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Jeremy Wells: Your client walks in with a form W2G reporting $75,000 of slot winnings. But then the client says, don't worry, I lost all of it, so there shouldn't be anything to report, right? This is a very similar case to something that just walked into my firm [00:00:30] not very long ago. And in cases like that, a few minutes later, you discover that the client has actually won and lost altogether, potentially hundreds of thousands, if not millions of dollars during the year on various gambling, wagering and betting activity. So now the question is, what of all of this is actually going to get reported on the return. Is [00:01:00] it the $75,000 on the W-2 G. Is it the couple million dollars of combined winnings and losses, or do you take the client's word for it that he lost all of it? And so you don't report anything? Or is it something in between? Gambling income and losses for tax returns can get complicated to report. So in this episode, I am going to break down how we report gambling and wagering [00:01:30] gains and losses, what we do with those W-2 G's, and how we work with clients to improve their reporting and especially their record keeping for that kind of activity. So in this episode, we're going to look at distinguishing wagering transactions from prizes, contests, and other kinds of taxable activities and income. We're going to calculate wagering gains and losses using the wager basis and the appropriate unit [00:02:00] of accounting.
Jeremy Wells: This is actually an issue that's come up in the courts quite a bit. What is the definition of wagering gains and losses? What is a wager and then how should we actually report that activity. We're going to look at calculating the deductible portion of wagering losses under code section 165 D. And we're going to especially look at how the one big Beautiful bill act changed that reporting. We're [00:02:30] going to deal with W-2 G's and think about why clients get W-2 G's, what they mean, and how we incorporate those into tax return preparation and how to look at them as part of the client's broader gambling records. And finally, we're going to differentiate the reporting paths for casual versus professional gamblers. So starting off wagering gains. These are [00:03:00] gross income. Gross income includes gains from wagering transactions. We'll get into what some of these terms mean here in a minute. But for now, we just need to understand that a taxpayer's gross income includes gains from wagering transactions. Now those gains can come from a variety of sources. Casino games, such as slot machines or Keno sports betting, and what's called parimutuel wagering. [00:03:30] So this is like horse betting, poker lotteries, paid raffles and then cash or other property that are received from these kinds of wagering transactions. All of this is what can produce these wagering gains. Now these transactions can also lead to wagering losses, which we'll talk about in a minute.
Jeremy Wells: But anytime we have a client that performs one of these wagering type transactions plays one of these casino games, downloads [00:04:00] and starts playing in a sports betting app. Goes to a poker tournament. If that individual has some gain from result of playing or participating in one of these games or applications, then there's potential for wagering gains. And then those gains are going to be part of that taxpayer's gross income. Now it's important to remember that a form W-2 G, which we'll talk more about later, but a form W-2 G is [00:04:30] not required for that gain to be taxable. So it's entirely possible for a taxpayer to have wagering gains that we don't see because there is no W-2 G. It's also possible for a taxpayer to get a W-2 G. And that only represents a portion of that taxpayer's wagering gain from that casino From that application, from that visit. So the W-2 G is [00:05:00] only telling us a small portion of the story. And that's a theme that I'm going to come back to a couple more times here throughout this episode. Section 61 is where we get the definition of gross income in the code. And of course, it broadly includes income from whatever source derived. That is the phrasing that you see in that code section. And of course, that includes this kind of wagering income. Now, [00:05:30] wagering losses, on the other hand, are deductible, but only against wagering gains, and only to the extent that the taxpayer itemizes wagering losses are an itemized deduction.
Jeremy Wells: And for tax years before 2026, a taxpayer can deduct the losses from wagering transactions to the amount of wagering [00:06:00] gains during that year. But starting in 2026, under a change to code section 165 D made by the One Big Beautiful Bill act, a taxpayer can only deduct up to 90% of gains of losses from wagering transactions only to the extent of wagering gains. We'll talk more a little bit later on about how this math actually works. But that is [00:06:30] a significant change for gamblers from the One Big Beautiful Bill act is cutting that maximum amount of the loss deductible from 100% up to the extent of gains before 2026 to starting in 2026, just 90%. So when it comes to gambling income, it's important to remember that we don't report the net for the year. We have to separate gains from losses. [00:07:00] Those are two different buckets and they get reported separately on the return. The winnings are included in gross income, and both the IRS and the courts have agreed on this point. So it's not really any more a point of contention. If there are lots of court cases, lots of IRS revenue rulings that discuss this question, and over the last several decades, virtually all of them home in [00:07:30] on the same approach that gambling gains and wagering gains are part of gross income.
