W-2Gs: Requirements Before & After Mar. 4, 2008

November 12, 2007 Update : The American Gaming Association is reported to have intervened with the IRS and negotiated a change in the terms of Rev. Proc 2007-57, so that alternatives will be available to casinos and cardrooms that will allow them to follow the original proposal in the revenue procedure or instead to merely issue W-2Gs to players whose net win is over a certain amount without having to withhold for income taxes from the amount won.  It is not clear yet whether that level will be the $5,000 defined in the original revenue procedure or some lower amount, such as the $600 that was targeted in the Binion's closing agreement discussed in the article below.  I will post details when the revenue procedure is reissued.

August 31, 2007 Update : IRS Rev. Proc. 2007-57 concludes that poker tournaments are "wagering pools."  This will undoubtedly result in operators of poker tournaments issuing Forms W-2G to and withholding income taxes from players who are paid proceeds (net of the buy-in to the tournament) of $5,000 or more at a 25% rate.  The revenue procedure becomes effective for payments made on and after March 4, 2008.  Click for a copy of the Rev. Proc.  Whether tournament operators will begin to issue W-2Gs without also withholding to players who win a net of less than $5,000 is subject to conjecture.  The Rev. Proc. does not address this question.

Here is the analysis by Russ Fox of the impact of the scope and impact of Rev. Proc. 2007-57.  This is reprinted with the permission of Mr. Fox from his blog, Taxable Talk, entry for Aug. 31, 2007.

Poker Tournaments Takes a Hit

Back in 2005, I speculated that the IRS would write a regulation requiring withholding from poker tournaments. The IRS will, on Tuesday, announce Revenue Procedure 2007-57, requiring withholding from any winner of a poker tournament who has received more than $5000 in winnings from the tournament.

First, this is a Revenue Procedure; this is the lowest form of IRS regulation. (The Tax Code is statutory law; it's the highest form of regulation. Next are IRS regulations. Those are promulgated under the Tax Code. Then come from Revenue Rulings and then, finally, Revenue Procedures.)

Entities do not have to follow a Revenue Procedure. But Revenue Procedures are written so that entities usually follow them. They include verbiage that reads (this is taken from Revenue Procedure 2007-57), "The IRS will not assert any liability for additional tax or additions to tax for violations of any withholding obligation with respect to amounts paid to winners of poker tournaments under section 3402, provided that the poker tournament sponsor meets all of the requirements for information reporting under section 3402(q) and the regulations thereunder." Of course, this implies the IRS may assert violations to entities that don't follow the Procedure. Effectively, all casinos will likely follow the Procedure.

So what does Revenue Procedure 2007-57 say? In Section 3.01, it classifies poker tournaments as a "wagering pool." It does so by referencing United States v. Berent, 523 F.2d 1360, 1361 (9th Cir. 1975). And IRS regulation §31.3402(q)-1(b)(2) requires withholding on wagers in a wagering pool if the proceeds from the wager exceed $5,000.

Interestingly, the Revenue Procedure states that withholding will be required: "A poker tournament sponsor is required to withhold and report on payments of more than $5,000 made to a winning payee in a taxable year...." Per the regulations, the required withholding rate is 25%.

This has two impacts. First, anyone who wins more than $5,000 will receive 75% of his winnings (unless subject to a higher withholding rate). Second, many casinos will again start issuing W-2Gs to everyone who wins in a poker tournament. Once casinos have to start issuing W-2Gs to a few people, casinos will come to the conclusion it's easier to issue them to everyone.

As to the Revenue Procedure itself, I think it's a poor application of the law. As I reported back in 2005, I don't believe poker tournaments are a wagering pool. Wagering pools are when you wager on something else, such as a horse race. Indeed, the IRS came to that same conclusion as I did in a private letter ruling in 2005. The reality is, though, that I don't think a casino or cardroom is going to challenge the IRS on this. Their attorneys and tax counsels will say that the easiest thing to do is to go along with the IRS Revenue Procedure. Entities that don't will potentially be subject to additional IRS scrutiny, so following the Procedure is the course of least resistance.

