Taxpayers Bet on Noncompliance as IRS Gambles Away Billions in Unreported Wagering Income

A recent report by the Treasury Inspector General for Tax Administration (TIGTA) revealed significant shortcomings in the IRS’s enforcement of tax compliance related to gambling winnings. Per the report, this lack of compliance and enforcement accounts for over $1 billion in lost tax revenue. Taxpayers are already seeing increased scrutiny of gambling income and losses by the IRS. 

Who Must Report? 

IRC Sec. 61 defines gross income as “all income from whatever source derived,” including winnings earned from gambling activities.  Gambling winnings are fully taxable and must be reported as income on an individual’s tax return. Gambling winnings and any tax withheld should be reported to the IRS on Form W-2G, Certain Gambling Winnings, by the gambling entity (“payor”). 

A payor must issue a Form W-2G if the winnings from: 

• a bingo game or slot machine are $1,200 or more; 
• a keno game are $1,500 or more, reduced by the wager; 
• a poker tournament are more than $5,000, reduced by the wager or buy-in; 
• any other game or bet are $600 or more and at least 300 times the amount of the wager, reduced by the wager.  

A taxpayer may be able to deduct gambling losses but only if they itemize deductions on Form 1040, Schedule A, and keep adequate records to support amounts of winnings and losses. Gambling losses cannot be claimed in excess of gambling income reported on the tax return.  

Withholding Requirements 

Under IRC Sec. 3402(q), federal tax is withheld on proceeds from a wager through regular withholding at 24%. A payor must withhold if: 

1. the winnings minus the wager are more than $5,000 and come from sweepstakes, wagering pools, lotteries, or 
2. other wagering transactions if the winnings are at least 300 times the amount wagered.  

However, under IRC Sec. 3402(q)(5), withholding is not applicable to winnings from bingo, keno, or slot machines. 

Backup withholding of 24 percent is also required if the winner (“payee”) does not furnish a correct Taxpayer Identification Number (TIN), regular withholding was not withheld, and the amount of the winnings meets one of the reporting threshold criteria above. 

Who Isn’t Filing? 

TIGTA’s report identified nearly 150,000 individuals who received over $15,000 in gambling winnings between 2018 and 2020 but failed to file tax returns. These non-filers accounted for a staggering $13.2 billion in unreported gambling income. Even more alarming is the estimate that the IRS could potentially collect $1.4 billion in additional tax revenue by addressing these cases. This represents a significant loss to the Treasury and highlights a major gap in tax enforcement. 

Of the identified non-filers, 37% were considered high-income, accounting for 90% of the estimated unpaid taxes. TIGTA notes that the IRS’s failure to prioritize these cases misses an opportunity to close the tax gap efficiently and sends the wrong message about compliance. 

The report also uncovered issues with information reporting. Hundreds of Forms W-2G were issued without proper taxpayer identification numbers (TINs), and payors failed to apply required backup withholding. This breakdown in the reporting system further complicates the IRS’s ability to track and enforce compliance. 

TIGTA’s Recommendations 

TIGTA made several recommendations to address the issues identified in their audit. Specifically, TIGTA recommended that the IRS: 

1. Begin appropriate enforcement actions on non-filers with gambling winnings, prioritizing high-income cases. 
2. Review non-filers with gambling winnings not identified by the IRS’s non-filer systems.
3. Analyze Forms W-2G with missing TINs to determine noncompliant gambling institutions.
4. Expand wager codes to include sports betting. 
5. Research the sports betting and online gambling industries to improve compliance efforts. 

The IRS agreed with most of TIGTA’s recommendations and committed to begin enforcement actions and conduct industry research. However, the agency disagreed with analyzing Forms W-2G with missing TINs, citing the low error rate. These recommendations aim to enhance the IRS’s ability to address noncompliance and potentially collect over $1 billion in unreported gambling-related taxes. 

With the explosion of online gambling systems, it is now easier than ever to casually gamble. This report serves as a stark reminder of the importance of proper tax compliance for taxpayers, especially those engaged in gambling activities. While the IRS’s enforcement may have been lax in the past, we can expect an uptick in the future. Therefore, it is crucial to remember that the obligation to report income and file returns remains. The potential for future crackdowns, coupled with penalties and interest on unpaid taxes, makes voluntary compliance the wisest course of action.