Taxes, Slots, and the Foreign Businessperson

ImageYesterday, the Court of Appeals for the D.C. Circuit made life a little easier for foreigners who come to the U.S., gamble, and lose. It held in Park v. Commissioner that a nonresident alien (that is, non-citizens who do not live in the U.S.) can deduct gambling losses against gambling gains from the same gambling session in determining her U.S. tax. This conclusion is certainly fair and administrable. But it is also wrong. 

There’s no dispute about what happened: when Sang Park, a South Korean businessman, came to the U.S. on business, he also visited casinos, played slots, and lost a fair amount of money doing so.

The tax code has historically looked unfavorably, at best, on gambling. A U.S. taxpayer who is not a professional gambler can only deduct her gambling losses to the extent  she has gambling gains in the same gambling session. Imagine, for example, Amy, a U.S. resident, goes to Vegas for a professional conference. While there, she plays blackjack. She wins $100 early in the night, but, as soon as she hits $100, she starts losing. By the time she goes back to her room, she has lost not only the $100 she won, but an additional $400. For tax purposes, she can only deduct $100; that $100 offsets her $100 winnings, and she ends the night with no tax bill, but is nonetheless $400 out of pocket.[fn1] She can’t deduct that $400, even if, say, she sells 5 shares of Google stock for a gain of $400.


Until yesterday’s holding, the result would be radically different for Mr. Park. He would owe taxes on the $100 and would be unable to offset it, even though he ended up in the hole by $400.

To understand why, we need (ever so briefly) to look at how nonresident aliens are taxed by the U.S.[fn2] Essentially, there are two possible tax regimes that apply to them. Under section 871(b), they pay taxes at U.S. rates on their net business income from U.S. sources. Under 871(a), on the other hand, applies to their non-business income (including income from recreational gambling). Under 871(a), they pay a flat 30% tax on their gross non-business income from U.S. sources.

I repeat: for non-business income, nonresident aliens pay 30% of their gross income.

Generally, that’s not much of an issue: a taxpayer would have negligible expenses related to the collection of interest and dividends, especially where that income was passive portfolio income.[fn3]

So how did the court come to its conclusion? It bases its holding primarily on three things: (1) that the rule treats foreigners differently than U.S. taxpayers, (2) that gambling “gains” are defined elsewhere in the Code as being net of losses from the same session, and (3) for administrability purposes. But the court is reasoning is deficient in all three counts.

 The court is clearly correct, of course, that the Code treats U.S. and foreign gamblers differently: U.S. gamblers can net their gambling losses against their gains. But so what? The tax law deliberately treats U.S. taxpayers differently than nonresident aliens in all sorts of ways. U.S. taxpayers don’t pay a flat tax on their gross passive income, U.S. taxpayers aren’t (generally) subject to withholding upon their receipt of passive income, U.S. taxpayers are subject to tax on not only their U.S.-source, but their worldwide, income. It is perfectly acceptable–and, in fact, common–for U.S. taxpayers to face different tax consequences than non-U.S. taxpayers. That’s the way the law is written, whether the income is from gambling or not.

Still, the court says, the idea of gambling “gains” is referenced in section 165(d), and there it means gambling gains less losses.

Except it doesn’t. What it does say is that a deduction for losses from gambling will be allowed only to the extent of gains from gambling (and the IRS has interpreted this to mean gains and losses from the same gambling session). The gains, then, are gross, not net. To net the losses from the gains, a taxpayer has to be allowed to take section 165 deductions. But section 165 if not available to nonresident aliens with passive U.S.-source income; a nonresident alien is subject to the 30% tax on the “amount received.” And Mr. Park clearly received his winnings from the slot machines, even if he decided to immediately put them back into the machine.[fn4]

Finally, that administrability issue: it has existed before, and Congress has dealt with it. Under section 871(j), Congress said that nonresident aliens would not owe taxes on winnings from blackjack, baccarat, craps, roulette, or big-6 wheel.[fn5] It may have exempted these table games because it was administratively infeasible to tax them.

It may be that taxing Mr. Park on his winnings, without letting him offset those winnings with his losses, is normatively the wrong way to impose a tax. The Court of Appeal’s choice–to tax only on net winnings from a gambling session–certainly feels fairer, and mirrors the taxation of U.S. taxpayers.

But it’s not the law. And, if it should be the law, it’s within the bailiwick of Congress, not the Court of Appeals for the D.C. Circuit, to change.[fn6]   

[fn1] If, on the other hand, she lost $100, but won $500 for the night, she could deduct the $100 of losses against her $500 of gains, and would only be taxable on her $400 net gain.

[fn2] Note that the following description, while accurate, is simplified.

[fn3] The big exception, of course, might be capital gains. But there our nonresident alien is even safer: under the U.S. tax law, her capital gains are treated as foreign-source income–even where they arise from the sale of stock of a U.S. corporation–so she doesn’t need to net her losses against her gains.

[fn4] This is important: his further gambling represented consumption. There’d be no argument that, had he taken his winnings and spent them on wine, on hotel rooms, on a vacation, or on any other non-gambling consumption, that he should be able to net the cost against his gambling winnings.

[fn5] And what is big-6 wheel? No idea.

[fn6] The I.R.S. has the option, of course–which it should take–of nonacquiescence, of following the decision only with respect to Mr. Park.

2 thoughts on “Taxes, Slots, and the Foreign Businessperson

  1. How do you respond to this remark in IRS Office of Chief Counsel Memorandum AM2008-11?

    “We think that the fluctuating wins and losses left in play are not accessions to
    wealth until the taxpayer redeems her tokens and can definitively calculate the amount
    above or below basis (the wager) realized.”

    It seems that by applying the “accession to wealth” standard to realize a “gain” under 871(a), then a nonresident slot machine player would not realize gambling income until after the player redeems his tokens or slot machine ticket. This suggests a per-session method over the per-bet method.

    Are you suggesting fluctuating wins and losses left in play are accessions to wealth? Or is another standard to realize a “gain” from gambling activity under 871(a) more appropriate?

  2. Brad, a couple thoughts on that: first, it’s in the context of “transactions,” which aren’t relevant to nonresident aliens.

    That said, I think the IRS is clearly wrong, at least with respect to slots. When tokens come out of the machine, the gambler has, not money, but property with value. She can use it to play the same slot machine, or a different slot machine. She might even be able to use it to buy a drink or, at least, tip a waiter (though the last time I was in a casino, I wasn’t 21, so I don’t know for sure). Even if not, she has an accession to wealth: she has received something of value that she can use to fund consumption.

    I assume it gets tricker with, e.g., poker (though, again, most of what I know about poker is from that old Mel Gibson movie). Is a poker game done at each hand, or does it run over the course of a number of hands? or does it end when you grab your chips and leave? It seems to me that that’s part of the reason why Congress just exempted table games (though it left poker as taxable, so the question’s still there).

    As a policy matter, the court’s opinion might be right; as a legal matter, though, Barba came to the right conclusion (even as the DC Circuit tries to argue it’s not disagreeing with Barba).

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