DISCLAIMER: THE INFORMATION CONTAINED IN THIS PAPER WAS TRUE, TO THE BEST OF MY KNOWLEDGE, AT THE TIME IT WAS WRITTEN.

THE TAX CODE CHANGES FREQUENTLY. YOU SHOULD CONSULT WITH A TAX PROFESSIONAL, LICENSED IN YOUR JURISDICTION, BEFORE MAKING ANY DECISIONS.

- MARK J. CHIARELLO, ESQ.

U.S Taxation of Non-Resident Aliens:

U.S Source Income from Wagering Transactions
By Mark J. Chiarello

INTRODUCTION

This paper examines the system under which the United States taxes non-resident aliens on their U.S. source income from recreational and professional wagering transactions. It is intended to serve both as scholarly commentary on the subject and as a reference for practitioners. A section addressing the system of taxation applicable to residents is included to give context to the main discussion.

TEXT

I. Gaming Income of U.S. Residents

A. Tax Liability For U.S. citizens and resident aliens gambling winnings (and complimentaries1) must be reported as gross income under 61 just like any other type of income.2 But when it comes to deductions allowable to determine net income, the treatment of gambling income diverges substantially from treatment of other forms of income.3

1. Recreational Gamblers Recreational players may offset their gambling income by claiming gambling losses as itemized deductions. Under 165 of the internal Revenue Code, deductions for gambling

losses are allowed, but only up to the amount of gambling winnings for that year.4 Also, excess gambling losses denied in one year may not carry forward to the next.5 In general, any expenses incurred in pursuit of a recreational activity are nondeductible personal expenses.6 Gambling expenses may not be characterized as gambling losses to make them deductible under 165.7 However, a gambler may deduct expenses for the production or collection of income under section 212.8 To take this deduction, the taxpayer must establish that he entered the wagering transactions with a genuine profit seeking motive.9 However, even where expenses are deductible, total deductions for losses and expenses are still limited to the amount of gambling winnings. 10

2. Professional Gamblers Although it is possible to classify oneself as a professional engaged in the business of gambling there is currently little reason for a US citizen or resident to do so. Prior to 1983, itemized deductions for recreational gambling losses were items of tax preference subject to the alternative minimum tax. Because professional gamblers are allowed to net their wagering transactions in determining adjusted gross income (AGI) they did not have these excessive itemized deductions.11 The benefit of avoiding the minimum tax led gamblers to fight for the right to file as professionals. The Groetzinger case confirmed that full time professional gambling for ones own account could qualify as a trade or business.12 In Groetzinger, the Supreme Court held that if one' gambling activity is pursued s full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business.13 But the Groetzinger case was decided on a very clear set of facts. The taxpayer spent 48 weeks a year, six days a week, 60 to 80 hours a week gambling on dog races. He had no other employment, kept detailed records and it was not disputed that he intended to earn a living by gambling.14 There is still some dispute as to how much less time and effort one may devote to gambling and still qualify as a professional under Groetzinger.

The history of the issue may serve to define the contours of the decision. In deciding Groetzinger, the court resolved a split in the circuits. The Tax Court considered professional gambling to be a trade or business based on a facts and circumstances test derived from the Higgins case.15 The second and sixth circuits had reversed Tax Court cases and denied professional status to gamblers. These circuit courts defined trade or business to mean holding one' self out to others as engaged in the selling of goods or s services.16 This holding out test was derived from a concurrence written by Justice Frankfurter in the DuPont case.17 In Groetzinger, the Court specifically endorsed the facts and circumstances test and rejected the Frankfurter test.18 For this reason, the tax court cases based on the facts and circumstances test should now be good precedent in all circuits. Under the current alternative minimum tax scheme, gambling loss deductions do not affect minimum tax and the incentive to treat gambling activity as a business is more limited.19 There is still some value to reporting lower AGI. This may be important because some deductions (i.e. medical expenses) have a threshold calculated as a percentage of AGI. Also, a professional gambler may deduct business expenses under 162.20 But, the limitations of 165 have been held to apply to professionals. Total deductions for expenses and losses may not exceed gambling winnings to produce a net operating loss in any year, and losses do not carry over.21 In return for these meager benefits, a professional gambler incurs social security self employment tax.22 In Basada v. C.I.R., the taxpayer was found to be engaged in the profession of a street hustler(gambling was one of his activities, others included pimping, panhandling, and hustling) .23 In this case the Service imposed professional status on the taxpayer over his objections, and assessed self employment tax.