Jeremy Wells: Losses are an itemized deduction. So a taxpayer can never deduct gambling losses in excess of winnings within the year. Also, no matter how much she loses. And notice that losses are only deductible as an itemized deduction for casual gamblers, we'll talk about professional gamblers and how they're a little [00:08:00] bit different later on. But if the taxpayer has both gains and losses and does not itemize, instead takes the standard deduction, then those gambling winnings are still income, even though none of the losses are deducted. So that's a bit of an unfair position for taxpayers to be in. And we'll look at some examples of that later on. It's important to note also that some states [00:08:30] may not allow any deduction for wagering losses. So it's important to understand not just the federal law but also the state law, because it's entirely possible for federal purposes for that taxpayer to be able to deduct the wagering losses, but the state not allow those losses to be deducted, so that can cause an adverse tax result for the taxpayer as well. So what do we mean by a wager? What [00:09:00] is that. Because we all face risk and different parts of our lives, especially our financial lives. So what is it that makes a particular transaction a wager as opposed to something different? Well, the courts have defined a wager as something risked or staked on an uncertain event. So in general, a wagering transaction has to involve consideration [00:09:30] placed at risk.
Jeremy Wells: So you need to actually have something of value that was yours, that has now been put on the line in order for a wager to happen. There also needs to be an uncertain outcome. So a good example of this is some sort of game of chance. Rolling a dice, flipping a coin, a game of keno, a game of poker, anything like that where you're not certain of what the outcome is going to be. And then finally, the possibility [00:10:00] of receiving a prize or some sort of return. So it's not just that I am putting money on this uncertain outcome, but if that outcome is what I want it to be, then I'm going to win some jackpot or some pool of money or something in return. Otherwise, if I don't get the outcome that I wanted, then I lose whatever I wagered on that outcome. The presence of skill [00:10:30] does not necessarily prevent an activity from being wagering, but the courts have found that there is a difference between transactions that are based on a wager, where there is that consideration on some uncertain outcome and the potential for a return versus situations where there is some skill at play and it's really down to the balance between is the outcome dependent [00:11:00] on that uncertainty, or is it dependent on a successful application of skill? Because we can say something like picking stocks or investing in real estate or even running a business, well, that means having some sort of investment.
Jeremy Wells: There's an uncertain outcome. You don't know whether that's going to be successful or not. You don't know whether the business is going to be profitable, or whether the stock market is going to go up. And if it does, then [00:11:30] we'll get some return off of that. However, those situations may not be wagering because the level of skill needed or expected to be able to participate in those kinds of transactions is really what's driving the return, along with a little bit of uncertainty. As opposed to wagering, which is more heavily favored on the uncertainty. As opposed to where the result comes from. Now it's important to understand. [00:12:00] Neither section 165 D, which is all about wagering losses nor the regulations, define wager or wagering transaction. They use that phrase wagering transaction, but they don't define it. There is a tax court case called Schachat. The tax court applied the terms ordinary, meaning something risked or staked on an uncertain event or a bet essentially might be what a layperson would call that. So the [00:12:30] most useful practical question, if you're looking at a client's transaction and deciding, trying to decide whether this was a wager or something different is what did the taxpayer place at risk for the opportunity to receive that prize. And so there's also a chief counsel advice 2020 42015 where the IRS applied a similar analysis to paid daily fantasy sports contests.
Jeremy Wells: Now, [00:13:00] one thing that we're going to have to understand is tax advisers in this realm of gambling and wagering, and especially when it comes to sports betting, is that it used to be the taxpayer had to go to a casino or go to some back room in town and sit down to play poker, to play keno, to play slots. Now, a lot of this gaming is available on cell phones and smartphones and devices and the internet, and [00:13:30] almost everybody has the ability to have that in the palm of their hand without leaving their home. So we're seeing a lot higher rates of gambling activity among taxpayers, among clients. So when we're talking about these new apps that might take these sorts of situations that we would experience in person in, say, a casino and making those part of a game, an application on the phone. There's been a question as to whether this still [00:14:00] counts as wagering, whether it should still be treated the same way. And in general, the IRS, the IRS and the courts so far have treated it very similarly. So in this memorandum, the chief counsel concluded that the entry fee to be able to participate in these kinds of contests was paid in a wagering transaction. Now, this is fantasy sports. This is where you pick your team, you pick your preferred players, and based on how they performed the prior week or weekend or [00:14:30] match or game that determined how you did in your own competition.
