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.