We’ve been conditioned to think that nearly every dollar added to our pocket is taxed. So when something isn’t taxed, it seems truly remarkable (or overlooked). When you add that it’s gambling winnings we’re talking about, the idea that anything isn’t taxed is, well, too good to be true. Confused? Allow the Tax Warriors to explain.
The black-letter rule is that every accession to wealth is taxable income, unless specifically exempted. Those exemptions are few and far between. There’s no question that gambling winnings are taxed, however they generally can be offset with gambling losses. Yet, a question recently arose, what about nonresident aliens?
If you’re not a U.S. citizen or permanent U.S. resident, can the IRS tax your winnings? This is where the tax rules get complicated. Nonresident aliens pay U.S. tax on their “fixed or determinable annual or periodical gains, profits, and income” from U.S. sources. That phrase is hard to decipher, but it includes gambling winnings.
The flip side is that nonresident aliens can only deduct items effectively connected with the conduct of a trade or business within the U.S. As a result, gambling losses are not deductible by a nonresident alien. Taxing winnings but not allowing related losses doesn’t seem very balanced.
Though in all fairness, even domestic gamblers have had to fight with the IRS about how to offset their wins and losses. In 2008, the IRS ruled that U.S. citizens could measure their gains on a per-session basis. In effect, you don’t have to compute each wager separately to determine if you won or lost and by how much. Just tally your total at the end of your gambling session.
The Tax Court reached the same conclusion in Shollenberger v. Commissioner, T.C. Memo 2009-306. As a result, now U.S. citizens (and resident aliens) can measure their gambling wins and losses on a per-session basis and don’t have to compute their losses/income bet by bet. But should this treatment apply to nonresident aliens who come to the U.S. to gamble? The IRS said no, aliens should pay tax on all gains, period.
But then came Mr. Park, a nonresident alien, who periodically came to the U.S. to gamble. Although he had net gambling losses, the IRS determined that he had both taxable gambling gains and non-deductible gambling losses, because it treated each bet separately. The IRS said he couldn’t offset them.
The IRS claimed that his wins were “effectively connected” to the U.S., but not his losses! What's worse is the U.S. Tax Court agreed. See 136 TC No. 28. Mr. Park appealed, and the D.C. Circuit Court of Appeals reversed. It held that the per-session rule applies to residents and nonresidents alike. See 12-1058 – US Court of Appeals - DC Circuit.
The Appeals Court said there was nothing in the law to vary the tax rules on gamblers depending on whether they were U.S. citizens. The court pointed out that the IRS itself had said that offsetting wins and losses per session made sense–for citizens. To the court, the IRS opened the door.
If the rule made sense for U.S. citizens, it made sense for non-residents too. The per-session approach avoids the administrative and practical difficulties of having to track every single win and loss. There is nothing in the law to make this rule any less sensible for nonresidents.
Trying to follow this line of reasoning is dreadfully confusing. In fact, it might be easier to beat the odds on a Friday night in Vegas. That being said, whether you are a U.S. citizen, a permanent U.S. resident or a non-resident alien, high-stakes gambling can certainly have an impact on your tax bill. Understanding how this impact works is the tricky part.
Should you have excessive gambling losses or gains, you should speak to your tax advisor about these occurrences. Large winnings can push you into a higher tax bracket and cause you to pay a higher rate than you originally thought applicable. The Tax Warriors® at Drucker & Scaccetti are always prepared to help you with this or any other tax-related matter. Call on us via the “Ask A Tax Warrior” button below if you have any questions.