WSOP prep: Tax implications of staking/profit-sharing agreements

The World Series of Poker is right around the corner, and thousands of poker players across the world will be making their annual pilgrimage to Las Vegas in pursuit of fortune, fame, and most importantly, a WSOP gold bracelet.

This year, for the first time, a player from the Casino City Home Game will be participating in the Series, playing in a $1,500 no-limit Hold'em event. Jas won his seat at a 10-player satellite following a year-long collection our home game made during cash games and tournaments. As part of the group's agreement, Jas has 50 percent equity should he cash in the tournament, while the remaining nine have varying percentages of the remainder, depending on how much we contributed.

While we are all friends and we trust each other, we agreed that it would be important to get everything in writing so that there would be no doubt as to who would get what should Jas cash. We were also concerned about the tax implications, should Jas happen to make a big score. We wanted to make sure we followed the tax code, but didn’t leave Jas with a huge and unfair tax burden should he make a six-figure score.

So I talked to Brad Polizzano, aka "taxdood" (visit his website taxdood.com and follow him on Twitter at @taxdood), a tax attorney and accountant who focuses on gambling. I wanted to know what people in situations like ours should do in advance of the WSOP (or any poker tournament where a prize would be split up) to be prepared, and what we'd need to know after the fact, should Jas cash and we all get a piece of it.

It turns out, there's quite a bit. Here's are the highlights of what I learned.

Documentation
Perhaps the most important thing to remember is to document everything. If you're going to have gambling winnings or losses on your tax return, you need to keep records of every gambling session you participate in, whether it's a home game, charity event, online or at a casino. Even with smartphones and cloud technology, one of the best ways to track your sessions is with pad and paper. As Polizzano says, a Mead notebook "breathes authenticity."

If you have a staking or profit-sharing relationship, it needs to be laid out in a contract. Make all parties sign it and agree to the terms. Otherwise, you're asking for trouble on two fronts: 1) You have no recourse if someone welches on you; 2) The IRS may whack you because you don't have proof other people had a stake in a big win.

Professional or amateur gambler?
Reporting requirements are different for professional and amateur gamblers, and the tax burden may be different depending on what category you fit in. Unfortunately, you can't just pick whichever one you want because it will lower your tax burden.

"There's established law both in the Internal Revenue Code and in court cases, including the Supreme Court, that established the standard for a professional gambler," said Polizzano. "The burden of proof is on the taxpayer to prove [they are a professional], and I see a lot of losing cases in part because the taxpayer just doesn't have sufficient records to support all the gambling activity that they claim to be engaged in. Really, to be a professional, a taxpayer has to gamble full time, like it's their job, like they're trying to earn a livelihood out of it."

Anyone who has played in our home game knows that we're all amateurs, with perhaps one exception. I'm not saying who.

Knowing what to expect when you cash out at the cage
Once you have your profit-sharing/staking agreement set up and everything is in writing, it's important to know what to expect should you cash in the tournament. The IRS requires that any payout consisting of a net profit of $5,000 or more (so in a $1,500 tournament, a cash of $6,500 or more) file a W2-G. You still have to claim wins for less than that amount, but the casino is not required to submit the tax form to the IRS.

In most casinos, players who have staking or profit-sharing agreements can come prepared with IRS Form 5754, and the casino will divvy up the winnings appropriately. However, Caesars does not allow players to use the form and will only pay the player who played in full. A Caesars official confirmed that they're not even making an exception in the $1 million Big One for One Drop, so I don't think they're going to make an exception for our $1,500 buy-in entry. Regardless, Polizzano advises completing the form to have everything documented.

Should Jas cash, he's going to receive the whole amount and we're going to have to split it up among ourselves.

Reporting the income
If Jas cashes for a net of $5,000 or more, the IRS will receive a W2-G from Caesars reporting that income, and they'll be looking for him to report that income on his tax return, so he'd better report it. However, he should only be paying taxes on half of it, as the other half will be split up by nine other people.

Let's say Jas wins $51,500 for a net of $50,000. There are two ways to report this. The first, and most simple way, is to claim a $50,000 gambling win and a $25,000 gambling loss as an itemized deduction, including Form 5754 with his taxes to clarify the staking agreement. However, this may not be the best way, as the full $50,000 will be added to his adjusted gross income, when in reality only $25,000 should be added to his adjusted gross income. That extra $25,000 may move him into a new tax bracket and may cost him some other deductions he may have otherwise been eligible for.

The other option Jas would have is to report $25,000 as gambling winnings, then report $25,000 of winnings as business income on a Schedule C, then include the $25,000 being paid out to the rest of us as gross receipts, as that's what's being paid out to the rest of us, as indicated on Form 5754. The "business" would net $0, and would not increase Jas's adjusted gross income beyond what he really won.

"The economics on the return are the same; you're reporting a total of $25,000 in winnings, just in a different way, and that keeps the adjusted gross income amount lower, because you're only reporting $25,000 as other income," says Polizzano. "If Caesars accepted the 5754, we wouldn't be talking about this, because there would be W2-Gs issued by Caesars to both the player and the backer[s] of the appropriate amount, but they don't, so this is where we are."

And Jas isn't the only person who will have to report the income. Should he cash, every person who has a stake in his entry will have to claim the amount they get from the arrangement. While the IRS won't be getting a W2-G from Caesars on our behalf, they will be getting the information that Jas includes on his return, so it will be important for everyone to claim the appropriate amount, or they should expect the IRS to come knocking on their door.