What will the impact be to tournament poker? First, there will be additional compliance with the Tax Code. Given that more W-2Gs will be issued, and withholding will occur, the IRS will see additional collections (which is their goal). The other major impact of this ruling is that money will be taken out of the poker economy. Once this Revenue Procedure goes into effect (March 4, 2008), about 25% of the prize pool of major poker tournaments will vanish. Of course, the IRS will correctly note that this money should have been paid in taxes at some point. However, given that gambling losses are deductible against wins, some of the withheld funds would never have been owed in taxes because of gambling losses.

Will this impact the number of players in major poker tournaments? Possibly. Where it may have the biggest effect is in a series of major tournaments. Suppose John Doe wins $10,000 on day 1 of a tournament. Under the new Revenue Procedure, he will only keep $7,500. There's a higher chance of him not entering additional events so that the funds don't reenter the poker economy.

Below is the text of an article I wrote a few years back.  I have not updated it.  I did look at the current versions of the IRS Instructions applicable to 2005, and they remain the same as the Instructions that I partially relied on in reaching the conclusions in the article.  Further current information is in Part 5 of Tax Aspects of Online Gambling, an article by Russ Fox.

I have an interest in the legal requirements as to when a W-2G is required to be issued in poker tournaments. An article appearing in Poker Digest and the general attitude in the industry is based on misinformation -- The Big Lie. The purpose of this article is to provide information on which an appropriate decision can be made as to whether to issue W-2Gs in poker tournaments.

The poker industry has been urged to follow the so-called Binion’s Closing Agreement. The portion of that agreement applicable to poker tournaments calls for the issuance of Forms W-2G to winners of $600 or more in poker tournaments, regardless of the relationship of the amount won to the buy-in, thus ignoring the 300-to-1 rule, which generally limits the need to issue a Form W-2G to situations where the amount won is 300 times the amount of the buy-in. The question is whether the so-called 300-to-1 rule is or is not always applicable to amounts won in poker tournaments.

The underlying theory given by those supporting the "Closing Agreement Theory" is that voluntary issuance of Forms W-2G will create a reporting mechanism satisfactory to the IRS and thus keep it from trying to take the position that amounts won in poker tournaments are not the ordinary form of gambling wins, but rather are the proceeds of a wagering pool where the tax law would require the casino to withhold income tax at a 28% rate for all gross wins of $5,000 or more.

The leader in this urging is Jim Perlowski who was instrumental in putting the agreement in place with Binion’s Horseshoe in Las Vegas.  (Mr. Perlowski was an IRS Industry Specialist at the time the closing agreement was signed. He subsequently retired from the IRS and began consulting with casinos on various tax issues involving the gaming industry.)

A Closing Agreement is between a particular taxpayer and the IRS. Closing Agreements are not publicly available and another casino may not rely on one to gain any actual comfort if it conforms its tax reporting behavior to that mandated in the closing agreement. So, there is just no basis for any casino to legally rely on an agreement between Binion’s Horseshoe and the IRS made ten years ago.

Internal Revenue Code Section 3402(q) governs when Forms W-2G must be issued and when withholding of income tax is required. The parts of Section 3402(q) that concern tournament poker are quoted in footnote [1] below.

It should be noted that under this statute the 300-to-1 rule applies to "other wagering transactions," but does not apply to proceeds from "wagering pools." It is this difference that supposedly is the support for the legitimacy of the Binion’s Closing Agreement.

The IRS has interpreted Section 3402(q) by publishing official instructions [link updated to 2004 Instruction] as to when tax reporting on Forms W-2 and 1099 is required. Taxpayers are allowed to rely on official IRS publications in conforming their actions to the requirements of the Internal Revenue Code.

The Instructions apply to three separate groups of gambling winnings. The only two that concern tournament poker are ordinary winnings ("other wagering transactions") and proceeds paid out from "wagering pools."