Jeremy Wells: So the question was whether this is based on an uncertain outcome or whether it was based more on your skill in picking the right players and in this case, the chief counsel decided that this is more based on an uncertain outcome than it was on skill. And so therefore, it's a wagering transaction because the participant placed consideration at risk for a prize whose outcome depended [00:15:00] materially on uncertain future events. Now, it's important to understand that these chief counsel advice memoranda, they're not precedential, but they do help illustrate the approach that the IRS would take in a case like this. Not every uncertain prize, though, is a wager or result in a wagering gain or loss, though, so there are some situations that we have to be aware of that would not be considered gambling [00:15:30] income or loss. So free sweepstakes and promotional drawings don't have any sort of consideration that have been put on the line. So if a client just signs up or puts in an email address or fills out a form in order to be entered to win something that's going to be winning a prize, not actually placing a bet. Game show prizes also are considered taxable income, but they're not part of a wager contest determined by skill. [00:16:00] Again, we've got to look at the balance between how much the outcome is depends on the skill versus the uncertainty over the outcome, and finally activities requiring no consideration from the participant.
Jeremy Wells: Again, this is these are these situations where the the client, the taxpayer, the winner didn't actually put anything on the line. In these cases, generally the prize is going to be taxable, but there's not going to be any [00:16:30] consideration of whether this is wagering or gambling income. So, for example, the winner of a free promotional drawing Placed nothing at risk. That prize is generally going to be included in gross income under section 61, but it's not going to be a wagering gain governed by 165 D. So why would this matter for the taxpayer? Well, if the taxpayer did have other gambling or wagering losses, then that income from the prize [00:17:00] or the award would not be included in the amount of gambling income. That could then be offset by that gambling loss. So revenue ruling 57521 considered a puzzle contest in which skill rather than chance, determined the winners. The IRS concluded that the contest was not a wagering pool or lottery. That ruling interprets the wagering and excise tax [00:17:30] provision, so we can only cautiously apply it to 165 D, the wagering excise tax is a separate issue that's out of scope for this episode, but it does indicate how the IRS thinks about wagering, thinks about those kinds of transactions, even if it's not precedential or directly applicable to thinking about wagering gains and losses under 165.
Jeremy Wells: D an entry fee doesn't [00:18:00] automatically resolve the issue. We might think of that entry fee as the consideration, but not necessarily. We have to determine what that payment actually purchased. So a fee paid for services, access or participation in a bona fide competition might differ from an amount staked for a chance to win a prize pool. Right? So just saying that you had to pay to enter a contest. If that contest, if the outcome of that contest depended on skill rather [00:18:30] than chance or luck, then that was not necessarily a wager. But now contrast that with something like a paid raffle, right? So the purchaser pays for a chance to receive a prize that is determined by choice. So in that case, that is a wager, right? The tax treatment depends on that transaction and the way the actual contest is determined. Focusing [00:19:00] on the wager is important because the wager determines the basis for the gain or loss. Now we typically talk about gambling income. And in fact that is the phrase that we see on schedule one of the 1040. However, the code actually refers to wagering gains and losses. And when we talk about gains and losses, we have to think in terms of like any other gain or loss situation, we have to look at what the basis [00:19:30] is and use that basis to offset the Proceeds from that outcome. And then the result is the gain or the loss.
Jeremy Wells: So in terms of wagering, a wagering gain means the amount won in excess of the amount bet. Right. The basis of that wager and a wagering loss usually means that the amount of the wager itself. So for example, if I bet [00:20:00] $100 against a friend on a coin flip and my friend also wagers $100, we now have a $200 pot. And that outcome is either going to be my friend wins it and I don't win anything, or I win it and my friend doesn't win anything. So if I win, I get the $200 pot, but I don't have a $200 wagering gain because it costs me $100 to be part of that transaction. So from the [00:20:30] payout, I deduct the wager what it cost me to participate in that transaction to arrive at my actual gain or loss. Now, if I lose, then my loss is the $100 that I bet. And I didn't win anything. But if I win, my gain is just the $100 that I won in excess of my actual wager. The distinction becomes critical when we're reviewing forms W-2 G. Depending [00:21:00] on the type of gambling box, one of that W-2 G may report an amount without subtracting the winning wager. But sometimes it does include the winning wager, but it may not include any other wagers placed before or even after that particular payout. So, as the preparer of the tax return, you have to determine whether the reported amount includes any [00:21:30] recovery of basis or the wager before treating that amount as taxable wagering gain.
