“Another difference between death and taxes is that death is frequently painless.”
—Anonymous
JEAN: If you’re a gambler, you’re lucky if you reside in one of the six tax-haven (or tax-heaven, in my opinion) states that don’t have any form of state income tax (Washington, Nevada, Texas, Alaska, South Dakota, and Wyoming). This is also true if you live in the near tax-haven states, like Florida, which only tax intangibles, or in Tennessee or New Hampshire, which only tax investments. Why are you lucky? You won’t have to pay your state any taxes on your gambling wins.
However, you’re not completely safe from all state income taxes. You may gamble and hit a jackpot in another state, one that does have a state income tax, a few of which automatically withhold state taxes from any win that generates a federal W-2G, regardless of the residency of the jackpot winner. This list of the latter (and the percentage that they withhold) includes:
| • | Louisiana: 6% |
| • | Iowa: 5% |
| • | Missouri: 4% |
| • | Indiana: 3.4% |
| • | Mississippi: 3% (The tax is withheld for all W-2G wins, but this is what they call a non-refundable state income tax—see further explanation in this chapter.) |
| • | Michigan: 4.35% (This withholding is for non-residents only and covers winnings from casinos, racetracks, and off-track betting.) |
| • | Connecticut: 5% (No withholding for anyone unless federal withholding is required, i.e., non-resident aliens.) |
If you’re a resident of one of the first four states in the above list and hit a jackpot on which the casinos in your own state withhold state income taxes, you don’t have a problem with this, since you’ll be paying state income taxes anyway and you can easily file for a refund if the amount withheld is more than your tax obligation.
However, if you live in Louisiana, Indiana, Michigan, or Connecticut, you face the same huge problem that residents in many other states face: the inability to deduct gambling losses from gambling wins. We talk about that problem later in this chapter. And the tax situation in Mississippi is so confusing that we give that state a whole section to itself.
JEAN: Once a non-resident has state income tax withheld on a gambling jackpot, it becomes a tax problem that can be very complex, depending on the two states involved and each of their tax rules and regulations. Each state has its own way of calculating income taxes for non-residents and for handling out-of-state income. Some states have reciprocity agreements with neighboring states or allow a credit on their own state form for taxes paid to other states, thereby alleviating the hassle of filing two state tax returns or being double-taxed. In any case, be sure to attach necessary documentation (like W-2Gs or 1099s or other state returns) to show where taxes from other states have been withheld or paid.
However, in many cases it’s a royal pain! If you’re entitled to a total or partial refund (and you aren’t in all cases), you may have to file a non-resident state form for the state where the jackpot was hit. I had to do this several years ago when I was an Indiana resident, hit a W-2G jackpot in Mississippi, and had 5% withheld for the Mississippi state income tax (they have since changed their system as I explain in a later section). It was a nightmare in Fraction Land, since all Mississippi figures had to be reported as a percentage of my federal figures.
Many gamblers just don’t bother filing a non-resident return to get a refund, especially a small one. And this might actually wind up being cheaper in the long run, especially if a professional has to be paid to do the extra tax return.
MARISSA: You may wonder if you need to file a non-resident state return in the case of a win in another state where no state tax is withheld. If you win money in another state that has a state income tax, you’re technically supposed to file a return in that state. However, in practice, very few do.
In the past, some states vigorously pursued out-of-state winners. California used to track down non-resident racetrack winners and bill them for California state taxes. In the early ’90s, New Jersey chased non-resident jackpot winners for a while, but then dropped the idea. Legally, any state can pursue out-of-state winners. However, this is difficult, because of widespread ignorance of state laws by non-resident taxpayers or deliberate non-compliance with them. As you can see by the above list, the trend is for the state to take the easier route and withhold taxes on the spot from all W-2G winnings or, in Michigan’s case, all non-resident jackpots. I won’t be surprised to see more and more of them doing this in the near future.
As we’ve repeated numerous times in this book, you need to check with a tax professional to get up-to-date tax information. This is especially crucial with state tax matters. I foresee a lot of new state gambling-tax legislation in the future, since there’s a strong trend for states to consider casinos their cash cows.
THE BIGGEST PROBLEM WITH STATE TAXATION
JEAN: Some states allow deductions for gross gambling losses to offset gross wins on their state returns, just as the feds do if you itemize. However, one of the biggest problems for many gamblers is in those states that base their income taxes on the federal adjusted gross income (AGI) figure, which includes the gross-win figure, while the state form has no allowance for gambling losses.