B. Reporting and Withholding Record keeping is a substantial issue in taxation of gambling income. A recreational gambler must report wins as gross income and losses as an itemized deduction. Failure to separately report all wins and losses can result in a conviction for filing a false return even if the taxpayer actually has no tax liability.24 On audit, the 3

taxpayer is expected to produce a diary with entries for each session and documents such as betting receipts, and casino transaction records to substantiate the wins and losses. Deductions have been denied to taxpayers who failed to meet the services standards for record keeping and substantiation.25 While a professional gambler nets wagering transactions for reporting AGI, wins and losses are still separate line items on Form 1040 Schedule C (Profit or Loss From a Business); and similar record keeping requirements apply.

1. Accounting for Wins and Losses Gaming transactions are subject to a unique system of calculating net income. While the service does not allow wins and losses to be netted for the year, neither does it require a taxpayer to separately account for every roll of the dice. The amount of activity that can take place before an entry recording a win or loss is required is called a session.26 The definition of a session varies significantly depending on the type of wagering the taxpayer is engaged in. For example: when a gambler plays blackjack for two hours, there are approximately 140 hands played. Each hand is either won or lost (a decision in industry terms). Fortunately the Service does not require separate record keeping for each decision. Results may be netted for a session. Cashing in ones chips or leaving a particular casino ends a session and requires a record keeping entry. Moving between tables may not end a session, but changing to a different type of game certainly does. Wagers on horse and dog races must be recorded separately for each bet placed even if multiple wagers are made on the same race.27 At the end of the year winning sessions and losing sessions are separately aggregated and reported as gross income and a deduction respectively.

2. Reporting by Casinos In addition to the reporting and record keeping requirements placed on individual taxpayers; operators of gambling establishments are also required to report certain transactions.

When the operator of a gambling business makes a payment of $1,200 or more in winnings from bingo or slot machine play, or $1,500 or more in winnings from keno play the reporting requirements are triggered. The operator must file an informational return (form W2-G Statement for Certain Gambling Winnings) with the Service and provide the gambler with a copy.28 Also, wagering transactions frequently give rise to reporting requirements under laws designed to prevent money laundering. Any cash transaction in excess of $10,000 must be reported on a Form 8362, Currency Transaction Report by Casinos (CTRC).29 These reports must be filed within 15 days of the transaction, and retained on file by the casino for five years.30

3. Withholding Under 3402 the operator of a gambling business must withhold 28% of the payment on a winning bet where the payment exceeds $5,000 and the payment is at least 300 times greater than the wager.31 In theory, this represents a balance between the governments interest in ensuring taxing large transactions, and the harm to the bettor of withholding on gross income in transactions with a low profit margin.32 In reality, withholding on U.S. residents is only really operative for lottery winnings. The statute exempts winnings from bingo, keno, and slot machines which are the only casino games that pay at odds greater than 300 to 1.33 And, pari-mutual wagers paying those odds make up a very small percentage of total betting volume.34

II. Taxation of Gaming Income: Aliens

A. Tax Liability Section 871 of the Internal Revenue Code imposes a tax of 30% on the amount received from sources within the United States by a nonresident alien not engaged in a trade of business in the US.35 Money won at a U.S. casino or racetrack is clearly U.S. 5

