jacattac
08-18-2005, 10:48 AM
This came accross my desk this morning and being both a poker player and a CPA I thought it was rather interesting. While it probably means absolutly nothing at this point in time, sounds like things may get interesting.
Featured Articles--
Operator of online game tournaments must report a player's net winnings of $600 or more
PLR 200532025
IRS has privately ruled that a taxpayer that operates a web site conducting online game tournaments must report a player's net winnings of $600 or more (basically, winnings less fee to enter the game) under Code Sec. 6041.
Facts. Taxpayer, whom we'll call Net Games operated an Internet site (Site) that sponsors on-line tournaments for games, such as checkers, golf, 9-ball pool, and mah-jongg, as well as for word games, games of strategy, and arcade-style games. Aside from an introductory period for new players, Site does not provide games for general entertainment purposes. After the introductory period, a player must enroll on Site and provide it with a credit card in order to establish an account. A player must withdraw amounts from his account to pay required entry fees for participation in a tournament. Winnings from a tournament are credited to the player's account. Net Games receives a payment for each tournament that is computed as a percentage of the entry fees for that tournament.
The tournaments are arranged into five categories:
(1) The maximum number of players accepted into the tournament is designated as well as preestablished winnings. If a tournament does not fill before it is closed, the tournament leader is awarded the full prize.
(2) The tournament does not have a limited number of players, but terminates at a specified date and time. Minimum prizes are preestablished. The number of players competing and the size of potential prizes can increase over the competition period. If a tournament does not fill before it is closed, the tournament leader is awarded the stated minimum prize.
(3) Two individual players challenge each other in an agreed upon game. When the tournament closes, the winner is declared and a predetermined prize is awarded.
(4) The tournament operates in the same way as other tournaments except that Net Games furnishes a prize, usually in the form of personal property, such as a television set.
(5) Players compete against their own past performances. Those performances are established based on historical game play scores of the player. Prizes are predetermined.
For all its tournaments, Net Games pays prizes specified at the outset to the winning players. It has structured its games to eliminate the element of chance (other than the element of random chance inherent in a particular game) so that individuals with superior skills or strategies win games. Net Games recognizes that there are situations in which it must report amounts it paid to players during a year and has come up with three methods that it could use to report payments:
Gross method -Net Games totals up the gross amounts credited to a player's account during a year, and reports totals of $600 or more on a Form 1099-MISC.
Net method -Net Games totals up the gross amounts credited to a player's account during a year and subtracts the entry fee from each tournament in which the player received some kind of prize. It then reports such net totals of $600 or more on a Form 1099-MISC.
Cumulative net method -Net Games totals up the gross amounts credited to a player's account during a year, and subtracts all entry fees paid during the year, regardless of whether the player received a prize from that tournament. It then reports such net totals of $600 or more on a Form 1099-MISC.
Net Games agrees that information reporting under Code Sec. 6041 is required for prizes of $600 or more it pays to winning players. Net Games wanted a ruling that the proper method of computing income from tournament play for information reporting purposes is the cumulative net method.
RIA observation: The amount reportable under this method is always lower than the amount reportable under the gross method and in most cases is lower than the amount reportable under the net method. The amount reportable under the net method and the cumulative net method is the same for a player who receives winnings from each tournament he participates in, which probably does not occur frequently.
Natures of games impacts reporting obligation. The ruling notes that different information returns apply for wagering and non-wagering transactions. Accordingly, the ruling had to determine whether the game-playing activities in the tournaments on the Site operated by Net Games constitute wagering. To be classified as wagering, the games must fall within the definition of either a "lottery" or a "wagering pool," terms that aren't defined in the Code or the regs on information reporting.
Wagering pool. Looking to the dictionary and cases, the ruling said a wagering pool is an arrangement to pool bets into a common fund, which is wagered on a sports event or contest, with the successful bettor (or bettors) receiving the pool proceeds, subject to the pool seller's commission. The ruling noted that in the games offered by Net Games, monies are received as entrance fees in order to compete for a preestablished prize that must be awarded in any case. There is no aggregation of the entrance fees into a common pool. Rather, the minimum winnings or prizes of property are predetermined and must be awarded irrespective of the number of participants or the total of the entrance fees collected. Thus, the ruling concluded that the tournaments do not fall within a common usage definition of a wagering pool.