Jeremy Wells: Now, how do we determine the time frame in which these gains or losses occur? Because it might sound like we need to keep track of every single individual bet, and every bet is going to lead to a different gain or loss. Except that would be burdensome. And that's the IRS [00:22:00] and the courts official take on that. And so we get a couple of important tax court cases on this question. One of them is Schollenberger v Commissioner. That's a 2009 tax court memorandum. We also get LaPlante v Commissioner from 2009. And in both of these cases. And then the IRS agreed, essentially in a memorandum in 2008 that what [00:22:30] matters is the session, and the session is the unit of time, and really the unit of gambling activity that we should be focusing on. This especially comes into play with more rapid kinds of gaming. The context here is thinking about slots. So slot machines, players usually sit at the slot machine for a period of time, are putting in coins or tokens or scanning their cards, depending [00:23:00] on the casinos technology. Pulling the lever on the slot machine. There's a result. And they're repeating this over and over and over again. So the question is, is each pull of the lever creating a separate transaction, or is the whole time that session that that individual is sitting at that slot machine and playing it? Is that the unit of analysis we should be looking at? And that's essentially what the courts and the IRS have come to agree on.
Jeremy Wells: We're looking at [00:23:30] the session. So the session result then is not the every single amount wagered and every single payout. Rather the session result is the amount that is available at the end of the session reduced by the amount that the taxpayer brought to that session. So to think about this in relatively simple terms, if I go to a casino with $100 and I [00:24:00] exchange that for tokens, and I sit at a slot machine and I play that slot machine for a while, and then at some point I get up and I leave. And now I have $200 for that session. I left with $200. I came in with $100. So my gain for that session is $100. On the flip side, if I came in with $100, I play the slots for a while. I run out of money and so I leave the casino, then at that point [00:24:30] I have a session loss of $100. So winning sessions produce wagering gains, losing sessions, produce wagering losses. And what we would look at is the results of those different sessions across the tax year. Now the authorities here, like I mentioned, are strongest for slot machine play. This is where we've seen this applied.
Jeremy Wells: So the appropriate unit for other wagering activities might differ. However, this this session approach is [00:25:00] a way to think about organizing client records, taxpayer records, and thinking about calculating the individual gains and losses throughout the year in order to arrive at the total amount of wagering gains and losses. But again, there is no definition in the statute or in the regulations about wagering gains and losses or transactions. So this is all writing on [00:25:30] a couple of tax court memoranda, opinions and an IRS acquiescence memorandum. So it's not the most well founded approach, but it is what tends to be the preferred approach, especially when it comes to these slot style games. But remember, it only is so far it's only been applied to slot style games. So for other kinds of games, there might be a different method that would make more sense to the IRS and to the courts. That [00:26:00] said, session accounting is not annual netting, so we have to look at each session individually in terms of whether that is a winning session or a losing session. And then would we start to tally up what the gambling winnings and what the gambling losses are. So imagine a casual gambler that has three different sessions in a year for session one, they have a $1,000 gain for session two. They have [00:26:30] a $700 loss. So that gambler went to the casino with $1,000 left with $300 left.
Jeremy Wells: That's one way that that gambler could have a $700 loss from that session. And then session three, let's say a $200 gain. So overall we've got $1,000 gain, a $700 loss and a $200 gain. That means that the winning session gains, or the total gambling gains for the year would be $1,200, and the losing session losses or the total losses would be $700. [00:27:00] So on that taxpayer's tax return, we would expect to see if that was the only gambling activity. We would expect to see $1,200 added to gross income and reported as gambling winnings, and see that $700 potentially deducted on schedule A as gambling losses. And because that's $700 is less than the $1,200, the amount of gambling income, and it's even less than 90%. [00:27:30] Starting in 2026, we would expect to see that $700 there if the taxpayer itemizes. But remember, if the taxpayer doesn't itemize, there's nowhere to report that gambling loss. And so that taxpayer would only show the $1,200 of gambling income. Now, what we can't do is simply report $500 of gambling income, because that's not the way this works. We report the total gains as [00:28:00] part of gross income, and we report the total losses. If the taxpayer itemizes, but only to the extent of 90% of those losses, and only to the extent of the amount of gambling gains, when the taxpayer has those losses, we have to keep that section 165 D limitation in mind.