source income. Specifically, gambling income is taxed as other fixed or determinable annual or periodical gains, profits, and income (FDAP).36 FDAP is very broadly construed and gambling winnings fall within the ambit of the term .37 The code also contains provisions requiring businesses that make payments of the type subject to 871 tax to withhold funds to pay that tax. Section 1441 requires a payor to withhold 30% of all payments made to aliens.38 Unlike 3402 which applies to US residents, 1441 applies to all payments regardless of the total amount or the odds at which the bet paid off.39 This is appropriate because there are no losses or deductions that could mitigate the taxpayers liability for the full 30% of the payment. Thus, the full amount of tax is withheld and the alien need not make additional payments or file for a refund. While it is hardly surprising that money won in the U.S. is taxable, the method of determining the taxable amount raises issues of equity and administrative feasibility. In Barba v. US, an alien sued for a refund of taxes withheld on keno40 winnings in Nevada.41 Barba objected to the tax imposed on his winnings because he had a substantial net loss on his US gaming activity for the year. The court interpreted 871 literally and imposed the tax on amount received, without reduction for losses or expenses.42 In a later private letter ruling, the service clarified its position that every single payment made to an alien is subject to tax without netting wins and losses within a session as is the case for residents.43 The difference in treatment between residents and aliens seems to raise an issue of horizontal equity. However, aliens and residents are not similarly situated in this case. The legislative history indicates that the purpose of withholding and taxing on amount received was to ensure collection of tax and relieve the Service of the difficulty of processing returns made by persons not present in the US.44 In general, the burden of administering returns by aliens justifies the simplified method adopted by 871(a). There is however and additional equity issue. Most items of income taxable under 871(a) are unlikely to have large associated losses or deductions. For income items such as compensation, interest and dividends; the amount received is usually quite

close to what would be net income. In wagering transactions however, aliens are subject to tax on large amounts received when losses would make the net income is small or even negative. Aliens who risk money in wagering transactions are taxed much more harshly that those who invest in stocks or bonds. But, as discussed below, this theoretical inequity is mitigated by several exceptions that result in little practical application of the tax. The tax and withholding scheme applicable to gambling winnings of aliens also creates an issue of administrative feasibility. The service has strictly interpreted the tax on amount received to mean that the payment of each individual winning bet is a taxable event.45 In addition to maximizing tax liability for the alien gambler, this ruling creates a substantial administrative burden. Where the gambler is playing a game like Keno there is time between rounds to withhold tax and fill out the necessary paperwork.46 But in a game like blackjack, where six players are winning and losing hands at a rate of seventy decisions per hour, this withholding requirement would bring the game to a halt. This administrative burden is mitigated somewhat by code provisions which exempt from tax and withholding the winnings from certain table games.47 Other table games receive the same treatment in practice, even without specific authorization. Also, regardless of game type, identifying aliens poses a serious problem. Even where it is feasible to perform some administrative tasks between races or between games; it is not feasible to ask every patron to prove U.S. residency after every wager. The common practice in the industry is to verify residency status and impose withholding only when a win exceeds the reporting or withholding thresholds applicable to residents and thereby triggers the operators procedures.48 This violates both the clear requirements of the statute and the Services published position, but the practice is widespread and there appears to be no action by the service to enforce more rigorous compliance.

B. Exceptions FDAP Tax Liability The 30% tax on amount received dramatically alters the expected outcome of a series of wagering transactions.49 Because other international gambling destinations offer tax 7

free environments, the decision for an alien to play in the U.S. depends on the availability of one of the exceptions to tax discussed below. 1. Exempt Games The most significant exception to the taxation of aliens gambling income is the complete exemption for the winnings from certain games. Section 871(j) provides that winnings on blackjack, baccarat, craps, roulette, and big-six wheel are exempt from the tax imposed under 871(a).50 A coordinated subsection of 1441 provides that there will be no withholding on winnings from these favored games.51 This exemption was added to the code in 1988.52 The legislative history of 871(j) is quite limited, but it indicates that, at the time of the amendment, the IRS was declining to enforce the tax on gambling income won at table games. 53 It seems likely that the service was declining to enforce the tax because of the administrative feasibility issues addressed above. The statute conformed the law to actual practice, and provided that the secretary could issue regulations taxing the games where it was determined to be feasible. No such regulations have been issued. At the time of the amendment, the specifically exempted games were practically the only casino games that presented the feasibility issue. Recently, casinos have developed new games such as Caribbean Stud Poker, and Let it Ride, as well as increasing availability traditional oriental games such as Pai Gow and Sic Bo. These fast paced multi player games present the same enforcement challenges as the exempted games. Currently the industry treats all table games alike and does not impose any withholding. Although there is no official ruling on the issue, the service has made no effort to tax these games. While the rational for avoiding an administratively unfeasible requirement is understandable, it is unclear why the service (and congress) chose to give up all taxation on table games. They could have taxed the gross amount of a winning session when an alien cashed in his chips. This would have alleviated the administrative burden, while preserving some of the taxable income.