Lottery. Examining various authorities, the ruling concluded that, in general terms, a lottery is a scheme to distribute prizes to participants who pay to win the prize by chance. Because Net Games does not allow players of dissimilar skills to play in the same tournament and takes steps to minimize the element of chance in its tournament play, the ruling concluded that the tournament games lack the essential element of chance and cannot be classified as a lottery.
Information reporting applicable to Net Games. The ruling noted that Code Sec. 6041 generally requires reporting of all payments of $600 or more to another person made in the course of trade or business. Reportable payments include rent, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable gains, profits, and income. The returns used to report these payments are Forms 1096 and 1099. (Reg. § 1.6041-1(a)(2))
The ruling says that a player wins a prize by successfully competing in one of Net Games's sponsored tournaments, so the entry fee to that tournament is a return of capital. Therefore, the amount of the prize includible in gross income is the prize amount net of the fee. Accordingly, only net amounts are considered income under Code Sec. 6041 . Entry fees for tournaments where a player does not receive a prize, however, are not a return of capital, and cannot be subtracted by Net Games when determining the income paid to a player. Although it is possible that individual players may be entitled to deduct on their returns entry fees they paid to Net Games, the individual player must report all of his income and take all applicable deductions on his individual return. There is no authority allowing Net Games to effectively take a deduction on behalf of a player by reporting the net amount to IRS on a Form 1099.
RIA caution: IRS expressed no opinion as to whether a deduction is available or the character of any deduction. IRS could very well take the position that amounts spent on games that produce no winnings are nondeductible personal expenses. Since IRS already concluded that the games aren't wagering transactions, IRS presumably would not allow players to deduct fees paid to participate in games producing no winnings as gambling losses that could offset income from games in which a taxpayer received winnings or from winnings from actual wagering transactions. (Gambling losses are allowable as a miscellaneous itemized deduction (not subject to the 2% floor) but only to the extent of gambling winnings.)
Bottom line. The rulings say that Net Games should use the net method in determining which players it paid $600 or more during a year and use Form 1099-MISC to report the income.
RIA Research References: For reportable payments of $600 or more, see FTC 2d/FIN ¶ S-3656; United States Tax Reporter ¶ 60,414; TaxDesk ¶ 814,001; TG ¶ 60202.
Featured Articles--
Operator of online game tournaments must report a player's net winnings of $600 or more
PLR 200532025
IRS has privately ruled that a taxpayer that operates a web site conducting online game tournaments must report a player's net winnings of $600 or more (basically, winnings less fee to enter the game) under Code Sec. 6041.
Facts. Taxpayer, whom we'll call Net Games operated an Internet site (Site) that sponsors on-line tournaments for games, such as checkers, golf, 9-ball pool, and mah-jongg, as well as for word games, games of strategy, and arcade-style games. Aside from an introductory period for new players, Site does not provide games for general entertainment purposes. After the introductory period, a player must enroll on Site and provide it with a credit card in order to establish an account. A player must withdraw amounts from his account to pay required entry fees for participation in a tournament. Winnings from a tournament are credited to the player's account. Net Games receives a payment for each tournament that is computed as a percentage of the entry fees for that tournament.
The tournaments are arranged into five categories:
(1) The maximum number of players accepted into the tournament is designated as well as preestablished winnings. If a tournament does not fill before it is closed, the tournament leader is awarded the full prize.
(2) The tournament does not have a limited number of players, but terminates at a specified date and time. Minimum prizes are preestablished. The number of players competing and the size of potential prizes can increase over the competition period. If a tournament does not fill before it is closed, the tournament leader is awarded the stated minimum prize.
(3) Two individual players challenge each other in an agreed upon game. When the tournament closes, the winner is declared and a predetermined prize is awarded.
(4) The tournament operates in the same way as other tournaments except that Net Games furnishes a prize, usually in the form of personal property, such as a television set.
(5) Players compete against their own past performances. Those performances are established based on historical game play scores of the player. Prizes are predetermined.
For all its tournaments, Net Games pays prizes specified at the outset to the winning players. It has structured its games to eliminate the element of chance (other than the element of random chance inherent in a particular game) so that individuals with superior skills or strategies win games. Net Games recognizes that there are situations in which it must report amounts it paid to players during a year and has come up with three methods that it could use to report payments:
Gross method -Net Games totals up the gross amounts credited to a player's account during a year, and reports totals of $600 or more on a Form 1099-MISC.