Our former state of residence, Indiana, is an example (see Appendix B4 for an Indiana sample tax form). Before we started filing as a business, which allowed us to net out our winnings, we complained about the unusual pain of having too many winning sessions! This unfair situation has made many a taxpayer give up gambling entirely, since he’s almost certain to lose in the tax game even if he wins at the casino game. And others have actually moved to more tax-friendly states, so they can continue with their chosen vocation or avocation of gambling.
A note: You may have triple tax trouble if you not only live in a state that has an income tax, but live in a city that has a municipal income tax as well. Each city has its own ordinances about how to treat gambling action. My only advice is to seek professional tax help in sorting through all the tax issues you’ll have.
MARISSA: For states that have an income tax, there are just a few main ways in which they treat gambling wins and losses. The majority of states “follow the federal.” That is, the format of the state returns is similar to the federal tax return, including permitting the deduction of gambling losses against gambling winnings.
Some states are what we in the business call “above the line”—states that follow the federal tax return only as far as the AGI (adjusted gross income) line. The key point here is that these states do not allow itemized deductions; therefore, since gambling losses are an itemized deduction on the federal form, there’s no place for them on the state forms (or they have special instructions that effectively bring the same result).
The following above-the-line states make it almost impossible to gamble with an advantage, no matter how skilled you are, and many recreational gamblers can’t gamble as much as they’d like because of the severe tax bite:
Connecticut
Illinois
Indiana
Louisiana
Massachusetts
Michigan
Ohio
West Virginia
Wisconsin
Two states, New Jersey and Pennsylvania, allow the taxpayer to net gambling wins and losses before reporting. It’s too bad that other states, and the federal government, don’t follow their example!
MISSISSIPPI—A CATEGORY OF ITS OWN
JEAN: Finally, there’s Mississippi, which adds a new kink to state income taxes on gambling. Formerly, they automatically withheld 5% state income tax from W-2G jackpots, but in 2002 they began taking out a non-refundable 3% gaming tax. For a couple of years, no one really knew what to call it. Was it a gambling tax? Was it a sin tax, similar to the one on cigarettes? Finally, the state, in the instructions for their state tax forms, began calling it a non-refundable state income tax.
MARISSA: Mississippi residents do get a small break, wherein the W-2G amount doesn’t have to be counted in their gross income for state income-tax purposes. And non-residents who live in a state with an income tax may take the withheld Mississippi tax as a credit on their state taxes if they’ve counted Mississippi winnings in their gambling income. Or those who itemize on their federal return could list the withheld amount as a deduction on Schedule A, under State Income Taxes. It is, however, a preference item for figuring the Alternative Minimum Tax, which means that the deduction could hurt you in certain situations. Gamblers who file as professionals may take this Mississippi withholding as a business expense.
JEAN: If I still lived in Indiana and hit a W-2G jackpot as I did before this new law went into effect, I wouldn’t need to go through the hassle I described earlier of filing a non-resident Mississippi state return. I could simply take the amount of the Mississippi tax withheld as a credit against my Indiana state taxes. Since I now live in Nevada, which has no state tax, and I file as a business, if I have Mississippi tax withheld, I can list that amount as a business expense.
JEAN: We mentioned earlier that some people actually quit gambling or move to a more tax-friendly state in order to escape the burden of unreasonable state taxation. Is there another option?
There’s one for a few gamblers: filing as a professional. Being able to deduct expenses and net out your wins and losses on Schedule C of your federal return allows you to report on your state return a realistic net income, rather than the much larger figure representing your gross wins.
However, it required more than half of Chapter 4 to discuss the stiff requirements for filing as a professional gambler. Our constant reminder to seek professional tax help is especially germane here. Filing as a professional may put you on a very bumpy road with the IRS as your too-close companion. And many people have found states to be very tough, even if you finally convince the feds. As I write this, I’m involved as an expert witness in a Michigan tax case against a video poker player. Even though the IRS has given its approval to her filing as a professional gambler, the state is arguing against that status on her state return.
In the next chapter is a state-by-state list with summary information on individual states and how they treat gambling income and losses. Notice that many states have special rules about lottery wins. This list is up to date as of the fall of 2011, but we suggest that you use the Internet to keep up with changes in state income tax laws.