The interests of the gaming industry are of course quite clear. Imposing tax on the gambling wins of their patrons would destroy the ability of US casinos to compete in the international market.54 The exemption for table games combined with the preference for table games exhibited by the international clientele is hugely valuable to the industry. There is however, no indication of a substantial lobbying effort on the part of the industry. It appears to be a fortuitous coincidence that the service cant find an efficient way to tax the games that foreign players choose.

2. Treaty The exemption for certain types of games discussed above covers a large part of gambling by aliens in the U.S. High value foreign gamblers exhibit an almost exclusive preference for table games. To casinos and the IRS the remaining gambling activity is not very significant. But to those aliens who choose not to play exempt games, the other methods of avoiding 871(a) tax on amounts received are very significant indeed. Gambling income of certain aliens is exempted from US tax by the treaty between the US and their country of residence.55 This exemption is accomplished by the Other Income article in the these treaties which provides that items of income not dealt with elsewhere in the treaty will be taxable only in the country of residence.56 The Technical Explanations to the Model Treaty indicate that gambling income is intended to be one of the items covered by the Other Income Article.57 An alien wishing to avoid withholding on a gambling win must be properly prepared to claim the treaty exemption. He must present the gaming operator with Form W-8BEN and a valid Tax Identification Number.58 Additionally, the U.S. Canada Tax Treaty has a unique provision allowing Canadian residents to deduct U.S. source gambling losses in reporting their U.S. taxable income.59 This deduction is taken at the end of the year by filing a 1040NR tax return. However, because they are still subject to withholding on all amounts received, the IRS earns (and the Canadian loses) interest on the funds until a refund is made.

Also, it would seem that treaty provisions exempting annuities are effective to exempt lottery winnings paid in the form of an annuity.60 But, the article at issue requires that the annuity be purchased for adequate and full consideration. 61 The service has indicated that it does not regard a one dollar lottery ticket as adequate consideration for a multimillion dollar annuity.62

3. Professional Status While the differences between professional and recreational gambling is slight for a resident, professional status can have significant tax advantages for an alien. If an alien does not play exempted games, and his country of residence either has no treaty or the treaty does not exempt gaming income, becoming a professional gambler may be the only way to avoid the 30% tax on amount received. As a professional gambler, an alien may treat his income from U.S. wagering transactions as income from a trade or business. This entirely removes the income from the FDAP regime of taxation on amount received. Under section 872(b), income effectively connected with the conduct of a trade or business within the United States is subject to a tax on net income at the same rates applicable to residents.63 Additionally, if the alien gambler is a resident of a county with which the US has a tax treaty, he may be able to exempt his gambling winnings altogether. Most tax treaties only tax business profits if an alien has a permanent establishment in the country where the profits were earned.64 As few foreign gamblers maintain a permanent establishment in the U.S., this would eliminate the tax burden altogether.65 In most cases interpreting trade or business for purposes of 871(b) there is no question but that the taxpayer is involved in a trade or business of some type, somewhere in the world. The issue presented is whether there is enough activity within the U.S. the characterize it as a U.S. trade or business. In the case of gambling however, it is possible that the transactions are recreational and there is no trade or business at all.

10

For this reason there should be a threshold inquiry as to whether the alien is actually engaged in the trade or business of gambling. This analysis should be based on the same principals used to analyze the question for residents. Although Groetzingers definition of trade or business was limited to the context presented in the case, it applies in this context. 66 By separating the issue of whether there is a U.S. trade or business, from the issue of whether the gambling activity is a trade or business at all; the issue is presented in exactly the same way as in Groetzinger. Under current case law, professional status is increasingly available. It is reasonable that worldwide activity should be considered. In the Basada case discussed above the Service held an individual engaged in a variety of activities, including gambling, to be conducting a trade or business.67 In Barrish v. C.I.R., the taxpayer was found to be in the trade or business of wagering on dog races even though he also maintained an active law practice.68

