The tax rules for gamblers can be summed up simply: "Heads, the IRS wins; tails, gamblers lose." The faux-friendly feds routinely nail gamblers for taxes on their entire winnings from horses, lotteries, slot machines, cards or other games of chance. But their losses are deductible just to the extent of their winnings. What's more, losing bets that undergo IRS scrutiny generally are allowable only when they're corroborated by records that pass muster with the agency -- a requirement that's neither more nor less stringent than for other kinds of write-offs
The Form 1040 instructions mandate separate reporting for winnings and losses. Gamblers can't reduce winnings by losses and report the difference, the way investors do for capital gains and losses. They must report the full amount of winnings for the year on the 1040 line for "other income" (line 21 on the 1040 for 2010). The instructions also tell them to specify "gambling" as the source of the winnings in the box to the left of line 21. This remains the case even if winnings are less than losses.
The tax code mandates that under no circumstances can a loss deduction exceed reported winnings for the year in question. This holds true whether those losses are incurred by recreational gamblers or professional gamblers. Moreover, the law absolutely bars any use of excess losses to offset wages, dividends, interest and other kinds of income. These rules are similar to the ones for hobbies. Hobby expenses are allowable only up to the amount of income generated by the hobby and can't offset income from other sources.
Gamblers can't deduct losses if they use the standard deduction. Gamblers can deduct losses only if they itemize on Schedule A of Form 1040. Year in and year out, gamblers get tripped up by this limitation.
Gambling losses are considered miscellaneous deductions that are claimed at the bottom of Schedule A. But gambling losses aren't subject to the nondeductible floor of two percent of adjusted gross income that applies to other kinds of miscellaneous expenses--for instance, unreimbursed employee business expenses, such as employment-related educational expenses and dues for unions or professional associations, and fees for return preparation and tax planning and investment advice.
Several imaginative taxpayers have tried to sidestep restrictions on loss deductions by claiming write-offs for their spending on trips to local tracks or longer jaunts to places like Las Vegas. For instance, John Shigeta made regular pilgrimages from California to shoot craps at the Sands Hotel and other establishments in Las Vegas. John's losses at the crap tables ran to $50,000 over a 10-year period, despite "dogged" efforts to improve his skill.
For 1967, his score was $1,300 won and $10,000 lost. In addition to subtracting losses of $1,300 from his winnings, John decided to reduce his tax bite by writing off $1,230 spent traveling to Las Vegas and staying in hotels there as an expense "for the production of income." But the law says such expenses are deductible only if an activity is profit-motivated. Consequently, the judge, though sympathetic, concluded that John flunked this test and threw out the entire $1,230. His honor reasoned that the main motivation for any crapshooter with an abysmal record like John's wasn't profit but pleasure.
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Julian Block is an attorney and author based in Larchmont, N.Y. He has been cited as "a leading tax professional" (New York Times), "an accomplished writer on taxes" (Wall Street Journal) and "an authority on tax planning" (Financial Planning Magazine). His books include Julian Block's Easy Tax Guide for Writers, Photographers, and Other Freelancers: Trim Taxes to the Legal Minimum