Gambling in Connecticut and Taxes
In May of 2021 Connecticut legalized online casino gaming and sports wagering (you can find the history and text of the bill here: https://www.cga.ct.gov/asp/cgabillstatus/cgabillstatus.asp?selBillType=Bill&which_year=2021&bill_num=6451) This was great news for people who enjoyed casually betting on sports or people who wanted to digitally play slot machines from the comfort of their homes as opposed to making the trip out to Mohegan Sun or Foxwoods. As soon as DraftKings and FanDuel rolled out their online platforms in October of 2021, people quickly began utilizing them. No one took a step back to consider the tax implications, implications which are incredibly unfair and which can generate enormous tax liabilities.
Even when you win, you still lose at tax time, especially in Connecticut.
Federal Taxation of Gambling Income and Losses
Let’s walk through the default treatment of gambling income. Let’s take the example of an individual that won $10,000 on specific sports bets and also lost $20,000 on other specific sports bets in the same year. At the federal level, you include all of your gambling winnings in your income. This $10,000 of income is reported on Schedule 2 line 8(b), which then carries to Form 1040 line 8. Your gambling losses are then reported as an itemized deduction on Line 16 of Schedule A, but this deduction is limited by the amount of winnings that has been reported as income, which means, despite having $20,000 in losses, the above individual can only report $10,000 of losses. Even at the federal level, this is an unfortunate method of reporting gambling income because, at least since tax reform in 2017 and the substantial increase to the standard deduction, very few taxpayers use the itemized deductions, and having to claim itemized deductions to utilize your gambling losses will normally result in more taxes paid on the gambling winnings. In this example, if you don’t have any other itemized deductions, you still will claim the standard deduction as it exceeds the $10,000 of deductible gambling losses, which will leave you effectively being taxed on the full amount of your gambling winnings (despite the fact that you lost a net $10,000 on gambling on the year). It’s also worth noting that even if you do utilize the itemized deductions, your gambling winnings will still increase your AGI (adjusted gross income) which can reduce or disqualify you from claiming a large variety of tax credits for which you may have otherwise been eligible.
State Taxation of Gambling Income and Losses
While the impact of gambling winnings and losses is unfavorable at the federal level, for some states, like Connecticut, the tax consequences are outrageous. Let’s take a hypothetical that is based on numerous cases that I’ve seen in the last few months. A taxpayer who, using FanDuel and/or DraftKings, actively played the online slot machines throughout the course of the year, having tens of thousands to hundreds of thousands of transactions (individual slot pulls). Let’s take the fictional example of a CT resident taxpayer who won $8,000,000 but lost $8,050,000 on the year, leaving him $50,000 poorer than he was at the start of the year as a result of his gambling activity. His Connecticut return starts with his federal AGI (which will include the $8,000,000 in winnings) but does not permit the deduction of any of his losses. Despite the fact that he’s lost $50,000 on the year, Connecticut is going to treat him as though he won $8,000,000 and will proceed to tax him on that $8,000,000. In this case the CT income tax on the $8,000,000 will be $559,200. Take a moment to digest the absurdity. He lost $50,000 on the year but owes over $500,000 in tax to CT for his gambling activity.
Unfortunately, most people aren’t aware that their gambling needs to be included in their income (despite receiving W-2Gs from FanDuel/DraftKings) and equally importantly, they aren’t aware that the IRS and Connecticut both receive copies of these W-2Gs. This means that if you don’t report your gambling income, the IRS and DRS will have the tools to adjust your return and increase your tax liability to account for any W-2Gs. It’s also important to note that a W-2G is required for slot machine winnings when “The winnings (not reduced by the wager) are $1,200 or more from a bingo game or slot machine”. This means if you bet $2,000 and receive $1,200 (an $800 loss) DraftKings//FanDuel are required to create a W-2G for you for that bet. The IRS and DRS will not receive any information relating to your losses and if they revise your return for you (because you did not include your gambling income on your original return) they will only be able to include the W-2G’d winnings (unless they open an audit to gather the additional gambling data outside of the W-2Gs).
Options to Reduce Your Gambling Tax Liability
Fortunately this isn’t the end of the conversation and there is a good chance that, if you find yourself in a situation similar to the above hypothetical, that we’ll be able to help you. Help comes in the form of a 2015 IRS proposed revenue procedure found in IRS Notice 2015-21(which finds its basis in several court decisions). The title of this notice is: “Safe Harbor Method for Determining a Wagering Gain or Loss from Slot Machine Play” This notice walks through the session method of accounting for slot winnings and losses.
