The arrival of the new year comes with a slate of resolutions and goals, but it’s also a time when Americans prepare to give the taxman his due. This process looks a lot different than it used to for the near 60% of adult residents who have become more frequent gamblers since the arrival of legalized sports betting in 2018.
Americans have long been aware that they are supposed to report gambling winnings as a form of income, but it has been overlooked, even by the Internal Revenue Service. In a September 2024 report commissioned by the Treasury Inspector General for Tax Administration (TIGTA) it was confirmed that the IRS has not enforced income tax return filing requirements for recipients of millions of W-2G forms (Certain Gambling Winnings) which indicated billions of dollars in gambling winnings. Billions is a big number, but how much, exactly? After analyzing W-2G forms with a total amount of more than $15,000 per individual in gambling winnings who did not file a tax return, the TIGTA found that from 2018 to 2020 alone, that non-filers were associated with an estimated $13.2 billion in total non-filed gambling winnings. The under-filing is expected to be significantly higher between the tax years of 2021 and 2023 as sports betting and gambling activity skyrocketed in that period. The date of this report infers one thing; the IRS will feel the pressure from the 2024 TIGTA report to drop the hammer on non-filed W-2G forms, particularly on the individuals with gambling winnings equal to or more than $15,000. This is a message that tax services and the media alike have been pushing leading into 2025, reminding those who even just bet on the Super Bowl to claim their winnings.
One may think that tax implications could deter gamblers, but with this expected lift in W-2G filings is a concerning feature in the U.S. federal tax code. This feature may encourage problematic gambling behavior in that it incentivizes gamblers to take bigger risks to hedge that they may pay to the IRS. Read ahead to learn more.
How U.S. Federal Tax Law Regarding Reporting of Gambling Winnings and Losses May Increase the Risk of Problematic Gambling Behavior
Gambling Losses Are Deductible
As the September 2024 TIGTA found, American gamblers haven’t been too motivated to report their winnings. But with the new push to file (to avoid punitive measures) they and their personal accountants are uncovering an enticing feature; the fact that gambling losses are deductible. The rules are as follows:
- Americans can deduct gambling losses, but only to the extent of their winnings and requires them to report all the money they win as taxable income on their return. To reiterate, losses can only be claimed to offset income from gambling winnings.
- The amount of gambling losses deducted can never exceed the winnings reported as income.
- The gambling loss deduction is only available to those who itemize their deductions.
Since financial loss in an inevitability in gambling, as per the Gambler’s Ruin formula, the ability to deduct losses removes some of the perceived risk for anyone who attempts to rationalize their participation in casino gaming and sports betting. It’s the new version of writing-off every lunch, dinner, and happy hour cocktail as a business expense. But there’s more to it than that, which connects to the part about how a gambling loss deduction is only available to those who itemize their deductions. But is this just a theory? Does the allowance of making gambling losses deductible and the itemization feature really encourage people to gamble more? Please keep reading.
Research Finds Evidence that Tax System Incentivizes Bettors
Recent research conducted by the Journal of Gambling Studies (February, 2023) did a deep dive to find out if the U.S. federal tax code does indeed incentivize risky gambling behavior as it applies to sports betting in particular. They theorized that the incentive is rooted in the fact that gambling losses can only be deducted if taxpayers are filing for itemized deductions. This part of the code indicates that the scale of gambling losses must be large enough to push a taxpayer’s eligible deductions over the standard deduction.
Any serious sports bettor has come to learn that the suggested (by “gambling experts”) breakeven winning percentage is 52.4%. This means that a sports bettor must have a win rate of more than 52.4% of their wagers in order to sustain a profit. This benchmark is where things get complicated with respect to tax law and gambling. Remember, the U.S. federal tax system provides a standard deduction of $12,950 per individual (which doubled in 2018) which indicates that it is more logical for casual gamblers to use standard deductions over itemizing. But this makes it harder for them to come out on top in gambling. Assuming a typical 110/100 sports bet and a marginal income tax of 22%, the required win rate to breakeven for those filing the standard deduction becomes 58.5% instead of 52.4%. A win rate that high is unheard of, even among sharp sports bettors who rarely sustain a long-term winning percentage of over 55%. An educated sports bettor seeking to maximize their deductible gambling losses via itemization will attempt to garner the adjusted (accounting for taxation) breakeven win rate by placing higher wagers.