Having determined that the wagering transactions are part of a trade or business, the issue of whether they constitute a U.S. trade or business may be addressed in a manner consistent with the case law on the subject. The point of the analysis is to determine whether the taxpayers activities have been significant and not just isolated or sporadic. The court has stated that before a taxpayer can be found to be ' engaged in trade or business within the United States' must, during some substantial portion of the taxable it year, have been regularly and continuously transacting a substantial portion of its ordinary business in this country.69 This suggests that a natural person present in the U.S. long enough to have a U.S. trade or business would be present long enough to be considered a resident anyway. But in InverWorld v. C.I.R., the court examined both the quantity and the quality of the taxpayers activities in the U.S.70 Under this analysis, a gambler who made several annual trips to the U.S. and gambled significant amounts could successfully file as a professional engaged in the trade or business of gambling in the U.S.

11

See Libutti v. CIR, 71 T.C.M. (CCH) 2343 (1996). The value of complimentaries (goods and services given to gamblers by casinos as rewards and inducements for further play) must be reported as income. But, it is considered gambling income and may be offset by gambling losses.
2

I.R.C. 61 (1994).

See Stephen A. Zorn, Federal Income Tax Treatment of Gambling, 49 Tax Law 1, 54 n.215 (1995). This article thoroughly addresses the anomalous treatment of gambling in the tax code and postulates that the distinctions are based in moral disapproval rather than the policies of equity or economic utility.

I.R.C. 165 (1994). (a) General rule.--There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. (d) Wagering losses.--Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.
5

See Kozma v. CIR, 51 T.C.M. (CCH) 956 (1986). See I.R.C. 262 (1994). See Whitten v. CIR, 70 T.C.M. (CCH) 1064 (1995).

I.R.C. 212 (1994). See Rowles v. CIR, 51 T.C.M. (CCH) 330 (1986); Shiosaki v. C.I.R., 30 T.C.M. (CCH) 110 (1971).
9

See Bessenyey v. CIR, 45 T.C. 261, 273 (1965), affd. 379 F.2d 252 (C.A. 2, 1967), cert. den. 389 U.S. 931 (1967). See Kozma at 956.

10

11

See I.R.C. 62(a)(1). This section allows trade or business deductions to be subtracted from gross income to determine adjusted gross income. For a professional gambler, losses are business deductions. Groetzinger v. Commissioner, 82 T.C. 793 (1984), aff' 771 F.2d 269 (7th Cir. 1985), aff' 480 U.S. 23 d, d, (1987). Id at 35. Id at 24.

12

13

14

15

Higgins v. Commissioner, 312 U.S. 212 (1941). See also Meredith v. Commissioner, 49 T.C.M. (CCH) 318 (1984); Barrish v. Commissioner, 49 T.C.M. (CCH) 115 (1984). 16 See Gajewski v. Commissioner, 723 F.2d 1062 (CA2 1983), cert. denied, 469 U.S. 818 (1984); Estate of Cull v. Commissioner, 746 F.2d 1148 (CA6 1984), cert. denied, 472 U.S. 1007 (1985).
17

Deputy v. Du Pont, 308 U.S. 488 (1940) (Justice Frankfurter concurring)

12

18

Groetzinger at 987. See Tax Equity and Fiscal Responsibility Act of 1982, 201(a), 96 Stat. 411 I.R.C. 162 (1994). See Kozma, 51 T.C.M. (CCH) 956 (1986); Valenti v. C.I.R., 68 TCM (CCH) 838 (1994). I.R.C. 1401 (1994). Basada v. CIR, 75 T.C.M. (CCH) 2159 (1998).

19

20

21

22

23

See U.S. v. Scholl,166 F.3d 964 C.A.9 (Ariz.1999) (federal court judge convicted of filing a false return because he reported no gambling income when losses were greater than wins).
25

24

See Colony v. CIR, TC Memo 1999-194

26

See RODGER C. ROCHE, E.A. & YOLANDA SMULIK-ROCHE, E.A., A TAX GUIDE FOR GAMBLERS 3-6 (2001). See also Rev. Proc. 77-29, 1977-2 C.B. 538.
27

See id.

