Steven Crist: Horseplayers avoid fiscal cliff but still face tax abyss

The tax-code changes passed last week by both houses of the U.S. Congress would have sent American horseplayers flying off a fiscal cliff had it not contained an exemption allowing them to continue deducting gambling losses against winnings regardless of new caps on itemized deductions.

The National Thoroughbred Racing Association deserves credit for lobbying for that reprieve, but its work in this area is not done. The Internal Revenue Service’s policies toward taxing gambling proceeds remains blatantly unjust and in need of reform. The continuing failure of the racing industry to change the fundamental problems with the tax code is costing it hundreds of millions of dollars a year in lost business.

The tax laws for racetrack gambling proceeds have changed little since the bygone era in which they were created, when the $2 bettor was the backbone of the industry and the most exotic wager was a daily double. It may have seemed reasonable then to consider a wager that paid more than 300-1 a lottery-like windfall to which the authorities had to be alerted. Today, however, with grandfather’s win-place-show bets accounting for less than a third of the handle, most players are regularly pursuing those higher-risk/higher-reward wagers, and getting themselves into tax trouble the moment they succeed.

The basic problem is that gross receipts, not net winnings, are considered income by the government. To keep things simple, let’s take the hypothetical case of a bettor who puts exactly $100,000 a year through the windows and gets back $95,000 for a net loss of $5,000. He’s enjoying himself and his hobby, is one photo-finish away from a winning year, and is beating the takeout. He, of course, should have no additional tax liability.

If that $95,000 in returns all came on bets that paid $602 for $2, though – payoffs that once were outlandish but that now are posted in almost every race on trifectas, superfectas, pick fours, pick sixes, etc. – his trouble is just beginning.

The IRS has been informed that he has additional “income” of $95,000. In theory, he can offset that by claiming an itemized deduction for $95,000 in gambling losses, but only in theory. Even with the exemption for this deduction – without it, his $95,000 would have been reduced depending on his income – he doesn’t really receive the full benefit of it, for three reasons. First, the insistence on calling gross receipts “income” probably kicked him into a higher tax bracket. Second, most states already have limits on the percentage of federal itemized deductions that can be applied to state taxes, so he’ll have to pay a state tax on his phantom gambling profit. Finally, the increase in his so-called income may subject him to an Alternative Minimum Tax, nullifying his wholly legitimate deduction.

Depending on his overall tax situation, our hypothetical $5,000 loser could be subject to an additional $5,000 to $35,000 in additional taxes on his non-existent “income.” Now, he’s losing $10,000 to $40,000 for the year on a hobby that doesn’t seem all that much fun and may well have become unaffordable, driving him permanently from the game.

It’s easily fixable. The best change would be to alter the definition of income from gross receipts to net winnings and the problems go away. Short of that, at least the current threshold triggers for reporting and withholding could be increased. Another helpful change would be to redefine the “base bet” amount used for those triggers to be the actual amount of the wager rather than $2. If someone plays a $32 trifecta or pick-four partwheel, the trigger should be 300-1 on $32, or $9,600, rather than pretending the player made only one winning $2 bet.

Pretending that someone who loses $5,000 in a year has actually realized $95,000 in additional taxable income is a cruel charade – an expensive one not only for taxpayers but for the nation’s racetracks. These and other tax burdens, such as the requirement for 25 percent withholding on payouts of $5,000 or more on 300-1 payouts, take massive amounts of money out of circulation that would otherwise be recirculated through the parimutuel windows.

Returning this money to bettors would spark a dramatic increase in annual handle that no marketing program will ever achieve, yet this issue remains low on the list of priorities among industry organizations. This is particularly mystifying because unlike the takeout decreases so many track operators stubbornly resist, there is no short-term revenue loss to fret about – just immediate handle gains and fairness for the customers.