Residents and non-residents alike pay tax on certain winnnings
Americans are always a bit surprised when it comes to taxes to learn just how little they are taxed in comparison to other countries. While most Americans believe they are taxed to death, the truth is that taxes stateside are just a fraction of what other first world countries tax their citizens. Taxes in the U.S. account for only 26% of GDP compared to 34% by other developed countries and in fact only Korea, Mexico and Chile are lower. The top income bracket is much higher in the United States than most countries, but very few ever reach that tax bracket and as has been witnessed in the U.S. election, there are always loopholes for the very rich to use to reduce their share of tax. As well, sales taxes, property taxes and gas taxes are far lower in the United States but other countries such as Canada and those in the EU generally subsidize health care, education and have a larger welfare system for the poor, so there is always a trade off. But one area where Americans pay tax that few other countries tax their citizens on is gambling.
In most countries including Canada, gambling winnings are considered a windfall and are tax free. Consequently. someone in Canada who wins a lottery or the jackpot at a casino will not pay any tax on those winnings. Similarly, if a UK resident wins their national lottery or hits the multi-million dollar Scoop 6 on horse racing, they are paid the full amount up front with no taxes withheld. In the United States, however, all winnings, including gambling, are considered income and must be reported. There are no exceptions to the rule and all worldwide income including money won at foreign gambling establishments, money won from offshore websites and even money won from illegal ventures must be reported. The government isn't allowed to use the information about the illegal winnings to have the taxpayer arrested. That said unless the taxpayer has a Marge Simpson type attitude and would rather die than lie they aren't going to declare offshore and illegal gambling, which is pretty much untraceable, on their income tax return under income. It's a reason bitcoin has become so popular for offshore wagering as well, since it is anonymous and completely untraceable. Not surprisingly, therefore some U.S. analysts I spoke to believe the U.S. is shooting themselves in the foot by their refusal to acknowledge offshore gambling and one analyst I spoke to believes it's a big misstep.
"Over a billion dollars is being bet offshore," a gambling analyst from New Jersey told me, "but the efforts to block banks from processing checks or ETFs from these companies has created a situation where the governments in the United States can't benefit. Almost all the foreign companies I spoke to indicated they would abide by IRS rules and issue tax forms and even withhold money where necessary but because our government refuses to recognize or cooperate with them, they use third party processors to issue checks written from unconnected banks. The gambling establishment is not identified on the check and the nature of the transaction isn't specified so there is no reason for the gambler to report the income as a result. No one in their right mind is going to win $50,000 from an offshore sportsbook, take a withdrawal and be given a check from a numbered company issued from a bank in Iceland and report it on line 1040 of the tax return. But for the government it's clear that denial and avoidance is considered a better strategy than admitting that offshore gambling is occurring and reaping tax benefits in return."
That said, when Americans do win money they may or may not have money withheld at the source and they may or may not be able to recuperate some of that money withheld.
I spoke with to a U.S. tax attorney with substantial experience in the gaming industry who asked that his name or company not be mentioned specifically and here were his comments regarding money withheld:
"Winnings from slot machines, bingo and keno is excepted from withholding on winnings. However, if the winnings are US$1,200 or more ($1,500 or more for keno), then the casino is required to provide the player with an information statement, a Form W-2G, to report the Internal Revenue Service the winnings. If the player refuses to provide his name, address, and social security number, then the casino is obligated to withhold under the "backup withholding" rules. Under the backup withholding rules, the casino will withhold at a 28% tax rate. Whether any portion of the amount subject to back-up withholding is refundable, will turn on the individual's facts and circumstances. Particularly, whether the individual is engaged in the trade or business of gambling and to the extent of losses suffered during the year. To be engaged in the trade or business of gambling is a high threshold; recreational gambling activity will not be sufficient.
There a couple of different withholding tax regimes in the U.S. that can apply to gambling winnings. The withholding can be triggered based on the type of gambling activity and/or whether the player is a U.S. resident or nonresident for U.S. tax purposes. As an aside, U.S. residency for U.S. federal income tax purposes can be different than residency from an immigration standpoint. Generally, a person will be treated as a U.S. resident if person is a lawful permanent resident (a/k/a a green card holder) or if they spend a sufficient amount of time in the U.S. during any year or during a 3-year lookback period."
Thus, if a person has to fill out a U.S. tax return regardless of his residency then all gambling winnings must be recorded.
"The U.S. federal tax law requires withholding at a 25% rate if a player receives winnings of more than $5,000 from certain types of gaming activities. These gaming activities include state-conducted lotteries, wagers placed in sweepstakes, wagering pools, or non-state conducted lotters, and wagering transactions in a pari-mutuel pool with respect to horse races, dog races, or jai alai. For other wagering transactions, the amount of the proceeds must be at least 300 times as large as the amount wagered. This latter rule effectively means that most winnings from table games will not be subject to withholding because the 300 times the wager standard would likely only be met in very rare circumstances (e.g. a straight flush in let it ride or a progressive win in Caribbean stud).
The 25% withholding rate is based on a reference in the statutory language to the regular income tax rates that apply to individual U.S. resident taxpayers.
The amount of the wager is subtracted from the payout to determine the amount of winnings for purposes of determining whether or not the dollar thresholds have been achieved."
Daily fantasy sports has not been specifically identified but DraftKings and FanDuel make it clear they will withhold winnings as necessary per government rules.
Several U.S. gamblers I have spoken to have told me that they do report all income but they keep close tabs on losses and suggest that keeping records of withdrawals from casino ATMs, losing tickets in sportsbooks, losing horse racing tickets etc. is essential. They also suggest that if one is vigilant enough they can ask the casino for a record of their losses, which many pit bosses can help identify from rewards cards.