Before we get to the results of the study, it’s important to look at how the study was motivated by gambler responses to the tax code and the rationale of sustaining a breakeven (or better) win rate. Individual excerpts from a popular Reddit on the matter make this clear:
“You are basically playing against luck, the books, and the tax code and you basically have to make a ton of bets (or at least a lot of larger bets) so that the deduction puts itemization as better than standard.”
“You could have $5,000 ‘winnings’ and $6,000 in losses, not have enough to itemize those losses and you’d technically owe taxes on the $5,000 even though you lost money gambling.”
“Glad I read this now and not six months from now. Very little reason to keep making small bets ($100ish per week) when I’m going to be taking the standard deduction.”
“Oh so you so itemize? That all makes sense then. Yes, I agree it’s very stupid. Ironically the low level bettors are the ones that get screwed the most“
“The IRS specifically states that you can itemize losses up to your winnings, so you can’t have a net negative, but yes. This is more of a problem for those that didn’t lose enough to itemize instead of taking the standard deduction.”
Regardless of whether or not a casual reader is clear on how itemization works when filing gambling winnings and deducting losses, it’s clear that the gambling community realizes that it makes more sense to increase wager amounts. It’s rationalized as a win-win scenario. If a large wager hits, the large payday (despite taxes) is enticing, while if it misses the large wager can be justified as per tax law. Now let’s get to what the Journal of Gambling Studies‘ research found.
The study indicated that when the size of betting reaches the point where itemizing is preferred over the standard deduction, the breakeven win rate tends to fall. That being said, the scale of betting required to attain a favorable win rate is substantial. Loss rates only fall significantly when the scale of betting levels-up to allow a gambler to itemize. The researchers remind readers that following this strategy to breakeven under tax law still generates bigger losses than otherwise (sans itemizing) given that larger wagers are risked. Further, researcher calculations found that individuals who pay lower marginal tax rates (lower income earners) may consider gambling large amounts to increase their chances of breaking even. Typically itemized deductions benefit higher-income individuals and households. But a lower income earner who gambles, who may have a couple of other deductions to itemize, may now opt into itemization instead of standardized deductions. But in order to hit the breakeven amount on gambling, they will realize that they must risk more to make the system work in their favor, so to speak. It’s gambling rationalization at its worst.
“In this paper we have documented that the current system provides an incentive for some bettors, in particular those on low to middle incomes, to scale up the size of their betting activity to improve their chances of breaking even. It is recommended that the federal tax code be amended to remove this perverse incentive.”
Admittedly, the U.S. federal tax code regarding the reporting of gambling winnings and claiming losses is a convoluted mess. Anyone who wants to get into the weeds can read the entire Journal of Gambling Studies report (and reference all data) right here. What counts most, is the moral of this story. It is extremely problematic that the federal tax code leads any type of gambler to think their best chance of winning or breaking even is to risk large amounts of money. And most concerning, is that the phenomenon is most evident in gamblers in the low to middle income bracket. The Responsible Gambling Council reports that people in lower income brackets already spend a larger percentage of their income on gambling than those in higher income brackets. Given that the risk of gambling harm increases when an individuals spends more than 1% of their family income on gambling, one can infer that the federal tax code is elevating gambling harms among more vulnerable populations.
Helps Perpetuate the Myth of Gambling as a Viable Profession?
“From what I understand, if your intent is to gamble as a business (or profession) you can file your gambling income as schedule C. This would allow you to net your wins and losses, but you’d also end up paying the ~15% self employment tax on your profit. This would be a more viable option for some people, but you’d have to try it both ways to see what the tax difference would be.”
The above quote from the very same Reddit discussion on the U.S. federal tax code regarding gambling shines a spotlight on one trend that has grown since the 2018 legalization of sports betting. Residents, namely young adult males, are looking towards gambling not just as a leisure activity, but as a profession. This is very problematic.
Not only does the aforementioned Gambler’s Ruin formula prove that in the long run the house always win, debt will eventually ensue. Further, so-called professional gamblers will draw a sharp eye from the IRS with the 2024 TIGTA report breathing down their neck. Then of course there’s the fact that this population segment (young adult males) face a higher risk of problem gambling behavior when compared to the rest of the population. View more on how Gambling as a Side Hustle is a Dangerous Myth.
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