Jeremy Wells: So again, before 2026, it was the lesser of the wagering losses or the wagering gains. [00:28:30] Starting with 2026 and on, it's the lesser of 90% of the wagering gains, excuse me, wagering losses or wagering gains. So for this purpose, the wagering losses include otherwise allowable expenses incurred in carrying on wagering transactions. This is another difference that we have in 165 D based on the One Big Beautiful Bill act. The ob [00:29:00] A that new revised section 165 D2 provides that wagering losses include deductions otherwise allowable in carrying on wagering transactions. Now, this is going to be particularly important for professional gamblers, not necessarily for casual gamblers because they're not going to have deductible expenses related to wagering. They're only going to have the wager. [00:29:30] All the other expenses would be personal and therefore nondeductible. But for someone who is a professional gambler, this is going to matter quite a bit, and we'll come back around to that later on. Now, in a tax court case of Mayo v Commissioner Tax Court held that a professional gamblers, ordinary and necessary business expenses such as the travel data services, other non wagering expenses like that were deductible under section 162 [00:30:00] without regard to the 165 limitation. But that changed with Tax Cuts and Jobs Act and now with OBB A. So the Tcja reversed that result for taxable years 2018 through 2025 by treating otherwise allowable deductions incurred in carrying on wagering transactions as wagering losses subject to 165 De.
Jeremy Wells: That provision was supposed to [00:30:30] expire after 2025, but the Oba made that rule permanent and imposed that additional 90% limitation starting in 2026. So Mayo is now essentially overridden by this change to 165 De. So let's think about how this could actually affect a taxpayer Zoom just a casual gambler here. And [00:31:00] the permitted loss deduction is claimed either on schedule C or by a casual gambler who itemizes. So let's look at a situation where we have a wagering gain of $100,000 and wagering losses of $100,000. Remember, these are two separate buckets. We can't net them the deductible losses starting with 2026 would be $90,000, 90% of those gambling losses. So the net effect here [00:31:30] is that even though that gambler broke even, they're still going to be $10,000 of gambling income. So economically, financially, this gambler broke even. But there's actually going to be $10,000 of taxable income, uh, added for that taxpayer. Right. So even if, right, let's say this tax payer incurred an extra $5,000 of otherwise deductible expenses [00:32:00] in carrying on that wagering activity, right? We're going to have 90% of $105,000 is $94,500. So we've got a situation where this gambler actually has more game wagering loss than wagering gain. But because of that, this taxpayer is still going to have positive taxable income from wagering. Right. Uh, so, so, you know, this is some phantom income here. This is [00:32:30] a taxpayer unfriendly, uh, approach here to, to gambling income for joint filers on a, on a, uh, married filing joint return, both spouses wagering gains are combined and then both spouses wagering losses are combined, but they are still kept in separate buckets.
Jeremy Wells: And the 165 D limitation still applies to the combined [00:33:00] amounts. So we could have one spouse with $100,000 of gain, another spouse with $100,000 of loss. We're still going to report that the same way as if a single individual had $100,000 gain and $100,000 loss. So in 2026. That's going to limit the deduction to just $90,000. And there's going to be a net of $10,000 taxable income there for those two. Back to form W-2 G. Thinking [00:33:30] about this now because all of this so far has been thinking about this from a fairly academic perspective. But the way I opened the episode was thinking about actually getting that client's W-2 G. It has an amount on it. The client swears that that is not how much gambling income that client actually has. So what do we do now? So we have to think about what this W-2 G actually is. It's an information return. It is [00:34:00] not a ledger of that taxpayer's gambling activity. So what is the W-2 G. Actually has usually it has the following. It has the payer and the recipient. So the usually the casino or the gaming application, which usually has a casino behind it that is actually issuing the payouts and the forms.
Jeremy Wells: So it has that information. It has the recipients information, it has the type and the date of the wager. One thing that's important to remember about [00:34:30] a W-2 G. I don't like that it's called a W2 because it makes us think of like an employment W2, which is a reporting of the entire year's wages for that employee. W2 G is not an annual report. It is a one time report. So it reports a payout, a single payout, not all of the payouts for the year, just a single payout. So it will have for that payout the type and the specific date of that wager. [00:35:00] And in fact, I've had clients where I've seen the dates on some of these W2 G's. And it strikes me as kind of interesting because you'll see some clients that will have a handful of W2 G's all with the same date, and you realize that it's one of the taxpayer's dates of birth. So tells me what they did for their birthday last year. I've also had clients where they have W-2 G's that are on 1225 of that year. So they spent Christmas Day [00:35:30] at the casino. It just gives you a little bit of an idea, a little bit of an indication of what some of your, your clients are doing, which is always kind of interesting, but that's the kind of information you get on a W-2 G that you don't see on a lot of other forms.