If poker tournaments are "other wagering transactions" then the requirements for issuing Form W-2Gs are as follows: "File Form W-2G for every person to whom you pay $600 or more in gambling winnings if such winnings are at least 300 times the amount of the wager."

No tax reporting is required unless the "300 times" trigger is met. It should also be noted that the casino has the option to reduce the amount of the win by the buy-in (and any related entry fee) if it wishes.

For Wagering Pools  the Instructions state: "File Form W-2G for each person [2] to whom you pay $600 or more in gambling winnings from a…wagering pool…if such winnings are at least 300 times the amount of the wager. The wager must be subtracted from the total winnings to determine whether withholding is required and, at the option of the payor, to determine whether reporting is required."

Thus, the Instructions, contrary to the specific language of Code Section 3402(q), envision that the "300 times" trigger applies to both "other wagering transactions" and "wagering pools." Withholding is again not required unless the "300 times" trigger is applicable. If the reporting requirement applies, then withholding would come into play only where the win, reduced by the amount of the buy-in, is more than $5,000.

If the 300-to-1 rule is applicable, there are no poker tournaments, other than freerolls, today where the issuance of a W-2G would be required. Even the opening event at the Orleans Open with over 1,000 players and a $125 buy-in does not presently meet the 300-to-1 requirement. The 2003 World Series of Poker Championship Event paid $2.5 million to the winner, but that is only 250 times the $10,000 buy-in, not 300 times. It is altogether possible that future tournaments may offer prizes of over 300 times the buy-in, but none do now.

If the Instructions wrongly interpret the law, taxpayers may nonetheless rely on them until the Instructions are rescinded or corrected.

Here is an interesting thought. If poker tournaments are wagering pools and Code Section 3402(q) actually requires withholding on wins of $5,000 or more regardless of the 300-to-1 rule, then the Binion’s Closing Agreement is wrong. The IRS cannot enter agreements that disregard the law. Does this mean that the issue of whether tournaments are wagering pools was just a straw man in the considerations leading to the Binion’s Closing Agreement? Are poker tournaments wagering pools?

The term "wagering pool" is not defined in the Internal Revenue Code. The term is defined in IRS regulation 44.4421-1(c)(1). [3]  There are no court decisions that define the term. There are a few internal IRS documents that discuss wagering pools in the context of an old Code Section. All of those internal decisions involve wagering situations where the bettor was able to wager on any person, team or horse in a field. That is not the case in a poker tournament, where the only person in the field who a player can wager on is himself.

To try to give some meaning to what a "wagering pool" is we might look at the context in which it appears in the Code Section: "Sweepstakes, wagering pools, certain pari-mutuel pools, jai alai, and lotteries." All of the other items in this string are betting situations where one can wager on any of the possible outcomes—any horse in the sweepstakes or pari-mutuel pool, any player in the jai alai contest, any number in the lottery. In addition, the bettor is not required to be a participant in the event like the player is in a poker tournament. Finally, the outcome insofar as the bettor is concerned is not based on any skill on his part.  The cited IRS Regulation certainly seems to confirm this analysis.

Given these observations, it would certainly be a stretch of statutory construction to conclude that a poker tournament is a wagering pool.

In the article in Poker Digest in which Mr. Perlowski was interviewed he supports continuing to observe the Binion’s Closing Agreement for the following reasons:

---"In my opinion, not following the Binion's Closing Agreement -- if given the opportunity -- is not a wise business decision for a poker entity or establishment to make. A gaming establishment that conducts poker tournaments is faced with three choices: 1) It can follow the Binion's Closing Agreement. Issue Closed! 2) It can follow the provisions of IRS Code Section 6041 that requires the establishment to issue a form 1099 to every player receiving cumulative payouts of $600 or more. What this does is shift the "burden of proof" in an audit situation from the house to the player, to show he/she actually received said amount as a gaming transaction and not for services rendered. It also places a horrendous record-keeping requirement upon the gaming entity to keep track of each player so as to determine when the accumulative $600 requirement is met. 3) It can follow the provisions of IRS Code Section 3402(q) and withhold 28 percent of each poker tournament payout of $5,000 or more. No W2-G would have to be issued under a $5,000 payout. This is a procedure that Jim Albrecht and I both found unacceptable for poker tournaments. Any form of withholding would destroy tournaments as we know them today, because many players would refuse to play under those conditions."---

All three arguments are wrong. First of all, as pointed out above a taxpayer cannot rely on a closing agreement that the IRS made with another taxpayer.