See Treas. Reg. 7.6041-1 (1977). (a) In general. On or after May 1, 1977, every person engaged in a trade or business and making a payment in the course of such trade or business of winnings (including winnings which are exempt from withholding under section 3402(q)(5)) of $1,200 or more from a bingo game or slot machine play or of $1,500 or more from a keno game shall make an information return with respect to such payment. (b) Special rules. For purposes of paragraph (a) of this section, in determining whether such winnings equal or exceed the $1,200 or $1,500 amount-(1) In the case of a bingo game or slot machine play, the amount of winnings shall not be reduced by the amount wagered; (2) In the case of a keno game, the amount of winnings from one game shall be reduced by the amount wagered in that one game; (3) Winnings shall include the fair market value of a payment in any medium other than cash; (4) All winnings by the winner from one bingo or keno game shall be aggregated; and (5) Winnings and losses from any other wagering transaction by the winner shall not be taken into account. (c) Prescribed form. The return required by paragraph (a) of this section shall be made on Form W-2G and shall be filed with the Internal Revenue Service Center serving the district in which is located the principal place of business of the person making the return on or before February 28 of the calendar year following the calendar year in which the payment of winnings is made. Each Form W-2G shall contain the following: (1) Name, address, and employer identification number of the person making the payment; (2) Name, address, and social security number of the winner; (3) General description of two types of identification (e.g., "driver' license", "social security card", or s "voter registration card") furnished to the maker of the payment for verification of the winner' name, s address, and social security number; (4) Date and amount of the payment; and (5) Type of wagering transaction.

28

13

In addition, in the case of a bingo or keno game, Form W-2G shall show any number, color, or other designation assigned to the game with respect to which the payment is made. In the case of a slot machine play, Form W-2G shall show the identification number of the slot machine. See 31 USC 5313 (1982) (statutory authorization for reporting regulations) ; 31 CFR 103.22(a)(2) (as amended in 2000) (requires financial institutions and casinos to report cash transactions ); IRS Form 8362, Currency Transaction Report by Casinos (CTRC).
30 29

See 31 CFR 103.27(a) (as amended in 2000).

I.R.C. 3402 (1994). (q) Extension of withholding to certain gambling winnings.-(1) General rule.--Every person, including the Government of the United States, a State, or a political subdivision thereof, or any instrumentalities of the foregoing, making any payment of winnings which are subject to withholding shall deduct and withhold from such payment a tax in an amount equal to the product of the third lowest rate of tax applicable under section 1(c) and such payment. (2) Exemption where tax otherwise withheld.--In the case of any payment of winnings which are subject to withholding made to a nonresident alien individual or a foreign corporation, the tax imposed under paragraph (1) shall not apply to any such payment subject to tax under section 1441(a) (relating to withholding on nonresident aliens) or tax under section 1442(a) (relating to withholding on foreign corporations). (3) Winnings which are subject to withholding.--For purposes of this subsection, the term "winnings which are subject to withholding" means proceeds from a wager determined in accordance with the following: (A) In general.--Except as provided in subparagraphs (B) and (C), proceeds of more than $5,000 from a wagering transaction, if the amount of such proceeds is at least 300 times as large as the amount wagered. (B) State-conducted lotteries.--Proceeds of more than $5,000 from a wager placed in a lottery conducted by an agency of a State acting under authority of State law, but only if such wager is placed with the State agency conducting such lottery, or with its authorized employees or agents. (C) Sweepstakes, wagering pools, certain parimutuel pools, jai alai, and lotteries.--Proceeds of more than $5,000 from-(i) a wager placed in a sweepstakes, wagering pool, or lottery (other than a wager described in subparagraph (B)), or (ii) a wagering transaction in a parimutuel pool with respect to horse races, dog races, or jai alai if the amount of such proceeds is at least 300 times as large as the amount wagered. (4) Rules for determining proceeds from a wager.--For purposes of this subsection-(A) proceeds from a wager shall be determined by reducing the amount received by the amount of the wager, and (B) proceeds which are not money shall be taken into account at their fair market value. (5) Exemption for bingo, keno, and slot machines.--The tax imposed under paragraph (1) shall not apply to winnings from a slot machine, keno, and bingo. (6) Statement by recipient.--Every person who is to receive a payment of winnings which are subject to withholding shall furnish the person making such payment a statement, made under the penalties of perjury, containing the name, address, and taxpayer identification number of the person receiving the payment and of each person entitled to any portion of such payment. (7) Coordination with other sections.--For purposes of sections 3403 and 3404 and for purposes of so much of subtitle F (except section 7205) as relates to this chapter, payments to any person of winnings which are subject to withholding shall be treated as if they were wages paid by an employer to an employee.