Jeremy Wells: Most other forms are annual reports. A W-2 G. Is from a specific day, you will see the reportable gambling winnings. And that's going to depend on the kind of game that was played. And we'll talk about that in a minute. You're also going to see if there was any [00:36:00] federal and state tax withheld. And then some more specific information about if that kind of gaming requires wager information to be reported on W-2 G. That's going to be on there as well. But like I said, it does not determine the taxpayer's total wagering gains or losses. It is not a full accounting of that taxpayer's gambling activity, even for the day. That is the date that that W-2 G [00:36:30] was issued. What you're seeing is a specific transaction that, uh, crossed a threshold that required that W-2 G to be issued. So it does not tell us whether the taxpayer had any other winning sessions. It doesn't tell us the reported payment, including a recovery of basis. With some exceptions that we'll talk about here in a minute. It doesn't include whether the taxpayer lost some or all [00:37:00] of that payout in the same session. It's possible to get a payout, turn around, put that payout back on the table or back into the slot machine, and then lose it all. It doesn't tell us how much the taxpayer won or lost during other sessions, either on the same day or different days in the year.
Jeremy Wells: And it doesn't tell us whether gambling below the reporting thresholds produced any additional taxable gains or losses. We're [00:37:30] only going to see payouts above the amount of the W-2 threshold. So what does that look like? Well, W-2 reporting depends on the kind of gambling. So for bingo and slot machines, a W-2 G is going to be triggered when there is a payout of at least $2,000. So you're not going to see any payouts of less than $2,000 even though they might have happened. For Keno, it's winnings of at least $2,000, minus the winning wager. [00:38:00] Now, this is a difference for Keno. We will see the wager taken out of the winnings for bingo and slot machines. We're only going to see the payout. So it's possible that that taxpayer has a $2,000 payout from a slot machine, but we don't know if it costs them $1, $5, $20, $100 to win that $2,000 payout for poker tournaments, we're going to see net winnings of at least $2,000 after reducing by the buy in, and then for racing, [00:38:30] sports, lotteries and other kind of similar gaming. We're going to see at least $2,000 and 300 times. The wager is what's going to trigger that W-2 G. So it's not just the amount of the payout. It's also that the payout was at least 300 times larger than the wager itself.
Jeremy Wells: But keep in mind these are information reporting thresholds. They are not income exclusion thresholds. They're not saying that [00:39:00] amounts won less than that because they don't have to be reported on a W-2 G. They don't need to be included in the taxpayer's winnings or losses reported on their return. Now, Treasury has proposed amendments to the regulations here. Uh, because these are relatively old thresholds, uh, but they, they still uphold, uh, those are still the thresholds, uh, even though they're a bit outdated now. [00:39:30] Now that W-2 G. Box one might exceed the taxable wagering gain. So think about a one slot machine session one session playing a slot machine. The form W-2 G. Jackpot is $2,000, but the amount committed to play the wager was $500. So the amount remaining when that taxpayer got up and left and ended the session was $1,600. [00:40:00] So your client is going to have a W-2 G. With $2,000 on it. But they're going to think there's no way I won $2,000 because I left the casino with $1,600 and 500 of that I brought in with me. So what's the actual session gain? It's the $1,100. It's the $1,600. They ended the session with, minus the $500 they [00:40:30] started with. So now we have a conflict. We've got a W-2 G that tells us we need to report $2,000 of gambling income. But we have the client's actual record, which tells us that it's only $1,100 of income.
