Ask the taxgirl: Illegal Gambling Losses

Taxpayer asks:

Hello, I would like to ask some questions about tax evasion and honest mistakes:

I am being looked into (audited) for tax evasion for 2006 where I failed to file tax returns for online poker winnings of about $60,000.00. I did not file these returns for the sole purpose that my losses outweighed the winnings. I had about ~$50,000 in profit from this online poker but I had lost over $75,000.00 in Las Vegas and through a sportsbetting through a bookie. My problem is that I showed a profit online but when I lost the money through the bookie, since this illegal, I did not know how to report it. The government can tax any income even if its illegal, but I did not know how to report my illegal gambling losses. During this year I did not know how to show my losses to the bookie. I am currently wondering what penalities would be assessed if I were charged with about 50,000 dollars in unpaid taxes. I am a 27 year old school teacher who has no record and has steered clear of crimes. Would the IRS have leniency towards me since this was my first time? Would they consider my plea that I did not know how to file the losses? Would the penalty we jail AND money owed or only one of them? I am very scared because I did not be this intentually or willfully try to evade paying taxes. I lost the money I won and have nothing to show for this (such as new house, car, etc). I am fearing jail very much, please give me your incite. Thank you.

Taxgirl says:

Before I even begin to answer this question, I am going to tell you to talk to a lawyer. I say this because: (a) I’m not your lawyer and (b) even though I have some thoughts for you to consider, this isn’t legal advice. You really need some guidance about your specific situation – with all of the facts and circumstances laid out for analysis. So promise me you’ll get some help, okay?

That said, to allay some of your immediate fears, here are some thoughts:

1, Gambling losses are deductible. Just as gambling winnings are taxable – even if gained illegally – gambling losses are similarly deductible as a miscellaneous deduction, no matter how obtained, to the extent that they don’t exceed your winnings. So, you’ll only be able to claim up to your winnings (sounds like $60,000) as a loss in the best case scenario.

2, To claim gambling losses, you need have sufficient records of your losses. Diaries and annotated financial records may qualify as sufficient, depending on how thorough they are.

3, All of this said, reporting any illegal income or losses on a tax return can generate a road map for any authorities that could choose to investigate. Depending on how often you actually engage in this kind of behavior, this could be a concern.

So do you claim the losses at audit? I don’t know. Again, you do need to consult with someone about whether to do this or not. Don’t go to an audit alone.

If you choose not to claim those losses, the most common scenario to come out of an audit is an assessment for back taxes plus interest and penalties. Depending on your circumstances, criminal charges can be a possibility but to be honest, it’s really not common. Criminal charges are usually reserved for those who folks who deliberately and purposefully evade taxation. It just doesn’t sound like the case here. It sounds like you thought that you broke even and were just really not sure how to report that properly.

If you are simply assessed at a higher amount, it’s not the end of the world. You can likely work out an installment agreement to pay it off.

Don’t run away from this, whatever you do. It is serious. But it’s also manageable. Again, you need a tax professional to give you some specific advice. It’s worth it.

And one more thing. Since you’ve told me your age already, I’m totally going to sound like your mother for a minute. Those are really big dollars to be gambling away – especially for a school teacher. And betting through a bookie? That’s scary business (I’ve eaten in South Philly, I know these things). It sounds like you might have a problem beyond your tax woes. A resource to consider is the National Problem Gambling Helpline Network (1.800.522.4700) – it’s completely anonymous and free to call. You owe it to yourself to get things straightened out.

Like any good lawyer, I need to add a disclaimer: Unfortunately, it is impossible to give comprehensive tax advice over the internet, no matter how well researched or written. Before relying on any information given on this site, contact a tax professional to discuss your particular situation.

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4 thoughts on “Ask the taxgirl: Illegal Gambling Losses

  1. I though illegal gambling losses were not deductibe against any type of winning, legal or illegal. Just as a drug dealer’s revenue is taxable, but he gets no deduction for cost of goods sold. Correct?

  2. I think there’s a distinction to be made with the drug dealer, cause there’s a whole lotta illegal going on there from start to finish.
    That said, I am not sure whether it’s permissible or not. I’ve searched and searched and while it’s clear, as indicated above, that losses are deductible, I didn’t see anything that distinguished illegal gambling losses (though I agree that, generally speaking, illegal activity such as making a bribe is not deductible). There are a number of gambling sites (not surprisingly) that argue that it is deductible, but with no real support. If anyone has a reference, that would be great.

  3. To follow up on my last comment, here is the specific statute referencing drug sales:

    § 280E. Expenditures in connection with the illegal sale of drugs
    No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

    There’s just a crazy level of specificity in the Code re drugs – mainly, I think, so that it can be used as an alternative weapon on the war on drugs. But that’s a policy discussion for another day!

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