31

14

32

See Stephen A. Zorn, Federal Income Tax Treatment of Gambling, 49 Tax Law 1, 54 n.215 (1995). (withholding on gross proceeds of all wins would result in significant over-withholding because the actual tax liability depends on wins minus deductions for losses.) I.R.C. 3402(q)(5) (1994).

33

Odds of 300 to 1 are only found on super-exotic wagers such as the pick six (gambler must successfully select the winners of six different races). I.R.C. 871 (1994). Tax on nonresident alien individuals: (a) Income not connected with United States business--30 percent tax.-(1) Income other than capital gains.--Except as provided in subsection (h), there is hereby imposed for each taxable year a tax of 30 percent of the amount received from sources within the United States by a nonresident alien individual as-(A) interest (other than original issue discount as defined in section 1273), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income,
36 35

34

See IRC 871(a)(1)(A)

37

See Barba v. US, 2 Cl. Ct. 674, 678 (1983). See also Commissioner v. Wodehouse, 337 U.S. 369, 393394 (1949).

38

I.R.C. 1441 (1994). Withholding of tax on nonresident aliens: (a) General rule.--Except as otherwise provided in subsection (c), all persons, in whatever capacity acting (including lessees or mortgagors of real or personal property, fiduciaries, employers, and all officers and employees of the United States) having the control, receipt, custody, disposal, or payment of any of the items of income specified in subsection (b) (to the extent that any of such items constitutes gross income from sources within the United States), of any nonresident alien individual or of any foreign partnership shall (except as otherwise provided in regulations prescribed by the Secretary under section 874) deduct and withhold from such items a tax equal to 30 percent thereof, except that in the case of any item of income specified in the second sentence of subsection (b), the tax shall be equal to 14 percent of such item. (b) Income items.--The items of income referred to in subsection (a) are interest (other than original issue discount as defined in section 1273), dividends, rent, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and income, gains described in section 631(b) or (c), amounts subject to tax under section 871(a)(1)(C), gains subject to tax under section 871(a)(1)(D), and gains on transfers described in section 1235 made on or before October 4, 1966. The items of income referred to in subsection (a) from which tax shall be deducted and withheld at the rate of 14 percent are amounts which are received by a nonresident alien individual who is temporarily present in the United States as a nonimmigrant under subparagraph (F), (J), (M), or (Q) of section 101(a)(15) of the Immigration and Nationality Act and which are-See supra note 29 and accompanying text.

39

Keno is a casino game generally resembling bingo or lotto. For each game a player selects in sequence from one to 15 numbers out of a total of 80 on a printed card and places a bet on them. The casino then randomly draws 20 numbers. If they coincide with those selected by the player, he wins. The amount won depends on the total numbers chosen per game, the amount of numbers which coincide and the amount wagered by the player. An average Keno game takes 2-3 minutes and winners are paid between games.
41

40

See Barba v. US, 2 Cl. Ct. 674 (1983). The casinos withheld and paid over to the Internal Revenue Service $18,474 of the total wins of $61,580.

15

42

See Id. at 680-681. See Priv. Ltr. Rul. 87-10-006 (Dec. 01, 1986) See Barba at 677-678. See Priv. Ltr. Rul. 87-10-006 (Dec. 1, 1986). See supra note 40. See I.R.C. 871(j) (1994).