Jeremy Wells: And this tells us that we have to ask questions. We have to get more information from the taxpayer when we see these W-2 G's. And this is the logic that we see the tax [00:41:00] court and the IRS apply. Now, a taxpayer may have taxable wagering gains from activities that might not necessarily produce a W-2 G. Also so winning sessions below the W-2 G thresholds. Fixed odds, sports betting and similar wins that failed at 300 to 1 reporting test. So if you have a client that places a relatively large wager and wins a reasonably sized jackpot [00:41:30] or payout, but it's less than 300 times the wager, there may not be a W-2 G. Triggered there. Untracked or cash gambling. If a taxpayer walks into a casino with cash leaves with cash and didn't trigger a W-2 G. Reported, then it's entirely possible that that gets missed. Other casinos or sportsbooks. Maybe the total amount of gambling wins and losses should be reported. [00:42:00] But the taxpayer plays at multiple casinos or on multiple apps and so doesn't trigger reporting on any one of them. And then of course, foreign or online gambling activity. And it's a bit dubious still how those entities should be reporting the gambling payouts for taxpayers that are using them. The same problem is going to arise with the smaller casino wins with cash [00:42:30] play with activity conducted without a player card. If the taxpayer doesn't use a card at a slot machine, for example, then there's no way for the casino to know unless that taxpayer cashes out.
Jeremy Wells: There's no way for the casino to know to issue the W-2 G. So it's possible that that taxpayer takes has winnings, but keeps the coins or tokens and saves them for another day. But maybe that other day doesn't come or doesn't [00:43:00] come until the next tax year. So there are winnings there. It's just not been cashed out. And so there's no reporting that happens. But the taxpayer's reporting obligation is still there under section 61. Right? It's not based on the information report. It's based on the fact that there's an accession to wealth here. And that means that there's income under section 61. So we have to reconstruct the activity, not just focus on the forms. So identify each type [00:43:30] of gambling activity. Ask the client what kind of gambling did you do last year. If we're preparing a tax return collect all the forms W-2 G and pay your statements. So even though we're not going to rely on the forms, we of course still need to have them because those forms get reported to the IRS. And IRS is going to expect to see numbers that make sense on the return relative to what was reported on those W-2 G's. But we also need to ask for wager [00:44:00] session and account level records. Now, most clients will not have this. They will have whatever win loss statement they can get from the casino or from the app, but that's usually going to be for the entire year.
Jeremy Wells: So we need to encourage clients and taxpayers to be keeping more specific records. One way they can do this is simply by looking at their own bank statements. So if they go to a casino and they load a certain amount of money onto [00:44:30] their player card, or they withdraw a certain amount of money at the ATM, then that will show up in their bank records. So have them search through their bank records to find at least those amounts, and then try to, you know, try to reconcile that with what the payouts or with what the eventual winnings were from those specific sessions. And then total the winning and the losing transactions [00:45:00] separately. Those should be two different columns. Those should be two different buckets that you're keeping track of those records in. Of course, reconcile those results to the information returns and then finally apply the section 165 D limitations along with the taxpayers reporting status. Again, joint filers pool their winnings and they pool their losses. They keep them separate, but they pull them as far as the couple. So both spouses winnings are added together. Both spouses losses [00:45:30] are added together. Then you're going to report that reconstructed gain. So when the form W-2 G differs from the taxable wagering gain, report the proper gain claim all the withholding in box four of course, and then prepare a form by form and session by session reconciliation.
Jeremy Wells: And you may want to consider attaching a statement to the return. Now, in my own tax software that I use, I will usually [00:46:00] get a an IRS rejection if the amount on schedule one reported as gambling income is less than the total of all the W2 G's. And in that case, I will have to make an adjustment on schedule one in other income. So I'll have a negative amount there, and that negative amount will reflect the wagers that weren't taken into account for that gambling income, uh, which is reported on [00:46:30] the W2 G's. It's really important that we make sure though, that the right amount of gambling income or wagering gains is reported. Now, I mentioned earlier that gamblers, especially casual gamblers, but all gamblers should keep adequate records. So gamblers should maintain a log consisting of at least the following information the date and type of specific wager or wagering activity. The name of the gambling establishment. [00:47:00] The address or location. The name of anybody else that they went with in case they need a witness at some point. And then, of course, the amount won, lost and wagered. Don't rely on those annual win loss statements. Those almost never have session level data that we need. Now taxpayer can always use other information as well, such as those forms W-2 G. The casino win [00:47:30] loss and player account statements, transaction histories, any bank credit card or ATM records, canceled checks, tournament travel records, all those sorts of things.
