Rakeback, taxes, and an argument for the IRS

[broiler]

The reason that the IRS doesn't send info to the Justice Department on illegal activities is the conflict that they would have with the Fifth Amendment. I think that there may be an old case about this, but that is a vague memory off of the top of my head. If the IRS gave tax return info to the Justice Dept., you would be able to claim Fifth Amendment rights and not file a tax return. The IRS has their own lawyers to try any cases resulting from tax return related issues in order to avoid any conflict.

[Tilt]

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Rake has already been deducted from your income. Rake back is income.

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I did not say that my proposed position was internally consistent with the spirit of the tax code. There are many instances where the treatment of income is inconsistent. Take the treatment of gambling winnings as income vs. gambling losses as an itemized deduction subject to the phaseout. That makes no sense from a transactional perspective. I think its possible that the transaction doctrine does not apply here.

[Tilt]

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Disclaimer: I am a CPA and have had 3 clients audited for online gambling in the last 5 years, two for sports betting and one for poker and sports betting.

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Thanks for weighing in. I apppreciate your perspective. I am a CFP who is trying to figure out how to handle my gambling winnings. I have consulted with a few CPA's that I work with in this business but there seem to be very few who have at this point actually interacted with the IRS on this particular point (namely volume rakeback discounts for online poker).

The attorney I consulted with has looked at the comps case and found it should not apply to rakeback that is classified as a rebate. She did not determine that rakeback is clearly excludable from income, only that it reasonable/arguably excludable. There is case law on the treatment of rebates that is favorable to taxpayers under similar situations. I caveat that with the statement that most of these cases are corporate taxpayers.

The question is not whether the IRS will agree with you, but whether it is arguable excludable or indeterminate. If audited I am sure I would just fork over the taxes for the rakeback rather than fight it. The real question is whether excluding it prior to an audit is reasonable or whether such an exclusion would be subject to penalty. If it is reasonable I would rather just exclude it and be aggressive.

[Tilt]

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If rakeback doesn't count as income, then rake doesn't count as a deduction, and you should pay tax on the full amount you made.

That is to say, if you win $10,000, but pay $6000 in rake, then your account balance only goes up by $4000. Feel free to pay tax on the full $10,000, since you think rake doesn't count.

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Let me put it another way. Gambling winnings have a definition. Rebates on goods and services have a definition. If I comply with both definitions then I am complying with the tax code. Those definitions do not have to be consistent with one another.

Also, I don't even have to be right for the strategy to be a good one. I only have to be arguably correct (i.e "have reasonable cause grounds").

It might not be a good idea, but its worth discussing/researching.

[broiler]

The IRS auditors that I have talked to consider the rake rebates to be a rebate in name only. Their opinion was that, since amount of play determined the size of the payment, rake rebate programs and bonuses are effectively the same thing. My research at the time led me to believe that the IRS would see comps, bonuses, and rake rebate as different names for the same thing. I think that the use of the word rebate in the description is what causes people to argue the taxability of the payment. The IRS looked at how the payment was generated at made their own assessment. The auditor stated that the company can call it a charitable donation or a grant, but that doesn't mean that you can get that kind of favorable tax treatment.

We weren't arguing the point with the IRS because the income was claimed on the tax return in question. Our goal was to try to see if we could get the income removed to lessen the audit change coming from other areas. We were trying to find a way to legally reduce the taxpayer's liability through a discussion of various grey areas. I will add that all 3 of the taxpayers were "fudging" on their taxes in different areas. We, as the CPAs referred by a tax attorney, were the middle man in the process.

I can tell you that my research found many corporate cases regarding rebates, but very little for individuals. This seems consistent with the tax attorney. I looked into the comps case because my gut feeling was that the IRS would use that as their guideline and I needed to be prepared for that.

I would agree that, under examination, it is much cheaper to pay the tax assessed when compared to the cost of attorneys and accountants to fight the change.

[Tilt]

Great info/background. Thanks. Posters like you are a reason for contributing to 2+2, despite the stream of snide idiots thrusting their e-penises as many did in this thread.

Based on your research/experience, do you think its "reasonable" to exclude the rakeback as a rebate? Or do you think the auditors would argue for penalties in an audit? The attorney and I suspect it is reasonable. In any case in my situation rakeback isn't likely to trigger a substantial underpayment penalty. What I wonder is whether an exclusion could be deemed a Sec 6701 abuse (or in your case aiding and abetting) violation. With no "on-point" reg, case or PLR I suspect it would not be.

[broiler]

You're welcome. I'm always up for a good discussion on tax related issues that pop up.

I don't think that the exclusion of this income would generate the substantial underpayment penalty. The IRS, in my experience, tends to look at that penalty in terms of tax impact of your position. Unfortunately, there is no solid rule on what any auditor will use as their magic number to assess such a penalty. The only cases that I can remember with these penalties involve outright fraudulent tax returns

I would add that the IRS is even more lenient on the preparer based penalties. The preparer based penalties seem to be held for preparers that do ridiculous things on tax returns. The only local cases that I can think of involve preparers that were using fraudulent deductions and documentation.

[MD2020]

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The reason that the IRS doesn't send info to the Justice Department on illegal activities is the conflict that they would have with the Fifth Amendment. I think that there may be an old case about this, but that is a vague memory off of the top of my head. If the IRS gave tax return info to the Justice Dept., you would be able to claim Fifth Amendment rights and not file a tax return. The IRS has their own lawyers to try any cases resulting from tax return related issues in order to avoid any conflict.

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Correct. The IRS is bound by the "silver platter" doctrine, which basically means that they can not give information to the local or state law enforcement agencies.

A quick Google search brings this up:

In 1952 Congress created a special tax, which acted like a trap for illegal gambling operators. Bookies who did not pay the tax were charged with tax evasion. Bookies who did were charged with violating federal anti-gambling laws. The U.S. Supreme Court knocked that out as a violation of the Fifth Amendment's protection against self-incrimination. So the Feds starting turning illegal operators, and their tax returns, over to state law enforcement agencies as if they were on a silver platter. In 1968 the U.S. Supreme Court said this maneuver also was unconstitutional.

http://rose.casinocitytimes.com/articles/14500.html

If you are running an illegal operation, like drugs or stolen property, you must report the income and pay taxes on it. But the IRS can't just fax your 1040 form to the cops and say "Hey, check out Joe Smith."

[Catt]

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Believe whatever you want, and pay your taxes accordingly.

I consider it income - I pay on everything I take from Neteller to my checking account. Makes it pretty simple for me.

Dogmeat [img]/images/graemlins/spade.gif[/img]

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That surely does make it simpler for you, but it doesn't make it correct. Whether your income (winnings, bonuses, rakeback) is kept at a poker site, at Neteller, or in your checking account doesn't affect its categorization as taxable income.

[david050173]

[ QUOTE ]

There's probably nothing specifically about rake rebates in the code. Therefore, there's probably room to argue that they fall into one of several existing categories. For example, when you get the 5th cup of coffee free, it's not earned income. So, I still think there's probably an argument that could be made.

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Yes you can make the argument. But if you look at the past cases for things like comps, airline miles, and the like it is pretty clear that you are not going to win. The arugment then comes do you have a good enough case to just have to pay taxes and not get major penalities (I think you still owe interest on underpayment no matter what but it has a been a while since I researched this). I have a feeling that will probably come down to scale. If you have 200K of rack back I have a feeling that is treated differently than if you had like 5k