43

44

45

46

47

See Treas. Reg. 7.6041-1 (1977) (requires reporting of bingo and slot machine wins in excess of $1,200 and keno wins in excess of $1,500); I.R.C. 3402 (1994) (requires withholding on lottery and parimutual wins in excess of $5,000 and where the payout odds exceed 300-1) In roulette for example, a bet on a color (black or red) pays 2-1. 15 spots are red and 15 are black, but the fact that 2 of the 38 spots on the wheel are green dictates that over time a gambler can expect to lose 5.26% of what they put at risk. But, in the short term, a gambler has a chance (or at least a perceived chance) to win at least one more bet than he loses and have a winning day. Withholding 30% of winning wagers means that a gambler must have significantly more wins than losses to just break even. I.R.C. 871 (1994). (j) Exemption for certain gambling winnings.--No tax shall be imposed under paragraph (1)(A) of subsection (a) on the proceeds from a wager placed in any of the following games: blackjack, baccarat, craps, roulette, or big-6 wheel. The preceding sentence shall not apply in any case where the Secretary determines by regulation that the collection of the tax is administratively feasible. I.R.C. 1441 (1994). (c)(11) Certain gambling winnings.--No tax shall be required to be deducted and withheld under subsection (a) from any amount exempt from the tax imposed by section 871(a)(1)(A) by reason of section 871(j).
52 51 50 49

48

Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100-647, 6134, 102 Stat. 3342 (1988)

See H.R. Conf. Rep. No. 100-1104 (1988), reprinted in 1988 USCCAN 5048, 5256-5257. 9. Gambling winnings of nonresident aliens Present Law A 30-percent withholding tax is imposed on certain U.S. source income not effectively connected with a U.S. trade or business. Subject to exceptions, the IRS collects this tax on gambling winnings of nonresident aliens. Currently, the IRS does not collect this tax on winnings from certain "table games." House Bill The House bill excludes winnings from blackjack, roulette, baccarat, craps, and big six wheel from the 30 percent withholding tax, except to the extent provided in regulations. The House bill is effective for winnings after the date of enactment. Senate Amendment No provision. Conference Agreement

53

16

The conference agreement follows the House bill.

54

See supra note 49 and accompanying text.

IRS Pub. 515, 2001 WL 239025 (I.R.S.) . Gambling income won in the United States by residents (as defined by treaty) of the following foreign countries is not taxable by the United States: Austria, Czech Republic, Denmark, Finland, France, Germany, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Netherlands, Russian Federation, Slovak Republic, South Africa, Spain, Sweden, Tunisia, Turkey, Ukraine, and the United Kingdom.
56

55

U.S. Model Income Tax Convention, Sept. 10, 1996, Article 21. Other Income 1. Items of income beneficially owned by a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State. 1996 United States Model Income Tax Treaty-U.S. Treasury Departments Technical Explanation. See IRS Pub. 515, 2001 WL 239025 (I.R.S.)

57

58

US-Canada tax treaty, Article 22, (as amended by article 11 of the third protocol 1995) 3. Losses incurred by a resident of a Contracting State with respect to wagering transactions the gains on which may be taxed in the other Contracting State shall, for the purpose of taxation in that other State, be deductible to the same extent that such losses would be deductible if they were incurred by a resident of that other State. 60 State lottery jackpots are commonly paid in the form of a monthly disbursements for a period of several years. This series of fixed entitlements does meet the definition of an annuity. US-Israel Tax Treaty Article 20 (1975) Private Pensions And Annuities (2) Alimony and annuities paid to an individual who is a resident of one of the Contracting States shall be taxable only in the Contracting State. (5) The term ' annuities'as used in this Article, means a stated sum paid periodically at stated times during , life, or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered).
62
63 61

59

Field Service Advisory Issue: October 12, 2001 July 5, 2001 IRS FSA 200141020, 2001 WL 1215164 I.R.C. 871(b) (1994). U.S. Model Income Tax Convention, Sept. 10, 1996 Article 7 1. The business profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein.

64

Casinos customarily provide hotel accommodations to patrons as an inducement to play. Few gamblers, (especially ones filing as professionals), would chose to maintain their own permanent residence instead of using those provided by the casino.
66

65

See Groetzinger at 983.

17

FN8. We caution that in this opinion our interpretation of the phrase "trade or business" is confined to the specific sections of the Code at issue here. We do not purport to construe the phrase where it appears in other places.
67

Basada v. CIR, 75 T.C.M. (CCH) 2159 (1998).

68

Barrish v. CIR, 49 T.C.M. (CCH) 115 (1984). (taxpayer spent three hours a day practicing law, four hours studying dog racing information, and attended evening races nearly every day). See Spermacet Whaling & Shipping Co. S/a v. C.I.R., 30 T.C. 618, 634 (1958). InverWorld v. C.I.R., 71 T.C.M. (CCH) 3231 (1996).

69

70

18