Jeremy Wells: But all of that should be supplemental to the taxpayer's log of their activity. Now, what governs here is Revenue procedure 7729, which lays out these record keeping requirements for gamblers. [00:48:00] But remember, all of this predates because it came out in 1977, predates a lot of the modern way that gambling works today. Things like player cards, things like casino, smartphone applications, mobile sports books, all of that is before this, but we still have the same set of rules when it comes to record keeping for gamblers. And again, we separate the gains from the losses. Those gains go on schedule one, and they're [00:48:30] included in adjusted gross income. The permitted losses go to schedule A for a casual gambler, and they're deductible only if the taxpayer itemizes and they don't reduce AGI. And we have to keep in mind that for high income taxpayers, that total itemized deduction may be reduced under the amended section 68 after the ob a so that's the two out of 37 rule. So it's possible [00:49:00] for a high income earner to deduct even less than the 90% of losses in 2026 and beyond. So again, even a taxpayer who breaks even gambling might still have taxable income to report. Now, I mentioned adjusted gross income for gambling gains and wagering gains. It's important to keep the effects of inflated AGI in mind [00:49:30] when we're working with taxpayers who like to gamble, because AGI affects a lot of other things on the tax return and otherwise.
Jeremy Wells: So taxability of Social Security benefits, credits and deductions that are subject to income limitations, the net investment income tax, Medicare income related premiums, otherwise known as Irma, is a big one here because a lot of gamblers tend to be retired. And so they are drawing Medicare benefits. [00:50:00] And the cost of those Medicare benefits is going to depend not on their taxable income, but on their AGI. So having an artificially inflated AGI could cost that taxpayer money down the road on their Medicare premiums. It's also going to affect the new additional deductions under the OBB, such as the senior deduction and the deductions for qualified tips and overtime compensation. And of course, there are going to be other federal and state calculations that are tied to AGI. A lot [00:50:30] of states start with federal AGI when it comes to calculating state income taxes. And again, some states don't allow a deduction for gambling losses. Now I mentioned professional gambling. So when does gambling become a trade or business. When any other activity becomes a trade or business essentially is the rule here. So if the taxpayer pursues the activity with continuity and regularity, engages in it primarily for income or profit, and does more [00:51:00] than gamble sporadically or as a hobby or amusement.
Jeremy Wells: Now that professional status is going to depend on contact conduct, not just what the taxpayer wants to be called. So calling yourself a professional gambler might help you be able to mentally reconcile the fact that those losses would now partially be deductible, and that those expenses might [00:51:30] be deductible on a schedule C, however, we need to look at the taxpayer's actual conduct when we're deciding whether to treat that activity as a schedule C operation as opposed to just a casual gambler. Now, in the Supreme Court case of Commissioner V Grotzinger for 80 US 23. In 1987, the Supreme Court held that a full time gambler, wagering solely for his own account, could be engaged in [00:52:00] a trade or business. That's where that comes from. That taxpayer devoted approximately 60 to 80 hours per week to wagering. Most of the clients that we get are not going to be gambling to the degree of being a professional gambler, unless they are actually depending on that income in order to essentially survive. So there are criteria. I've got a prior episode on whether an activity is a hobby versus a business, [00:52:30] and I go over some of those indicators of whether an activity is a business or not. Go listen to that episode because that directly applies here as well. Like I mentioned, professional gamblers are going to report that activity on schedule C, they report their wagering gains on schedule C, there's allowance for deducting permitted wagering losses and related expenses, but they remain subject to the 165 limitation and they will pay self-employment tax on [00:53:00] net earnings.
Jeremy Wells: All right. Some key takeaways to wrap this episode up. Taxable wagering gains come from the underlying activity not from the forms. Yes. Get the forms W-2 G. Yes. Notice the amounts on them. But there's still more work to do. Don't just copy the amounts from the W-2 G's onto the 1040. A wagering transaction requires something of value placed at [00:53:30] risk on an uncertain outcome. If it's not an uncertain outcome, if it's rather a trial of skill, or if there's not been any consideration placed in order to win the result, then that wasn't may not have been a wagering transaction. Wager basis, and that proper accounting unit such as the session, determine the gain or loss. Again, not the amounts reported on forms. Starting in 2026, [00:54:00] only 90% of wagering losses can be deducted. So if you have clients that have historically been deducting their wagering losses, make sure they understand that they're going to lose 10% of those losses, uh, starting with 2026. And then casual and professional gamblers report differently. So be very clear on whether that gambler is actually a professional or not. But both are still going to be subject to that. Section 165 D [00:54:30] limitation. If you found value in this episode, please let me know by liking and leaving a comment in your podcast application of choice or on YouTube.