On September 16, the Garden City Group is set to start the claims process for American players who have money stuck on Full Tilt Poker. Some players have even begun to receive emails detailing the payout process. As the date rapidly approaches, players are starting to wonder what impact claiming that money will have on their own personal taxes.

Russell Fox, an Enrolled Agent at Clayton Financial and Tax in Las Vegas, is an expert in the field of taxes for gamblers. He has many clients who gamble professionally and has been practicing in the field for over 25 years. He has a blog where he writes about all different kinds of tax information, at www.taxabletalk.com.

Fox sat down with Card Player to discuss the remission process and how that will impact people who will be claiming money.

Steve Schult: Over the next few months, players from all over the country will be claiming their balances from their Full Tilt Poker accounts. Is this considered taxable income?

Russell Fox: Well the answer is that for some people it is going to be taxable, some people won’t, some people a portion will be taxable and for some, almost all of it will be taxable. It is really an ‘it depends’ situation.

I have got to start with a disclaimer because I am giving advice to the general public. This conversation is limited to the one or more federal tax issues addressed in the conversation. Additional issues may exist that could affect the federal tax treatment of the transaction or matter that is the subject of this opinion and this opinion does not consider or provide a conclusion with respect to any additional issues. With respect to any significant Federal tax issues outside the limited scope of this opinion, the article was not written, and cannot be used by the taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.

But let’s look at a very simple case. Somebody started playing on Full Tilt in April of 2011. He deposited nothing. Somehow he got a freeroll and he turned $0 into $1,000. He rightly decided not to claim any of this money on his 2011 tax return because he did not have what is called constructive receipt.

Let’s say you are a business owner and you get a check at the end of December and you decide not to deposit that check until January so that you can avoid paying taxes on it for this year. You can’t do that because you have constructive receipt. As long as you could have gone to the bank and deposited it, under federal tax law, you should have deposited it so it’s income. It works in reverse.

If there is substantial doubt on your ability to collect money, then you don’t have constructive receipt. As with Full Tilt, as of December 31, 2011, there was more than substantial doubt. There was tremendous doubt that we would ever see anything. So as of 2011, there was no constructive receipt. Even today we still do not have constructive receipt. We know that the money is going to come, at least we think 100% of it, but it hasn’t come yet and it’s more likely in my view to come in 2014 than in 2013. So until that money actually shows up, it’s not income.

Going back to my hypothetical, that one individual is going to have $1,000 of income when he gets it.

Now let’s look at another individual. That individual again, has $1,000 on Full Tilt which he won in 2010. He claimed it on his 2010 tax return. He never withdrew the money and come April 15, 2011 that money vanished. He will not have income. It will just be returning funds that he already paid tax on. Mind you, that individual should keep good records of it. He might be audited on this and he might have to show the IRS that this is the return of funds that he previously paid tax on and therefore there is no income. We don’t know if the Garden City group is going to issue 1099s or not when people get this money back. If so, the IRS will assume that the money is income.

If it isn’t, the first step is to complain to Garden City Group and try to get them to correct the form. The second step is that you would have to note on your tax return that the form is wrong, that you have attempted to correct it, and then you will get an IRS notice saying that you should have included it and you will have to fight it. But in the standpoint, pretty much black and white, if an individual already paid tax on the money, it is not taxable in let’s say 2014 because he already paid tax on it. You only pay tax on your winnings once.

Those are the simple cases, by the way.

SS: My next question is probably going to transition to more of the complex cases. Let’s say somebody had deposited money onto the site and had been continuously losing money. They have lost money gambling, but they still have money on the site when everything happened. They have lost money previously and this is just what is left on the site. How is the government going to decipher between those who won and lost money and what are the tax implications of those two situations.

RF: Well first of all, gambling is not taxed the way people think. For a professional player, it pretty much is. A professional player gets to net his wins and losses over the course of the year, though he is supposed to keep records of every session. But in essence, if you have $50,000 of winning sessions and $30,000 of losing sessions, you will pay tax on $20,000.

An amateur doesn’t do that. An amateur gambler has to report those numbers on two separate places on their tax returns. The $50,000 of winnings is considered other income. It goes on line 21 of form 1040. The $30,000 of losses is an itemized deduction on schedule A. Eventually, the tax payer will pay tax on the net $20,000. But because of how this is done there can be a lot of implications. You also can only deduct losses up to the amount of your winnings. It’s written into the tax code.

So in 2009 and 2010, the amateur gambler has been depositing and losing money, but he probably won a few times. So he should have reported $2,000 of wins and $2,000 of losses each year. Now in 2011, he probably didn’t report anything. This is something that an individual will probably need to report his gambling activity for 2011 in 2014, but it is probably going to be something that will have to be discussed with a tax professional because it is going to depend on the individual’s circumstances. Each person will have slightly different circumstances. Those facts and circumstances do matter. With professionals, it’s pretty straightforward.