The Session Method
The session method allows you to group some gambling activity into ‘sessions’, permitting you to offset wins with losses within each session. The rationale here is that it is unreasonable to expect Taxpayers to report every pull on a slot machine as a distinct taxable event and that it is much more reasonable to look to the amount of money you had when you sat down at that slot machine and compare it to the cash still in your pocket when you’re walking away from that slot machine. The same logic applies to other casino games, like poker and blackjack, as it would be unreasonable to tax you on every single hand of poker you win when each hand is a part of the larger game. With games like poker and blackjack it’s a bit easier to pin down a session than something like online slots. If you sit down with a group of friends to play a game of poker until there is one winner, only that ultimate winner (the only person walking away from the table with more money than they brought to it) should be taxed, regardless of the fact that the other players won many of the hands throughout the course of the game.
Consider the appropriate application of this ‘session’ idea to online slots, you’re gambling from the convenience of your home, on the same ‘machine’ i.e. your computer, but with a single click of a button you can hop from one virtual slot machine to a different virtual slot machine. In the online slots context, every single bet and every single win is recorded and at the close of the year the companies providing those virtual slot machines will issue the W-2Gs for all of the wins that exceed $1,200, regardless of the fact that you may have lost much more than you won in any particular gambling session. The proposed revenue procedure suggests that sessions for purposes of slot machine gambling should be the entire calendar day, and that taxpayers should only have reportable wins when, at the end of the day, they have more in winnings than losses. In my view, this is a much much more reasonable way to determine the amount of gambling winnings that an individual has and for many people, application of this method will dramatically reduce their Connecticut tax liability.
Let’s hop back to the earlier example of the taxpayer that won a total $8,000,000 on the year but lost a total of $8,050,000. Under the session method, we will have to get the spreadsheet of all of their transactions (FanDuel and DraftKings will provide these spreadsheets but their responsiveness to requests goes down dramatically near the tax deadline, so make sure to put in your requests for this data early or plan on going on extension). Once we have this spreadsheet we’ll divide it into 365 different sessions and calculate the net winnings or net losses for each day (assuming that all gambling activity for that individual was slot machine gambling). The person in our hypothetical actively played online slots daily and finished 50 days with net winnings and had 315 days with net losses. Separately aggregating their 50 days with net winnings results in $300,000 of ‘winnings’ and aggregating their loss days results in $350,000 of ‘losses’. This individual will report $300,000 of gambling income and will report itemized deductions for their losses of $300,000 (because the deductible amount of losses is capped by the reported amount of winnings). With that amount of gambling income, the impact of the session method at the federal level will be fairly small compared to the alternative (reporting $8,000,000 of income and then deducting $8,000,000 in losses) because most available tax credits that are AGI dependent will be phased out with income over $300,000. The impact on their Connecticut return will however be dramatic. In this hypothetical, the session method will reduce their state tax liability from $559,200 to $20,970. I certainly agree that it is still wildly unfair that this person will have to pay over $20k in tax when they ultimately lost $50,000 on the year, but it’s a markedly better outcome than the $599,200 of tax that would result without the application of the session method.
2015-21 Is Only a ‘Proposed’ Revenue Procedure
Unfortunately, this is still only a proposed revenue procedure and despite the fact that it came out over 8 years ago at the time of writing this article, no final procedures have been released. This means that you are at risk of an adverse determination in the event of an audit. The IRS certainly could conclude that it is inappropriate to utilize the guidance in this proposed procedure, but that still leaves you with the ability to rely on the court decisions that have approved the ‘session method’. It is worth noting that these decisions don’t define ‘session’ as liberally as the 2015-21 notice, and the appropriate size of the ‘session’ could be reduced below the calendar day that is suggested in 2015-21.
It’s also worth noting that the proposed revenue procedure is specifically for slot machine play and this calendar day session length should not be extended to other types of gambling.
Lastly, I’d also mention that professional gambling is an entirely different issue and professional gamblers are treated very differently with greater flexibility to deduct their losses but self-employment tax will apply to their net winnings. You also have to meet a bunch of requirements, requirements that are very difficult for the average gambler to meet, in order to be considered a professional gambler. A deep dive on those requirements is beyond the scope of this article, but it is worth noting that there are separate requirements and that they are difficult for the average person to meet.