Gambling winnings and losses tend to be an integral part of the yearly returns that are filed. As a matter of fact, it can be seen that gambling winnings are considered to be taxable income. This implies that they are supposed to be reported under both, federal, as well as state income taxes. In order to offset the gambling winnings, it is important to list them on the annual gambling losses on Schedule A of the tax return. In case records are not properly kept and maintained, the likelihood of an IRS Audit, pertaining to a gambling loss, is highly likely.
Gambling losses are considered a huge trigger for IRS Audits, primarily because, in a lot of situations, individuals don’t normally keep a proper record of the amount that was lost during the gambling process. Regardless of the fact that gambling losses can be deducted up to the winnings, doing so also has an inherent chance of triggering an audit.
In the case where an IRS Audit is triggered pertaining to gambling losses, a specialized IRS Audit lawyer can help deal with the formalities, and the audit process in a smooth manner.
Therefore, in short, YES, the IRS does audit gambling losses.
However, it must be noted that gambling losses are only audited under situations where there are apparent red flags pertaining to the audit process itself. In other situations and scenarios, gambling losses do not always trigger IRS Audits.
Categorization of gambling income
There are two major types of gambling incomes that are considered for tax-related purposes. Firstly, there are recreational gamblers, and then there are regular gamblers.
As far as recreational gamblers are concerned, they are categorized as individuals that gamble on an irregular basis. Their livelihood is not solely dependent on gambling, and therefore, they just do it for fun. On the other hand, regular gamblers are individuals that categorize gambling as their main source of income. This is the sole income source of the individuals, and hence this is supposed to be treated slightly differently.
In the case of recreational gamblers, they might not always have gambling winnings or losses in their financial statements. However, regular gamblers will always have gambling losses in the financial statements.
What triggers IRS Audits pertaining to gambling losses?
As mentioned earlier, the main reason behind IRS auditing gambling losses mainly lies in the realms of red flags being identified by the IRS. These red flags mostly occur as a result of misinformation on part of the filer, pertaining to excessive gambling losses mentioned on the financial statements.
For example, lack of documentation, or excessive losses claimed as gambling losses often turn out to be a very major red flag, because it might indicate window dressing to reduce income in an artificial manner.
In the same manner, in case of parked figures, without proper proof, can also trigger IRS Audits, regardless of gambling surplus, or loss. If individuals, who gamble recreationally have absurd amounts or figures in their financial statements, it might give ground to IRS to believe that there is something absurd that needs attention at the earliest.
Reporting Gambling Winnings and Losses
In accordance with the tax law, it is important to realize that individuals who are recreational gamblers (i.e. they gamble for recreation), are allowed to deduct their losses. This amount is mainly used in order to offset gambling income, which is then reported to the IRS as taxable income. Gambling losses are not always deducted from the non-gambling income.
In the case where an individual wins money through gambling, the winnings need to be reported to the IRS using a W2-G Form. On the other hand, other gambling winnings are reported directly on Form 1040 as “Other Income”. Under most circumstances, Form W2-G is obtained from established gambling businesses, which are known to be registered with the IRS.
Followed by this, items on the losses on Schedule A are also included under itemized deductions. These losses are subsequently deducted from the winnings (earned via gambling) to reduce the taxable income, equivalent to the earnings.
How to prove gambling losses?
Given that the net amount of gambling winning and losses are supposed to be included in the IRS Audit, it is important to realize that certain aspects pertaining to gambling losses should be presented as proof to avoid red flags as much as possible.
This requires individuals to keep a proper log of all winnings and losses, as much as possible, including the slips and other documents that can be presented as proof. For example, all proof of lottery participation, raffles, horse and dog races, casino games, as well as other poker games are supposed to be included in the overall documentation process.
In the same manner, it is also important to include the date and the type of gambling that a person engages in and other details like the venue where the transaction took place and the other people involved in the transaction. Other documentation that can be used to prove the losses include Form W2-G, Form 5754, wagering tickets, as well as other receipts that have been received from the gambling facility.
Can IRS Audit pertaining to gambling losses be avoided?
Regardless of the fact that there is no foolproof way to guarantee that the loss cannot be altogether avoided, there are some best practices out there that can help to ensure that the risk of IRS Audit is altogether minimized to a maximum level.
It must be understood that deducting gambling losses is important, but there is a need to document these losses as proof of actual incurrence. Therefore, in order to deduct these losses, it is important to understand that individuals are required to keep a record of gambling winnings and losses. This record is then used to prove that certain losses are won through the process of gambling.
The records that need to be properly maintained are as follows:
- Date of gambling
- The type of gambling involved
- The people that are gambled with
- The name and address of the location where the gambling took place
- The total amount that is won and lost
Keeping a proper record of all this information, and communicating it with IRS is used through an audit.
The records are obtained using gambling sources, like lotteries, casino games, or poker. They include the fair market value of prizes, like cars and trips.
In the case where individuals don’t normally keep a record of gambling losses, itemization of these losses tends to be a red flag for the IRS. This is particularly in the case where there are significant winnings pertaining to gambling. Therefore, itemizing the losses is considered to be a red flag for the IRS, and it eventually results in an audit.