Online Casino

With the legality of gambling over the Internet in the United States being unclear, the lack of a firm federal law creates something of a tax conundrum.

To give an example of the problems faced by the tax authorities as well as individuals, let's look at the fortunes of a California resident, who this year won around $50,000 while playing online video poker. This sounds like a wonderful win for a player, especially as she didn't have to visit a brick and mortar casino which would have meant driving for several hours then having the additional expense of staying in a hotel. There are many advantages to playingat online casinos and our winner made full use of them playing from home. However, while she may have won $50,000 on one game, she actually spent more than $40,000 on a variety of games before she cashed out the $50,000. So, that being the case, would her losses therefore be deductible?

In any other business, if your expenses amount to a proportion of your gross earnings, they are deducted from the gross total to provide a net income figure. The resulting net figure is that which is liable to tax at the standard rate. So here is the conundrum.

The winnings from gambling forms a taxable part of a person's income, just like any other form of income. When gambling, you will incur expenses in the form of paying for all of your games as losses before finally winning, if you are lucky. You must also report all of your gambling derived winnings to the Internal Revenue Service for each fiscal year, so what about your losses? And if those winnings came from an online gambling establishment, are they even legally taxable?

There is no doubt that online gambling has many advantages over visiting a land based casino, such as you get to sit where you want, you don't have to breathe in cigarette smoke or listen to shouts and whoops from other noisy gamers. You can also take a break when you want to and no one is going to step in and take your machine while you're away. It’s the legality of Internet gambling that is causing all the headaches, because there simply is no clear, defining federal law that states incontrovertibly that gambling online is illegal. That means it comes down to state law and whether the state you live in has explicitly outlawed Internet gambling in some form or another. Currently, Illinois, Louisiana, Indiana, Washington and South Dakota are the only states to have such defining laws.

The UIGEA, which was passed in 2006 and comes effective on 1st June 2010 following a last minute extension to its deadline, does not define the legality of Internet gambling from a user's standpoint. In fact it only makes banks and financial institutions police their financial transactions to block those associated with online casinos. So currently, the only kind of online gambling that can be defined as completely legal is sports betting. 

Getting back to the issue of taxation then, there are plenty of problems concerning winnings derived from online gambling.

To start with, there is no guidance issued by the IRS that deals specifically with Internet gambling, according to an IRS spokesman. In any case, financial gains obtained from wagering transactions are included as part of a person's income. It doesn't matter whether those gains came from bets made online or in a brick and mortar establishment.

The system is to report your total gross winnings but don't deduct any of your losses. Deduct these are miscellaneous deductions on the Schedule A. There is a special Line 28 for this where such deductions are taken in full. There is no 2% reduction of adjusted gross income. All gambling deductions must be limited to winnings.

So getting back to our lucky winner above, the IRS says she is entitled to take the $40,000 deduction, as long as the cost of all her wagers can be substantiated. It would be easy enough to obtain a printout from online activities to prove the value of deposits made to her casino account. As a matter of fact, the IRS actually hints that despite the disputed legality of the activity, the deductions are still allowable.

So with the IRS satisfied what about at State level? In this case it's California and for the purposes of income tax there is currently no clear guidance as to whether online poker is legal or illegal. It is then up to the taxpayer to determine the legality of their actions. While California state law fails to provide for legal Internet gambling, there is actually no law that specifically outlaws Internet gambling.

It would be quite unfair to have to pay tax on a $50,000 win, when the net winnings only amount to $10,000. It's even worse if you end up with a net loss by the year end. The best advice is to report the win as income and make a deduction itemized as a miscellaneous deduction. Then hope that you'll never be audited by the state!