Are non-resident aliens who receive gambling winnings while visiting the U.S. able to deduct the gambling expenses incurred in earning the gambling winnings? And can they avoid the withholding tax on their gambling winnings? The court addresses these international tax law issues in Park v. Commissioner, 136 T.C. 569 (T.C. 2011).
Facts & Procedural History
The taxpayers are South Koreans who visited California for vacation. Taxpayer-husband frequented a casino during these trips to play the slot machines.
He won 138 slot machine jackpots that totaled $431,658. The casino withheld $30,480 from the winnings. The casino’s records showed that taxpayer-husband had losses in excess of his winnings.
The taxpayers returns did not report the gambling income or expenses. But the casino reported the winnings to the IRS on a W-2G, Certain Gambling Winnings.
The IRS audited the taxpayers return and made adjustments for the gambling income.
Tax on Gambling Winnings
The general rule is that gambling winnings are subject to income tax. This includes winnings from slot machines. Gambling income is offset by deductions for expenses incurred to obtain the winnings. This includes the cost of lost bets.
The Rules for Non-Resident Aliens
The rules for gambling winnings received by non-resident aliens are different. Nonresident aliens are not able to offset gambling income with gambling expenses. Thus, they are taxed on the gross gambling winnings.
For nonresident aliens, gambling winnings are subject to a 30% withholding tax. This amount is withheld by the casino before being paid to the non-resident alien.
This limit on gambling expenses and the requirement to make withholding applies unless the nonresident alien is a professional gambler, i.e., his gambling activity is significant enough that it rises to the level of being a business rather than a hobby.
But What About the Tax Treaty?
Some U.S.-tax treaties exempt gambling income from tax in the U.S. The applicable treaty is the U.S.-South Korea income tax treaty in this case.
As noted by the court:
The U.S.-Korea income tax treaty does not establish an exemption from tax for South Korean residents with respect to U.S. gambling income, and there is no provision permitting South Korean residents to deduct gambling losses or to otherwise net gambling losses against gambling winnings.
Given that the treaty does not address gambling winnings, the court concluded that the winnings are subject to income tax in the U.S., there is no offset for gambling expenses, and the withholding tax must be made on the winnings.
Most Favored Nation Treaty
But the taxpayers did not argue these points. Instead, they pointed to the U.S.’s other treaty with South Korea which grants most favored nation status on South Korea.
Most favored nation status gives citizens of the other country the most favorable treatment given the treatment provided for in other U.S. treaties with other countries. Put another way, it gives citizens of these favored countries the best deal out there when comparing all treaties that are in force with every other country.
The court considered the U.S.-Japan Tax Treaty, which exempts U.S. gambling winnings for Japanese citizens. Under this treaty, Japan citizens do not pay tax on U.S. gambling winnings if Japan has a similar rule. The treaty requires reciprocity.
But South Korea does not have a similar rule whereby U.S. citizens are not subject to tax on gambling winnings in South Korea. Given the absence of such a rule, the court concluded that the most favored nation treaty did not afford the taxpayers an exemption from U.S. withholding or the allowance of gambling expenses to offset gambling income.
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