SS: Were players allowed to write off frozen full tilt money as a gambling loss?

RF: No. Let’s use Ultimate Bet as an example because those funds are probably gone. At the end of 2011, Ultimate Bet and Absolute Poker were still negotiating with the DOJ. First off, if the funds were lost, they weren’t lost in gambling. The tax code has a very specific definition of what is considered wagering and the funds were not lost because of you playing poker and losing.

They were lost because the site vanished. They were lost because of federal government activity. So it is not a gambling loss.

SS: Are you able to write off that money at all?

RF: At the end of 2011, nobody could really write that off because in the cases of all the companies, there was a likelihood that something was going to happen. In Full Tilt’s case, it did, but it just took a while.

To take what is called a casualty loss, you must have certainty, that is one of the requirements of taking a casualty loss. For example, let’s say your house burns down and you are negotiating with the insurance company. You are unsure what the insurance company is going to pay you. Until that is resolved, you don’t have certainty of what your loss is. Once the negotiations are done and assuming there is no lawsuit involved, you then have an absolute dollar amount and have a casualty loss.

In the case of Absolute Poker and Ultimate Bet, certainly now, but arguably at the end of 2012, it was fairly clear that people were not getting a penny back. Therefore there was certainty and it was time to take a casualty loss. Now a casualty loss, just so you know, tax code does not make it as easy as “I had $20,000 and I get to take $20,000 as a writeoff.” For the professional, the answer will be generally yes with the caveat of that money had to be included in income or had to be deposited.

Now for an amateur gambler, a casualty loss will start with whatever the dollar amount is on the site and subtract $100 because Congress said so. You then subtract 10% of your adjusted gross income. So for example, let’s say you make $100,000 and that is your adjusted gross income. You had $5,000 on the site. After you subtract $100, you have $4,900 and then you subtract 10% of your adjusted gross income which is $10,000 and you have a negative number. You have no deductible casualty loss. For many amateur gamblers, that money is just gone.

Another factor about casualty losses are that they are extremely high audit risk issues. Many people tend to cheat on their taxes and this is an area which lends itself to it. Can you prove that you lost that money? Do you have a screenshot of your absolute poker balance showing that you have that money on the site? In taxes, you are guilty until proven innocent. You have to show and prove the numbers if you are audited.

SS: Moving towards the audit process, are there any red flags that will set off the audit process? Some players will be claiming a lot of money. Is claiming your money going to set you up for future audits?

RF: I’m not going to use anyone specific, but let’s say Russ Fox had a million dollars and I get that. In the case of mine, assuming I never claimed it as income, I’m going to put it on my tax return. The higher your income, the more likely you are to be audited. That’s just a fact. Because a full-fledged field audit costs the IRS a lot of money. So if the IRS audits you and you make $100,000 and they audit me and I make $1,000,000 and we both cheat on our taxes by 10%, the IRS is going to get a lot more bang for their buck by auditing me.

Are these going to be red flags for audit? Nobody knows at this point. If you remember going way, way, back to Neteller. When they went under, I thought as did a couple other people I know, the IRS would use this information for audits. They didn’t. I know of clients who received in the high six-figures from Netellers and they were not examined. Mind you my clients report their income so it’s possible the IRS pulled the tax returns and saw that Joe Smith received $292,000, but he’s claiming $400,000 in income, so let’s move on.

SS: Let’s say someone has been a winning player, has been cheating on their taxes, and hasn’t been claiming income on the money they have been withdrawing. What kind of penalties and what kind of trouble are they going to be in?

RF: Well, I’m licensed so anyone who has been cheating on their taxes and not paying their winnings, my strong advice to them is to meet with a tax professional and come clean to him unless you are guilty of criminal conduct. If you’ve cheated and you haven’t reported say seven figures of income, go see a tax attorney. There is no privilege in tax returns. If I prepare a tax return and they subpoena the returns and the information, I have to give it. What a tax attorney will do is farm the work out to a tax preparer, someone like me. The attorney can tell me to amend the tax returns and when the IRS comes and talks to me, I don’t know anything, I just did the returns.

The other rule of thumb is that if you go to the IRS before they come to you, usually, criminal issues won’t happen. The IRS does not do a lot of criminal prosecutions, unless you are high profile like Wesley Snipes. The IRS targets people who would have good deterrent value because they are high profile.

The simplest advice I can give to anyone who should have claimed income, but didn’t is to amend your return, pay the tax, pay the penalties and interest, and it’s over.

Here are some links to other gambling related tax articles on Fox’s Blog, TaxableTalk.com:

Discussion of Casualty Loss on FTP, UB/AP (written in December 2011)

Is it Time to Take a Casualty Loss on AP/UB? (written in December 2012)

Staking at WSOP

Staking Update (2011)

Tournament Deals at WSOP