How are your March Madness brackets looking? Are you one of the millions of Americans that placed a small wager in your office bracket pool? Even if you did not partake, probably a lot of your clients did. Does it still look like you have a chance to win the pool? If you do win, do you know that the winnings are taxable income? If you do not win, did you know that your wager may not be deductible as a loss? All this is because you generally cannot net gambling income against gambling losses, reporting only the net income. You must report the gambling income, and, separately on the tax return, report the gambling losses, but only if you itemize your deductions and only to the extent of your gambling winnings. Unless you are doing your March Madness wager with a Nevada licensed sports book, your March Madness wager is probably illegal gambling, but that in general would not affect your federal tax treatment. Whether legal or illegal, gambling income is subject to tax and gambling losses may be deductible to the extent of gambling winnings.
Should March Madness wagers be considered gambling? What about skill, you ask? You follow basketball closely and complete your brackets with a great deal of knowledge about each team in the tournament. You are not like some of the other employees in the office filling out brackets randomly or based on emotion for or against a particular team. Gambling can generally be described as wagering something with the possibility of receiving a reward, the receipt of which is based more on chance than skill. Poker is subject to debate as to whether it is more of a game of skill than chance. Daily fantasy sports leagues are subject to a similar debate in various states. Wagering on the outcome of the NCAA Basketball Tournament, however, is generally considered to have an outcome based more on chance than skill and is generally considered gambling.
The following bracket chart provides ten rules applicable to gambling activity and how to properly account for that activity at tax time. The basic rule is that winnings are always taxable, whether from legal gambling, illegal gambling, or a game of skill. How losses are handled can be more difficult. A professional gambler who provides his primary support from gambling could report his or her gambling winnings, losses and related expenses on IRS Form 1040, Schedule C. The more typical amateur gambler would report gambling winnings as other income on the tax return. Gambling losses would be reported on Schedule A only if itemized deductions are claimed and only to the extent of gambling winnings. There are various IRS reporting requirements applicable to gambling payouts; however, even if your winnings were not reported to the IRS, they are still taxable. If you were ever audited for other purposes and the IRS auditors discovered unreported bank deposits from gambling activities, you would face collection activity for unpaid taxes, interest and penalties and perhaps even criminal tax evasion charges. If illegal gambling is involved, the IRS might even report you to state authorities responsible for illegal gambling activities.
And what if you can treat that daily fantasy sports league as a game of skill rather than gambling? Then, the IRS hobby rules apply. The income from the fantasy sports league is still taxable as other income. You may, however, be able to offset the fee for entering the contest in which you won a prize and only report the net amount. Other entry fees for losing contests and other direct expenses related to the hobby may only be deducted to the extent of winnings, may only be deducted if you itemize your deductions, and may also only be deducted to the extent that those hobby expenses and any other miscellaneous itemized deductions to which you may be entitled exceed two percent of your adjusted gross income.
Keeping good records will be very important to protect you in the event of an IRS audit. You will likely have records of any W-2Gs reporting gambling winnings or 1099s reporting other income received, but you will probably have to make an effort to maintain good records of smaller winnings and expenses and losing wagers to support any deductions to which you may be entitled. So remember, with any benefit usually come a few burdens. The benefit of winning your March Madness office pool will come with a few burdens at tax time.
Mark A. Luscombe is the principal federal tax analyst at Wolters Kluwer Tax & Accounting.
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