Tax Deductions for Gambling Losses: What IRS Secretly Wants
For those who play, bet, or wager, this is for you.
If you play, eventually you will win. Some win big. But those losses really stack up, as well. You must report your winnings on your tax return. You should get to claim your losses too, right? But have you ever wondered why the IRS seems to never allow gambling losses in tax audits?
Why the IRS Frowns on Gambling Losses
When your tax return preparers ask about gambling losses, year after year, the answer is usually the same: “But my losses were “waaaay more” than my winnings.”
The accountant adds an “itemized deduction” for gambling losses on the customer’s tax return, but only to the amount of winnings. In our “good faith” system of tax reporting, tax return preparers will accept that customer’s claim of losses. The customer gets to deduct losses, enough to offset the full amount of the winnings.
“But my losses were “waaaay more” than my winnings.”
And that sort of makes gambling income almost tax-free! The problem is that the IRS does not want gambling winnings to be tax-free.
IRS Auditors Strict Gambling Losses, IRS Tax Attorney (Naperville IL)
This is How the IRS Looks at It
There are a few things to think about here:
Players (both winners and losers) want their gambling activity to be treated like a business. On the subject of taxes, this means that all wins should be reduced by all losses. However, unless the Taxpayer is a Professional Gambler, the activity is not a business.
Instead, the IRS sees “casual gambling” as a hobby. This “hobby” designation still applies to habitual gamblers or even problem gamblers. Unless enough of the rules are met to be considered a professional gambler, that person is treated like it is a hobby.
There is a clear distinction between hobbies and businesses. Businesses are intended for profit. Hobbies are primarily for personal enjoyment.
If an activity is classified as a hobby (often called the “hobby loss” rule), taxpayers can deduct expenses, but only up to the amount of income generated by the hobby. (This is called the Hobby Loss Rule, under IRC Section 183.)
Basically, this means they cannot claim a net loss from a hobby, as they could with a business.
The “Sessions Reporting” Method is Getting More Popular
Applying that Hobby Loss Rule to gambling losses, the IRS auditors look at it this way: Auditors only allow proven expenses associated with the winning bets, because those are income sources. However, losses are not income sources and are not always considered to be allowable expenses.
But courts and the IRS agree that the burden on Taxpayers to prove their investment in the reported winning bets is an unreasonable requirement. And that is why we developed the “Sessions” method of reporting gambling income.
For the “Session Rule”, the Tax Court draws an analogy to the recovery of capital investment. In this comparison, you calculate the casual gambler’s gross income from a wager, play, or bet transaction by subtracting the bets placed to produce the winnings.