Taxation of Gambling
This installment of our Tax and Vice blog series will discuss the tax treatment of cancelled debts. I will use a recent California Appeals case (Tak Chun Gaming Promotion v. Long) to illustrate the potential tax consequences when a gambling debt or any debt gets cancelled or there is a so called cancellation of debt income. Learn more about the taxation of gambling and cancellation of debt.
The Tak Chun case is an instant classic that sounds like something from the Hangover movie franchise. According to the court’s opinion, an Arcadia man named Kevin Long borrowed about $11 million US dollars to gamble in casinos in Macau. The court writes he only paid back about $1.7 million of the loan. Tak Chun Gaming sued Long in the California courts to recoup the debt. The California courts dismissed the case because of a long-standing common law rule that California courts generally do not enforce gambling debts. * So, in short, Kevin Long got to gamble over $9 million of the house’s money and walked away scott free…. or did he.
As much as we would want to buy Mr. Long a beer, his storied victory in court may have potential tax ramifications. As a general rule, when a person’s debt is cancelled, they recognize income. To illustrate this principle, let us assume I buy $100 of groceries on my credit card. I borrowed $100 from my bank to purchase my groceries incurring a $100 debt. My bank transmits $100 (less some fees) to the grocery store. I did not recognize $100 of income because although I got $100 of groceries, I have an obligation to pay my bank $100.
Now let us say for one reason or another the credit card company forgives or cancels my debt. I got to borrow $100 and receive $100 of groceries, but no longer have to pay back the $100. I may now have to now pay tax on that $100 of groceries I received.
Likewise, Mr. Long received $11 million in gambling tokens. He did not receive taxable income at the time he received the tokens because he had an obligation to pay an $11 million debt. Now that the debt was cancelled, he may have to pay income tax on at least a portion of that cancelled debt.
There are some exceptions to the cancelled debt rule. Debts discharged in bankruptcies, cancelled debts of insolvent taxpayers, and certain cancelled home mortgages may not be subject to tax. Perhaps Mr. Long may be able to take advantage of some of these exceptions.
At RJS LAW, we help clients with tax audits and related problems of every kind. In addition, we advise clients with taxation of gambling issues, estate planning, probate, domestic, and international tax planning. Call us at 619-595-1655 for a free consultation if you have a tax problem or would like to discuss tax and estate planning to avoid tax issues.
* Before you run off to Vegas and max out your credit cards to see if you can repeat Mr. Long’s exploits, you should be aware there are exceptions to the general rule that California does not enforce gambling debts. Casinos and others who lend money know these exceptions and are going to protect themselves better than did Tak Chun Gaming. And you will probably not fare as well as Mr. Long did if you attempt to replicate his exploits. So please, borrow and play responsibly!
Written by Joseph Cole, Esq., LL.M.