Tuesday, November 28, 2006

The IRS Loves Gambling

Consider my lucky friend Rupert who went to the casinos last night and won $100,000 on the $10 slots. Boy did he feel good, even calling me in the middle of the night to claim that his luck had finally turned. God is once again on his side. It didn’t even bother him that the casino gave him a W-2G acknowledging his winnings to the IRS since he knew that he could deduct his $100,000 in losses for the year. You see Rupert keeps very good records and he understands that his casino losses can offset his gambling gains. Thus, he has no income for the 2006, according to his calculations, and no income tax liability.

Unfortunately, Rupert may have God on his side, but the IRS is playing for the other team. You see when he completes his income tax forms for 2006, he will show $100,000 in winnings. But his $100,000 deduction appears on Schedule A (Other Expenses) which means that it is first subject to a 2 percent cap. Thus he is allowed to deduct only $98,000. Next, Other Expenses, such as casino losses are subject to the AMT. This means that the $98,000 moves to the AMT form so that he is essentially (plus or minus a percent or two depending on his other income and deductions) subject to a 28 percent tax rate on his AMT expenses.

After completion of his tax returns my fictional friend Rupert now owes the IRS approximately $27,000 despite having earned a net of $0.00 in the casinos for the year. It should come as a surprise to no one that the government LOVES casinos.


Ed Morse said...

Ernie, I think we have now established why you do economics and I do tax. I don't think the details of your tax analysis are quite right here.

Gambling losses are subject to a limit, but that limit is gambling winnings (see IRC section 164(d)). These losses are itemized deductions (unless you are a professional), but not miscellaneous itemized deductions subject to a 2% of AGI floor. And as such, they are not an AMT preference.
But you are correct that there can be adverse tax consequences for gamblers. For example, a gambler who might otherwise be eligible for an Earned Income Credit may price himself out of one, as AGI is counted, not taxable income. Same deal with child credits and other benefits depending on phaseouts.

Folks who want to know more about this should buy our book, Governing Fortune (forthcoing early next year by the University of Michigan Press - preorder on Amazon - early and often!). See chapter 9.

Best regards.

Anonymous said...

You think that's bad. In the Massachusetts state lottery, winnngs can only be offset against the cost of the lottery ticket. Hence, any winnings are treated as income irrespective of cumulative losses.

Ed Morse said...

Good point, anonymous. Also, it should be noted that in some states, there may be an AMT adjustment for state tax purposes. I believe Minnesota may fall in this category.

Ernie Goss said...


My comments come from one of your people--my CPA lawyer. He thinks your analysis is wrong.


Anonymous said...

Ok, here's the WORST junk I've EVER heard !!!! A friend of mine in Michigan, (unluckiest chump ever) has almost $200K in W2G's, but hasnt won a dime in Michigan. No big deal, right? WRONG !!!! In the State of Michigan, you CANNOT deduct your losses against your winnings !!!! Well, to me, winnings aren't winnings unless you can show an improvement in your own personal financial well-being. In other words, post a gain. Where is the constitutionality of this "law"??? Even the federal IRS doesn't buy into this crap. My buddy is sick. 7 grand out the window. Worst state in the country to gamble in. Unbelievable.