When Tax Changes Are Implemented, It Impacts Everything

The fact that so many gambling books and commodities are sold leads me to conclude that the number of people who gamble for enjoyment much outnumbers those who gamble professionally. (By “professional gambler,” I mean people who are authorized to file their taxes as “professional gamblers” because they meet the Internal Revenue Service’s strict requirements.) 

Many of us bet for fun, but others of us prefer to play games where we have an advantage over the casino. In other words, we don’t play any games in which the house has a big edge. We don’t want to bet until there’s a decent possibility we’ll get more than 100% of our money back, taking into consideration both the odds of winning the game and the casino’s incentives. 

The new federal tax law, formally known as the Tax Cuts and Jobs Act of 2017, went into effect for tax years beginning in 2018, making it far more difficult for inexperienced gamblers to gain an advantage over the house. Since the standard deduction has been increased and a new cap on the amount of state, local, and property taxes that can be deducted has been imposed, it is now much more difficult to deduct gaming losses. This completely changed the situation! 

(Before we continue, I’d like to emphasize that the material provided here is not intended to be tax advice. The following are merely the gambling-related musings of an average player who is not a professional gambler and was surprised by the results after conducting some study.) 

Assume for a moment that you live in Southern California. You are married but do not have any children; you work during the day and enjoy visiting Las Vegas on occasion to gamble. You should only wager when you believe you have a good probability of winning. You only play Full Pay Deuces Wild video poker, which is regarded as the best game of its sort in the area by vpFREE2. In Las Vegas, the highest denomination available costs $1.25 each hand and has a payout ratio of 100.76 percent. Also, assume you play the game correctly and don’t make any strategic errors. You’d earn 0.95 cents per hand. Right? 

This is because both the federal and state governments want a cut of your earnings while caring nothing about your losses. (After all, they regard gambling to be an evil act.) (How could they possibly want to subsidize something like that?) We need to understand your taxes better to grasp this. 

Assume you have no other sources of income except your wage and your spouse’s salary, which bring in a total of $130,000 every year. Assume you and your spouse file jointly and your only income taxes are those imposed by the federal government and the state of California. For the sake of simplicity, I’ll also assume that you have no changes to your income, tax credits, the alternative minimum tax, or any of those other things.

If you don’t donate thousands of dollars to charity every year, have big medical expenditures, or have already won and lost a significant amount of money through the gambling this year, your situation may be quite identical to the one I’m attempting to illustrate here. However, if any of them apply to you, your situation is likely to be considerably different from the one I’m describing here. Even if you do not qualify for such remarkable deductions, much of what I will discuss in the following paragraphs may still apply to you, albeit with some changes. 

Let’s go over your state of California taxes quickly. Using the state of California’s published tax rates, you would be eligible for a personal exemption of $244 and a standard deduction of $9074, bringing your total taxable income to $120,682. In California, your tax liability would be $5560, with an effective marginal tax rate of 9.3 percent. (The figures for 2020 would be identical, with just a few modest adjustments to account for inflation.) 

Remember that this is the marginal tax rate. It has a big impact on the decisions you make when gambling. This means that California will seek 9.3 cents of your extra income for every dollar you earn. 

Your federal taxes will come next. For tax years beginning in 2018 and thereafter, the federal tax regulations will be drastically altered. For the year 2019, the new tax legislation in the United States provides each taxpayer a standard deduction of $24,400, which is much more than in previous years. Personal exemptions, however, are no longer possible. 

Given the facts of our example, it would be wiser to take the standard deduction rather than try to lower your tax burden by itemizing your expenses. Only if you itemize your deductions will you be able to deduct the $5,560 in California state taxes you paid. (Even if you pay significantly more in state and local taxes, the new federal tax legislation allows you to deduct only up to $10,000 in local taxes.) According to the IRS data for 2019, your marginal tax rate would be 22%, your federal taxable income would be $105,600, and your federal tax would be $14,949. Your federal taxable income would be $130,000 less $24,400, or $105,600. Keep in mind that the current proportion is 22 percent. This means that the IRS expects you to pay 22 cents more in taxes for every dollar you earn. 

