Federal lawmakers tried to put a dent in online gambling with enactment in 2006 of the Unlawful Internet Gambling Enforcement Act. The law is designed to restrict U.S. gamblers' access to online, foreign-based websites.
The law, however, hasn't affected players as much as it has payment processors, says Brad Polizzano, a tax attorney with Tenenbaum Law P.C. in Melville, New York.
Polizzano points to the U.S. Department of Justice's seizure in April 2011 of the Internet domains of the 3 biggest offshore online gambling sites operating in the U.S. at the time: Full Tilt Poker, PokerStars and Absolute Poker/UltimateBet.
In addition, several of these sites' principals, as well as individuals processing financial transactions to and from these sites, were indicted for bank fraud, illegal gambling and money laundering, says Polizzano.
But more recently, some states have taken a "if you can't beat them, join them" approach. Nevada allows companies in the Silver State to apply for licenses to operate poker websites. New Jersey, home to Atlantic City's casinos, also offers online poker at its casinos.
Fantasy sports: games or gambling?
Complicating the online betting issue is the popularity of fantasy sports games.
The operators of these websites, the most popular of which are Draft Kings and FanDuel, say that they are games of skill. Participants, they say, rely on their knowledge of the real sports leagues, teams and players in order to win money on the corresponding fake teams and players they select.
Opponents of the fantasy sites argue that they are thinly veiled online gambling.
State attorneys general in several states, including Nevada and New York, agree and have shut down the fantasy sites in those jurisdictions. Several members of Congress are calling for investigation of the fantasy sports industry.
Tax and gambling misconceptions
With the popularity of online betting and fantasy sports increasing, there is growing interest in legalizing the practice. If that happens, any accompanying regulations would help state revenue departments and the IRS enforce tax compliance in connection with winnings.
Polizzano, who is known on social media as "TaxDood," says there are 3 tax areas that many gamblers don't understand well.
One is the difference between recreational and professional gambling. Most people fall into the recreational category; they visit a casino or racetrack a couple of times per year and buy lottery tickets.
In these cases, any winnings should be reported to the IRS as "other" income. Recreational gamblers also can reduce the amount of their taxable winnings by itemizing their expenses and counting gambling losses as a deduction in the "other miscellaneous deductions" category of Schedule A.
Professional gamblers, on the other hand, essentially gamble regularly with the intent to profit enough to earn a living. The tax court ruling that set up the standards for professional gambling, says Polizzano, "basically requires people to file one way or the other, professional or recreational."
"A lot of gamblers think they can file any way that minimizes their tax burden," he says. "But they really don't have a choice. They must pick one category or the other."
And while the tax code generally is very harsh toward gamblers, says Polizzano, professional gamblers got some good news from the U.S. Tax Court. In Mayo v. Commissioner, the court held that a professional gambler may deduct "ordinary and necessary" business expenses beyond the extent of a taxpayer's net gambling winnings.
Record winnings and losses
Both types of gamblers, however, share one thing. They need to keep very good records of their gambling activities. This, too, is an area of confusion for taxpayers, says Polizzano.
A recreational gambler can't simply net wins and losses -- that is, combine them and report only the total. Rather, a gambler must add all winnings and report them as income. The losses are itemized and can be claimed as a deduction, but only up to the amount of winnings reported that year.
To substantiate these amounts, the IRS says you must keep records of every single gambling session. "You spend 15 minutes at the craps table and finish up with $500. Take a break, then spend 45 minutes at the blackjack table. That's another session," says Polizzano. "In my opinion, that's overly burdensome. Who really does that?"
Another documentation requirement, per IRS Publication 529, Miscellaneous Deductions, is that you keep a diary or log of gambling activities. The log is supposed to show not only the amounts you win or lose, but also the date and type of your specific wager or wagering activity, the name and address or location of the gambling establishment, and the names of other persons present with you when you gambled.
"If they get the 'dear valued taxpayer' letter from the IRS that wants them to substantiate their gambling activity, they won't be able to do that because they haven't kept track," says Polizanno.