Net method -Net Games totals up the gross amounts credited to a player's account during a year and subtracts the entry fee from each tournament in which the player received some kind of prize. It then reports such net totals of $600 or more on a Form 1099-MISC.
Cumulative net method -Net Games totals up the gross amounts credited to a player's account during a year, and subtracts all entry fees paid during the year, regardless of whether the player received a prize from that tournament. It then reports such net totals of $600 or more on a Form 1099-MISC.
Net Games agrees that information reporting under Code Sec. 6041 is required for prizes of $600 or more it pays to winning players. Net Games wanted a ruling that the proper method of computing income from tournament play for information reporting purposes is the cumulative net method.
RIA observation: The amount reportable under this method is always lower than the amount reportable under the gross method and in most cases is lower than the amount reportable under the net method. The amount reportable under the net method and the cumulative net method is the same for a player who receives winnings from each tournament he participates in, which probably does not occur frequently.
Natures of games impacts reporting obligation. The ruling notes that different information returns apply for wagering and non-wagering transactions. Accordingly, the ruling had to determine whether the game-playing activities in the tournaments on the Site operated by Net Games constitute wagering. To be classified as wagering, the games must fall within the definition of either a "lottery" or a "wagering pool," terms that aren't defined in the Code or the regs on information reporting.
Wagering pool. Looking to the dictionary and cases, the ruling said a wagering pool is an arrangement to pool bets into a common fund, which is wagered on a sports event or contest, with the successful bettor (or bettors) receiving the pool proceeds, subject to the pool seller's commission. The ruling noted that in the games offered by Net Games, monies are received as entrance fees in order to compete for a preestablished prize that must be awarded in any case. There is no aggregation of the entrance fees into a common pool. Rather, the minimum winnings or prizes of property are predetermined and must be awarded irrespective of the number of participants or the total of the entrance fees collected. Thus, the ruling concluded that the tournaments do not fall within a common usage definition of a wagering pool.
Lottery. Examining various authorities, the ruling concluded that, in general terms, a lottery is a scheme to distribute prizes to participants who pay to win the prize by chance. Because Net Games does not allow players of dissimilar skills to play in the same tournament and takes steps to minimize the element of chance in its tournament play, the ruling concluded that the tournament games lack the essential element of chance and cannot be classified as a lottery.
Information reporting applicable to Net Games. The ruling noted that Code Sec. 6041 generally requires reporting of all payments of $600 or more to another person made in the course of trade or business. Reportable payments include rent, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable gains, profits, and income. The returns used to report these payments are Forms 1096 and 1099. (Reg. § 1.6041-1(a)(2))
The ruling says that a player wins a prize by successfully competing in one of Net Games's sponsored tournaments, so the entry fee to that tournament is a return of capital. Therefore, the amount of the prize includible in gross income is the prize amount net of the fee. Accordingly, only net amounts are considered income under Code Sec. 6041 . Entry fees for tournaments where a player does not receive a prize, however, are not a return of capital, and cannot be subtracted by Net Games when determining the income paid to a player. Although it is possible that individual players may be entitled to deduct on their returns entry fees they paid to Net Games, the individual player must report all of his income and take all applicable deductions on his individual return. There is no authority allowing Net Games to effectively take a deduction on behalf of a player by reporting the net amount to IRS on a Form 1099.
RIA caution: IRS expressed no opinion as to whether a deduction is available or the character of any deduction. IRS could very well take the position that amounts spent on games that produce no winnings are nondeductible personal expenses. Since IRS already concluded that the games aren't wagering transactions, IRS presumably would not allow players to deduct fees paid to participate in games producing no winnings as gambling losses that could offset income from games in which a taxpayer received winnings or from winnings from actual wagering transactions. (Gambling losses are allowable as a miscellaneous itemized deduction (not subject to the 2% floor) but only to the extent of gambling winnings.)
Bottom line. The rulings say that Net Games should use the net method in determining which players it paid $600 or more during a year and use Form 1099-MISC to report the income.
RIA Research References: For reportable payments of $600 or more, see FTC 2d/FIN ¶ S-3656; United States Tax Reporter ¶ 60,414; TaxDesk ¶ 814,001; TG ¶ 60202.