Let’s go down to business, shall we? You’re visiting Las Vegas for the first time this year. You find your favorite Full Pay Deuces Wild slot machine and take a seat. You decide to play only one hand. What are your genuine expectations of yourself? 

If you win at gambling and keep some of your winnings, the amount of money liable to taxation will rise. If you gamble and lose money, you will incur gambling losses; nevertheless, this will not reduce your tax liability. This is because you must experience a considerable loss from gambling before it is advantageous to itemize deductions rather than take the standard deduction. Because the standard deduction is $24,400, if you itemize your deductions instead of taking the standard deduction, you will only be able to deduct $5,560 in state taxes.

If you wish to take advantage of the itemized deductions, you must have a total gambling loss equal to the difference between those two figures, which is $18,840. However, this is insufficient. According to the Internal Revenue Service, “you CAN NOT deduct more than the amount of gaming income you provide on your return” for gambling losses. As a result, you’ll need at least $18,840 in gaming winnings and $18,840 in gambling losses for the full year. You’ve most likely been in such a situation, but getting there required a large amount of risk-taking on your part. Even if you find yourself in this situation, the following dialogues may still apply to you, albeit with some variations. 

Let’s have a look at the actual statistics for your favorite game. I used the Wizard of Odds Video Poker Strategy Maker to calculate the chances of getting a great hand when playing Full Pay Deuces Wild. If we exclude taxes, the total return is 1.007620. As a result, it is a game with a payout rate of 100.7620 percent, and you may expect to have a 0.7620 percent lead over the casino. 

When taxes are put into the equation, however, a quite different picture emerges. Because the state and federal governments demand $312.61 of your winnings, the Natural Royal Flush prize has been lowered from $998.75 to $686.14 (4000 coins of 25 cents minus your original stake of $1.25). The same can be stated for the Four Deuces, which have been reduced in value from $248.75 to $170.89. This extends down to the Straight, which would be worth 86 cents rather than $1.25 if purchased separately. However, taxes do not affect the outcomes of the pay table’s lower-paying combinations. For example, if you win a Three of a Kind and get your investment back, you haven’t won anything and your gambling revenue is zero. If you don’t win a hand and wind up losing the $1.25 you started with, your taxes won’t change because you can’t deduct gambling losses from your taxable income. 

Considering the possibilities, there is a 55% probability that you will be unable to make a hand, in which case the loss will be entirely yours. In 28.7 percent of the hands you played, you would tie. If you played any of the other 17 percent of the games, you could walk away with anything, but the governments want their cut. 

After counting up all of the revised victories, I discovered that instead of having a 0.76 percent advantage, you can expect to lose 16.59 percent of the time. The odds are worse than the disastrous tie bet in baccarat, and they are three times worse than the double-zero roulette. (Those bets remain weak, and they become even more problematic when the impact of the asymmetrical taxation that I just discussed is included.) You wouldn’t even consider playing a game in which you expect to lose 16.59 percent of your initial wager, would you? 

You may have thought you had a 0.76 percent lead, but your opponent has a 16.59 percent advantage over you. The casino has no benefit either, as it expects to lose 0.76 percent of its revenue as a result of its faultless performance. The governments hold the upper hand in this circumstance! Even if we exclude the taxes that the casino would incur if and when it wins your money, the state and federal governments still have a 17 percent edge in this bet. 

Close readers will have picked up on a fault in my logic above. Although we were only able to compute the edge for a single wager, you will not be taxed on each bet you place. Instead, you will be taxed on a per-session basis, which may involve many wagers. When you make a large number of bets, the range of possible outcomes narrows, and the mathematical variance (about the total amount of money at risk) falls to a lower, more manageable level. 

