Gambling Taxes for Losers: Did You Bet on UNC? How Does This Loss Affect My Taxes?

See here for my first installment on Gambling Taxes for Winners.

The Losers

Restrictions on Losses

Gambling losses are deductible to the extent of winnings and only as miscellaneous itemized deductions -- so you must itemize to get any tax benefit from losses. But losses are not subject to the 2%-of-AGI floor that applies to most other miscellaneous write-offs.

Professional gamblers can treat losses as a business expense on Schedule C rather than as an itemized deduction on Schedule A.

The amount of deductible losses cannot exceed total winnings for the year. Thus, if you win $1,000, but lose $15,000 throughout the year, your total deduction for the year is only $1,000. The balance of your losses ($14,000) is lost forever and does not carry forward to be used in a future year.

Record keeping for losses: While winnings are reported by the casino or other payer to the IRS, it is up to you to keep track of your losses for the year. If you are a regular gambler, it's a good idea to keep a log or diary -- written or electronic -- tracking your betting activities. Records should show the date and type of wagering activity, the name and location of the gambling establishment, the names of other gamblers present if applicable, and the amounts won and lost. Retain all losing tickets for lottery games and bets at the track.

Suggestion: If you fail to do this, you can follow the lead of a couple who used their credit card, debit card, and bank statements showing cash withdrawals at a casino to help substantiate their losses (see Traci A. Tomko, TC Summary Opinion 2005-139, http://www.smbiz.com/sbtc05.html).

Planning Strategies

What can you do to make the most of your luck? As when you receive any income windfall, it is advisable to minimize taxes through tax-planning measures that include...

Charitable giving. Reduce your taxable income by being generous to worthy causes. Note, however, that your charitable contribution deduction for the year for cash donations is limited to 50% or less of AGI. AND, some charitable donations are taxable.

AGI planning. Keep AGI low by using salary reductions where possible -- maximize contributions to your 401(k) and flex spending account (FSA). Realize capital losses in excess of capital gains up to $3,000. Take advantage of above-the-line deductions (e.g., traditional IRA contributions).

For sizable purses, consider using "partnerships" or trusts for family income splitting. This will allow payments to be spread among family members and, where applicable, taxed at lower rates. Reduce oral partnerships -- loose agreements to split winnings -- to a written agreement before collecting the prize money to avoid fighting among the parties later on.

Important: While tax planning may be a prime concern after a sizable win, asset protection, such as by using an LLC (to hide your identity) or a Nevada Spendthrift Trust (which gives the trustee control of the money), should also be considered. Publicized winners, such as those who win a big state lottery, often become targets of the unscrupulous. Work only with trustworthy advisers -- those you already know or for whom you have sound recommendations.

Also take into account state and local income taxes, if applicable, when planning.