a quick tax question in honor of my darling off-spring. Do you have to pay taxes on money won through on-line poker, and if so what's the amount you need to "earn" to pay taxes, and if you don't file taxes, will anyone ever figure this out?

My answer:

Yes, darling offspring absolutely does need to pay taxes on money won through on-line poker. It's no different than winning a state lottery or winning a year's worth of dog food on a game show--it is taxable income.

The general principal is "All income, from whatever source derived," is taxable unless there is an explicit provision in tax law exempting it."

There is no provision in tax law exempting on-line poker winnings, so it's definitely taxable.

If the offspring in question can be claimed as your dependent, he can earn up to $5,700 in wages on a W-2 before s/he needs to file a tax return. However, unearned income (which is probably what the IRS would consider his gambling winnings, since I gather he is not a professional gambler) has a much lower minimum filing requirement. Over $950 in unearned income, and your dependent offspring definitely needs to file a return.

But, bear this in mind: once he has enough income to be required to file a return for any reason, then even $1 of gambling income needs to be reported on it. So...let's say offspring makes $6,000 in wages and thus has to file a return, and he wins a $1 on-line poker bet. Then the IRS will expect to see total income of $6,001 reported on the return.

As for whether anyone would ever figure that out, I would not hazard a guess on that. For years, people thought that if they kept their money in Swiss bank accounts, the IRS would never find out because Swiss banking laws kept the info out of IRS hands. Well, that information is no longer protected--foreign banks, including Swiss banks, have come under pressure to share information about their depositors with the IRS. Some folks are in a lot of trouble going back years and years--trouble they never dreamed of at the time they put the money in those foreign bank accounts. The amounts of taxes, interest, and--especially--penalties can be huge, far greater than any original tax owed.

On-line gambling is a highly visible target for the IRS--and rules on accounting for losses and offsetting them against gains are really tricky--you really need to keep excellent documentation especially if you had losses as well as wins. The IRS is very quick to assess tax on gross income but the other side of the coin--allowing deductions for losses is much trickier. As the tax law rulings say, "Deductions are a matter of legislative grace," and that means that you need to cross all the t's and dot all the i's in adhering to the rules to get the benefit of any of those deductions to potentially offset some of the gambling winnings.

There are technical aspects of gambling tax law that go beyond my IRS VITA certification. We can handle small routine gambling winnings, like a state daily numbers win, but I would tell any prospective VITA client who had a complicated ledger of wins and losses in on-line poker that s/he is out-of-scope for us, and needs to consult a professional tax preparer knowledgeable in gambling tax law.

I would also advise such a person NOT to wait until tax season to think about these issues. They need to maintain meticulous records to stay out of trouble. Enrolled Agent Russ Fox specializes in gambling tax issues and has some useful background perspectives in these articles.

The bottom line: get thy darling offspring to a knowledgeable tax professional if s/he has been engaging in on-line poker games for money.