Assume, for argument, that you put not one, but two bets. You would lose both of your wagers roughly one-third of the time. In 31% of circumstances, you’d lose one of your two bets and get the other back with a Three of a Kind, losing half of your total wager in the process. At other times, you either lost everything or won everything. As a result of this move, the total amount of money you stand to lose will be lower on average. If you experience a total loss, you will be responsible for making up the difference on your own (that is, you will not be able to reduce your tax liability as a result of the loss). According to my estimates, playing two hands reduces the projected loss from 16.59 percent of your total stake for one hand to 13.71 percent of your whole stake for two hands. When the figures are added up, playing two hands results in a lesser predicted loss. 

By increasing the number of hands played during a session, the anticipated loss can be reduced even further. Playing ten hands results in a 7.26 percent loss, fifty hands results in a 3.68 percent loss, and one hundred hands result in a 2.71 percent loss. Even if you play a thousand hands, you should expect to lose 0.92 percent of your total wager, according to my calculations. 

Because I only had a limited amount of time, my computations had to be finished promptly. If you play a certain number of hands in a session, you may gain an advantage over the other players after a certain number of hands. However, the statistics I’ve provided above should be eye-opening. (If you pay a higher tax rate, they will be much more difficult for you.) 

Let’s go over them again: you planned to play a thousand hands of Full Pay Deuces Wild in one session. You expected to be needed to deposit a total wager of $1250, to win $9.52, and for the government to retain a percentage of that sum. You were under the assumption that you still had a sense of hope. However, when your taxes are properly calculated, even if you play flawlessly, the true expectation is that you will lose $11.50 during your thousand-hand session. If the casino does not provide you with a significant number of comps for your play, you should avoid gaming. ( I’ll never understand why a casino would provide a game with a 0.76 percent edge against them and then offer comp gamers an additional 0.92 percent on top of that, but I suppose it’s feasible if there’s an unbelievable deal. If you come across such a game, proceed with caution and make sure you appropriately assess the value of any bonuses. They’re giving away a car, but the winner will also have to pay taxes on it! 

Can you expect to make money from gambling if you already have a well-paying day job and don’t file your taxes as a professional gambler in light of the most recent tax law changes? Yes, but only if you have a considerable advantage over your competitors or if you have something to compensate for your losses (such as a voucher or a past win): 

You get free play because of a voucher, and there are no requirements that you wager any of your own money (like some of the coupons that can be found in the Las Vegas Advisor or the American Casino Guide). You have a significant edge because there is no possibility of winning. 

You have a matchplay coupon, right? To decide whether or not it is worthwhile to play the game given that you would be wagering some of your own money, you must make certain calculations based on your marginal tax rates. Match play coupons usually provide a big advantage over the casino, so it may be advantageous to play if your total marginal tax rate is not too high. This is because these coupons give the player an advantage over the house. 

You’ve already won more money than you’ve lost in this session as a result of redeeming a voucher or utilizing free play? Because losses can now be deducted from your taxes until you conclude your gambling session, you can play any game while you are still in the black, even if you have a theoretical advantage. However, you should not continue playing if you lose the money you previously gained or if your gaming session comes to an end. 

Last but not least, a tax-adjusted technique may perform slightly better than commonly available options (which do not account for taxes): If you alter your strategy and reduce the number of hands that end in no payment, you may be able to reduce your expected loss. I don’t have the tools to calculate such a strategy for an extended session, but we can accomplish it for a single wager using the Wizard of Odds calculator. If I entered the tax-adjusted return for each wager into the calculator (using the tax scenario indicated in the previous paragraph), the calculated strategy would have a predicted loss of 16.58 percent rather than 16.59 percent. Someone like me could try to design an optimal strategy for a multi-bet session, but in my opinion, the longer the session, the closer such a strategy would be to a method that is widely available to the general public. 

If you have other sources of income and are not filing your taxes as a professional gambler, you must understand your taxes and take into account your marginal tax rates to decide if you have any in the gaming industry. This was the key point I attempted to make in this post. The significance of this cannot be emphasized because itemizing deductions are no longer nearly as beneficial as they once were.