Income won in other countries by Americans also should be reported but no foreign government will withhold winnings for the IRS. It is up to the gambler to report it. But if the win is substantial, i.e. over $10,000 the bettor may have no choice but report it. Anything over USD$10,000 must be declared when coming back to the United States and if it's not, it can be seized. And if the winner decides to take a check or ETF from the casino, the banks can easily identify that the money is won from a gambling establishment and many banks can and will report that income to the IRS.
As for non-U.S. residents who win in the United States the matter isn't nearly as simple. Again, the tax attorney explained:
"Nonresidents are ordinarily not subject to the normal withholding rules discussed above for U.S. residents. Instead, any payment to a nonresident can be subject to a 30% withholding rate unless a statutory or treaty-based exception is available. The withholding tax for nonresidents can particularly painful because the tax withheld is ordinarily not refundable from the U.S. For gambling proceeds, only a few countries have withholding tax exceptions included in the tax treaties.
In practice, the 30% nonresident withholding tax will be triggered anytime a nonresident win exceeds any of the dollar thresholds mentioned above. The reason is because once the player identifies himself as a nonresident, the casino will be obligated to withhold at a 30% rate."
It should be noted that the following countries have withholding tax exemptions: Austria, Belgium, Bulgaria, Czech Republic, Denmark, Finland, France, Germany, Hungary, Iceland, Ireland, Italy, Japan, Latvia, Lithuania, Luxembourg, Netherlands, Russia, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Tunisia, Turkey, Ukraine, and the United Kingdom.
Noticeably absent from that list is Canada and until a few years back there was no type of tax treaty between the two countries. A recent tax treaty, however, does allow Canadians to recuperate some of the money withheld if they can prove losses. One company in Canada that has been able to help Canadians recuperate money withheld by U.S. casinos and racetracks is Refund Management Services.
If Canadians do win over the limits identified they will have money withheld and be given a form 1042-S - Foreign Person's US Source income subject to withholding.
The one exception to this rule seems to be with daily fantasy sports. Large winners I have spoken to have said they avoided having money withheld by the DFS sites by filling out a W8-BEN and sending it to the DFS site. This form provides information about the winner and satisfies the IRS that money didn't have to be withheld. The DFS sites also require a scan of a drivers license or government issued photo I.D.
Again, the tax attorney explained the W8-BEN
"The U.S. Form W-8BEN is primarily used to determine whether any withholding is required for certain foreign financial assets under the Foreign Account Tax Compliance Act ("FACTA") and to claim treaty benefits. The actual Form W-8BEN is approximately 20 pages in length, but a person will only respond to certain parts of the form based on the person's withholding status. Form W-8BEN is delivered by the recipient of payments to the payer. The form is delivered under penalties of perjury – as is the case with all U.S. federal tax forms and returns. The Form W-8BEN is relied upon by U.S. payers to determine whether or not it has a withholding obligation. The latter point is important because without a proper W-8BEN, the payer will likely be required to withhold at a 30% rate. A gambler may deliver a Form W-8BEN to claim a treaty benefit that the proceeds of a gambling activity are exempt from the 30% withholding tax.
Fantasy sports could present some interesting issues. The first issue from a federal tax law standpoint is whether any proceeds are received from a "wagering pool," a "sweepstakes, or a "lottery". The federal tax law analysis of the meaning of these turns does not necessarily turn on the state law definitions with respect to what is, or is not, gambling. In fact, a point that many non-tax lawyers or lay persons often do not recognize is that there can be a disconnect between the conclusions reached under the U.S. federal tax law and state laws."
The tax attorney also questioned why the W8-BEN is sufficient for Canadians:
"I would be curious what position the fantasy sports operators take with respect to the characterization of any winnings. Are the winnings from a "wagering pool" or gambling? If not, what is the basis for a nonresident to claim a treaty benefit? From a U.S.-Canada Tax Treaty perspective, my recollection is that gambling winnings are not exempt from withholding under the U.S.-Canada Tax Treaty."
Talking to Canadian winners it seems that the determination of whether the DFS site withholds tax is based on the $5,000 win and the 300 times stakes win. One person that won first place and $20,000 in a contest had 30% held at the source despite sending the W8-BEN, while another who won $4,500 when finishing 8th in a $27 buy in contest did not have money withheld.
I asked someone at DraftKings for an explanation but they simply sent me their policy on the issue:
Declaration and payment of all income taxes associated contest winnings are the sole responsibility of the contest winner. All earnings are considered income and, as such, are taxed according to the applicable Federal, District, state and local laws. DraftKings cannot estimate your tax responsibility or answer questions about Federal, District, state or local exemptions, or tax calculations. You may want to consult a tax professional, government tax office, financial adviser or other appropriate professional for answers to your tax questions.
So, whether to report gambling winnings and how much isn't always so clear. There is no question that any Americans that are given a W-2G form after winning big must declare that income and can possibly recuperate some of the money withheld but any money that does not meet the withholding threshold or that is won in a foreign jurisdiction is up to the honesty of the gambler to report. Foreigners who win in the United States or from legal U.S. based gambling websites should theoretically report that income as well but most generally don't unless they try to recuperate some of the money they have withheld.
A question many people have is whether the U.S. would be better off in the long run to adopt the policies of other governments and determine gambling winnings to be tax free. There is a good argument that doing so could help increase betting at casinos, racetracks and on the lottery that could more than offset anything the government would gain in taxes from reported gambling income. But that's an article for another day.