By Eva Rosenberg
Admit it – ever since that first electronic game of solitaire, we’ve been hooked on computer games. The more competitive of us like to play against each other, and there are lots of online sites where we can compete for free or cash. My favorites include WorldWinner.com, Pogo.com, King.com and Games.com. These are places where you don’t get surprise viruses piggybacked on the software.
Generally, when playing games for money, all you do is spend – paying for the games. Even when you win, you “re-invest” the proceeds into more games. It’s the rare individual who walks away from online games with a net profit for the month.
Win or lose, U.S.-based online game companies are issuing a 1099-MISC based on your gross winnings. Since there is no real income, you wish they could net the wins and losses.
Unfortunately, as the law now stands, they can’t. And it’s not hard to generate wins worth several thousand dollars a month, even when your payments into the system are only $50 a session. Why? Each time you win a game, your gross winnings increase. You use your winnings to pay for the next game. If you’re good, that $50 might last a week or even a month. By the end of the day, the week, the month, you will have no money. But you may have reinvested your winnings to the tune of several thousand dollars for that period of play.
So, how should we treat this income? Is this the same thing as online gambling?
No. Online gamblers believe they can actually win money. Some people net thousands of dollars a year – at least for a while. Gamers are under no such illusion – but we play for the sheer joy of competition. Sounds like a hobby to me.
How does that work on your tax return? Losses from hobbies are not treated like gambling losses. You report the winnings on the 1099 as “Other income.” Your losses are reported as itemized deductions. The deductible losses are limited to the total winnings. Then, they are reduced by 2% of your adjusted gross income (AGI). Folks who don’t have enough overall expenses to itemize, don’t get to use their losses at all. Gambling losses don’t get reduced by that extra 2%.
I ran computations for kids who are dependents on their parents’ tax returns, with no other income. Looking at a variety of winning amounts, there was no instance that generated a tax liability, as long as the tax return was prepared properly.
However, taxes were generated for folks who have wages or other sources of income. Consider a single person with $30,000 in wages. His or her federal tax liability is about $2,000. Add $20,000 in gaming wins, and the taxes soar to more than $3,600.
The amount is a lot lower for someone on Social Security with the same income and losses. Individuals receiving Social Security pay no taxes on those benefits as long as their total income, including half the Social Security benefits is less than $25,000 ($32,000 for couples filing jointly).
Without the 1099, they have no tax liability. The gaming income increases their AGI, and some of their Social Security benefits become taxable. End result, over $200 in taxes. It’s not huge. But with a lot of free time, those phantom winnings can add up.
In both cases, some of the taxes can be reduced by using itemized deductions, which would have been absorbed by their standard deductions. Look for things like state taxes, vehicle registrations, donations and job-related expenses.
If taxes are going to become a factor, perhaps it’s wise to monitor those gross winnings – and play for a while on those free sites.
Readers, have you been hit with these gaming 1099s?
Eva Rosenberg, EA, is the publisher of TaxMama.com. Rosenberg is the author of several books, including the newest edition of “Small Business Taxes Made Easy.” She also teaches a tax-pro course at IRSExams.com.