Secondly, no Form 1099 is required to be issued to winners of poker tournaments. The official IRS Instructions for Form 1099 state: "Also enter in box 3 prizes and awards. Amounts paid to a winner of a sweepstakes not involving a wager. If a wager is made, report the winnings on Form W-2G, Certain Gambling Winnings."

Lastly, as I have demonstrated above, the $5,000 payout level does not come into play unless the "300 times" requirement is met.

Thus, we are back to the starting point. The rules relating to Forms W-2G are the applicable rules for poker tournament winnings. Taxpayers are entitled to rely on the official interpretation of the IRS's own regulations. That interpretation says a Form W-2G should only be issued where, among other things, the winnings are both over 300 times the wager and $600. The $5,000 amount bandied about by some only comes into play when a Form W-2G is required to be issued and none is required where the 300-to-1 rule is not met.

End notes:

[1]  IRS Sec. 3402(q)
Extension of withholding to certain gambling winnings
(1) General rule
Every person, including the Government of the United States, a State, or a political subdivision thereof, or any instrumentalities of the foregoing, making any payment of winnings which are subject to withholding shall deduct and withhold from such payment a tax in an amount equal to 28 percent of such payment….
(3) Winnings which are subject to withholding
For purposes of this subsection, the term "winnings which are subject to withholding" means proceeds from a wager determined in accordance with the following:
     (A) In general
     Except as provided in subparagraphs (B) and (C), proceeds of more than $5,000 from a wagering transaction, if the amount of such proceeds is at least 300 times as large as the amount wagered….
     (C) Sweepstakes, wagering pools, certain pari-mutuel pools, jai alai, and lotteries Proceeds of more than $5,000 from -
          (i) a wager placed in a sweepstakes, wagering pool, or lottery (other than a wager described in subparagraph (B))…
(4) Rules for determining proceeds from a wager
For purposes of this subsection –
    (A) proceeds from a wager shall be determined by reducing the amount received by the amount of the wager, and
    (B) proceeds which are not money shall be taken into account at their fair market value….

[2]   The Instructions also contain the requirement that the casino paying gambling winnings must issue multiple Forms W-2G, if any are required in the first place, when provided with a form 5754. The Instructions state: "The payer is required to file Forms W-2G based on Form 5754."

[3]  Subpart D--Miscellaneous and General Provisions Applicable to Taxes on Wagering,  Miscellaneous Provisions Sec. 44.4421-1  Definitions.
... (c) Other terms used--
    (1) Wagering pool . A wagering pool conducted for profit includes any scheme or method for the distribution of prizes to one or more winning bettors based upon the outcome of a sports event or a contest, or a combination or series of such events or contests, provided such wagering pool is managed and conducted for the purpose of making a profit.
    (2) Sports event. A sports event includes every type of sports event, whether amateur, scholastic, or professional, such as horse racing, auto racing, dog racing, boxing and wrestling matches and exhibitions, baseball, football, and basketball games, tennis and golf matches, track meets, etc.
    (3) Contest. A contest includes any type of contest involving speed, skill, endurance, popularity, politics, strength, appearances, etc., such as a general or primary election, the outcome of a nominating convention, a dance marathon, a log-rolling, wood-chopping, weight-lifting, corn-husking, beauty contest, etc.
    (4) Conducted for profit. A wagering pool or lottery may be conducted for profit even though a direct profit will not inure from the operation thereof. A wagering pool or lottery operated with the expectancy of a profit in the form of increased sales, increased attendance, or other indirect benefits is conducted for profit for  purposes of the wagering tax.