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Taxation without justification: how the IRS should help our industry
Monday, July 7, 2014 - by Chris Wittstruck, Esq

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Chris Wittstruck

There are few, if any, issues facing the racing industry where all segments are in complete agreement. Just mention of words like whipping, takeout or Lasix® evokes countless vocal opinions across a broad spectrum.

If ever there was a matter on which the entire horseracing community could stand uniformly positioned, it is the obstinate insistence by the Internal Revenue Service to treat horseplayers differently from all other types of investors with regard to withholding of portions of their winning wagers.

On June 6, the United States Trotting Association joined a chorus of prominent industry groups, publications and federal officeholders in calling on the I.R.S. to stop harming racing by failing to either understand or appreciate the unique nature of 21st century pari-mutuel betting. This lack of knowledge or concern results in the unfair calculation of the amount of tax withholdings assessed against handicappers who successfully prevail when playing super-exotics.

Fortunately, much has recently been written about the withholding problem in industry publications. This article will identify the problem; summarize how the industry is attempting to formulate a solution, and how you can play a part in getting the solution implemented.

In our grandfathers’ day, tracks offered only win, place and show wagering, later adding a revolutionary bet called the daily double. In essence, it was difficult to make an outrageous score on a $2 wager. Very few horses go off at 99-1 or better, and only an infinitesimal amount of them actually win.   Only the rare daily double pays in the hundreds of dollars.

Today, the superfecta, pick-six and other combination and parlay offerings constitute the lion’s share of wagers made on horse races. These dominant betting opportunities often produce payoffs in the tens of thousands of dollars for a single $2 wager. Of course, winning the big one is usually not simply an exercise of pure luck; professional players often invest hundreds or even thousands of dollars in an attempt to cover as many potential outcomes as possible. By anticipating the probable value of a payoff, the bettor assesses the risk and intensively wagers accordingly. These plays constitute what is aptly called gambling, but arguably the gamble is little different than, for example, those involved in oil wildcatting or opening of a high-end restaurant.

Of course, it’s the province and duty of the I.R.S. to assess and collect taxes. If a bettor hits a score over $600 and the odds are 299-1 or more, the track is required to report the winnings on I.R.S. Form W-2G. In applying this law, consider a bettor who cashes a $50 win ticket on a horse at 50-1 odds and receives $2,550. Since the odds were less than 299-1, there is no reporting requirement. Conversely, if a neophyte bets a single, straight $2 superfecta on his 4-digit street number and hits for $1,000, the lucky first-timer would go home with lots of cash, as well as a copy of Form W-2G which the track uses to report his gain to the I.R.S.      

While the reporting rules might appear to produce conflicting results, the true concern involves the area of mandatory withholding on certain winning wagers.   Although the I.R.S. recognizes that legitimate expenses are to be subtracted from gross revenue in calculating taxable profit for a business venture, the problem is that the assessment of tax withholding from supposed “profit” in the racing realm is skewed, to say the least.

The applicable section of the Internal Revenue Code requires racetracks to withhold 25% of purported profit when the bettor wins more than $5,000 from a wagering transaction in a pari-mutuel pool with respect to horse races, provided the amount of such proceeds is at least 300 times as large as the amount wagered.

 

From the statutory language, it plainly appears that Congress intended that the total amount wagered into a particular pool be treated as the handicapper’s investment capital. Like in any other business, that capital investment should serve to reduce by equal amount his gross winnings when calculating his profit for withholding purposes. Unfortunately, congressional intent in the tax realm is solely determined by the I.R.S.

 

In a 1976 private letter ruling, a vehicle by which the I.R.S. gives its guidance to taxpayers under a set of submitted facts, the Service determined that only the investment on the actual winning combination counts as the “wagering transaction in a pari-mutuel pool” for tax reporting and withholding purposes. How does the present application of this archaic Service interpretation of the Code create the problem?

 

Assume a gambler invests $800 to cover 400 possible pick-six combinations at $2 a pop. He hits the parlay, and it pays $5,600. While the payout is over $5,000, the fortunate bettor really only received odds of about 6-1 in relation to his investment: or did he?

 

The I.R.S. takes the position that only the wager on the winning combination, and not the other 399, constitutes the specific “wagering transaction” referenced in the Code. In other words, rather than credit his entire $800 outlay in the pick-six pool as congress unmistakably envisioned, the Service credits only the $2 spent on the cashed winning combo. Thus, while only receiving 6-1 on his total investment, his I.R.S. imputed odds are about 2,800-1. This triggers not just Form W-2G reporting, but also a 25% tax withholding on winnings. The racehorse gambler actually walks away from the mutual window with $1,399.50 less of the payoff.

 

The overwhelming majority of horseplayers don’t invest thousands of dollars into super-exotic pools on a regular basis. Should we cry for the successful, high-end handicapping aficionados? Maybe not; but the concern is that some of these folks might place their investment capital elsewhere.  Undoubtedly, some already have. This simply drains the already well-parched pari-mutuel pools.

Moreover, by taking 25% of earnings out of the hands of the career players who are still around, the industry loses churn; meaning that instead of being able to wager this money again and again, the sum literally sits on account with the Service unless and until the big gambler can recoup it months later via her federal tax return filing. This decrease in handle, especially in racing states with no alternative gaming, is devastating. Racetrack managements, horsemen, breeders and the state all miss out on countless sums of takeout dollars.

 

Luckily, it doesn’t take an act of congress to reverse this situation. While previous attempts at congressional clarification have failed, the problem isn’t really with the language of the law, but rather with how the I.R.S. inexcusably construes it against horseplayers.

 

Consider a medium-sized retailer who embarks on a $1,000,000 marketing campaign. The endeavor actually yields a 6% increase in gross sales. Would the I.R.S. limit the deduction for the marketing expenditure to $60,000? Hardly. Yet, the I.R.S. withholds pari-mutuel earnings as if only that tiny fraction of the total investment made by the horseplayer allocated to the single winning combo was his cost of doing business.

 

You can help change this surreal circumstance by adding your name to an online petition already supported by thousands of individuals and groups. The petition simply mirrors what at least 17 members of congress have already demanded: That the I.R.S change course and consider the total amount invested by a taxpayer in a pari-mutuel pool when determining whether tax withholding on winnings is warranted. A link to the Petition is here:  

 

https://www.change.org/petitions/u-s-department-of-the-treasury-when-reporting-withholding-winnings-clarify-that-the-entire-amount-wagered-into-a-pool-by-an-individual-will-be-used-to-determine-whether-the-winnings-are-at-least-300-times-the-amount-of-the-wager?recruiter=103240080&utm_campaign=mailto_link&utm_medium=email&utm_source=share_petition

  

Apparently, the Washington-based tax lawyers working for the Service don’t frequent Rosecroft Raceway or Laurel Park. If they did, they’d understand the business of pari-mutuel wagering from the big bettors’ prospective. We can only hope that they amend their tax guidance in this matter soon, while there are still some whales around that can benefit.

Chris E. Wittstruck is an attorney, a director of the Standardbred Owners Association of New York and a charter member of the Albany Law School Racing and Gaming Law Network.

Editor's Note: The views contained in this column are that of the author alone, and do not necessarily represent the opinions or views of the United States Trotting Association.


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