Hidden Gambling Tax Hits Retirees Hard
Gambling losses do not impact your tax return nearly as much as gambling winnings. Losses only partially offset the tax effects of gambling winnings.
If you’re a regular gambler in retirement, this means your fun can cost you thousands more in taxes and increased Medicare Part B premiums each and every year. I call this the hidden gambling tax.
Even a win of a few thousand can have unintended effects, costing you more in taxes than what you won – even if you have gambling losses to offset it.
Let’s take a look at how gambling winnings and losses impact the rest of your tax return by going through these four steps:
- Required reporting
- Treatment of gambling losses versus gains
- How gambling winnings affect your modified adjusted gross income
- How an increased modified adjusted gross income causes you to pay more tax
Required Reporting of Gambling Winnings
Casinos are required to report gambling winnings if they exceed a certain limit ($1,200 of slot machine winnings for example). Gambling winnings get reported on the first page of your tax return on line 21.
What amount of gambling winning must be reported? The IRS says all gambling winnings must be reported on your tax return, and if amounts exceed limits below they are reported on Form W-2G:
- $1,200 or more at a slot machine or bingo game (amount not reduced by the amount of your wager)
- $1,500 or more in keno winnings (amount can be reduced by the amount of your wager)
- $5,000 or more in poker tournament winnings (amount can be reduced by the amount of your wager)
- $600 or more on betting if that is at least 300 times your bet (amount can be reduced by the amount of your wager)
Treatment of Gambling Losses vs. Gains
Once you report gambling winnings, you can also then report gambling losses. Gambling losses get claimed as an itemized deduction, in section 28 in “Other Miscellaneous Deductions”. You are only allowed to claim losses up to the amount of winnings.
This means if the casino reports $50,000 of winnings, but throughout the year you gambled a total of $60,000, winning back $50,000 but losing $10,000, you can’t claim that $10,000 loss on your tax return.
In order to claim losses, you must keep gambling records and receipts.
Yes, you do get to deduct the losses so you don’t pay income taxes on the winnings, but that is only part of the story. The rest of the story has to do with how gambling winnings affect your Modified Adjusted Gross Income (MAGI).
How Gambling Winnings Affect Your MAGI
As gambling winnings are reported via the first page of your tax return (with total winnings being reported before they are offset by losses) this has the effect of increasing your MAGI. Your MAGI is calculated before you get the benefit of reducing it by any itemized deductions such as gambling losses. So gambling winnings increase your MAGI – even if you didn’t actually win anything when comparing winnings to losses.
Other tax calculations are compared to your MAGI to determine whether you pay more tax in other areas or lose out on some deductions. An increased MAGI can mean you pay more in other areas and/or lose out on some deductions.
How MAGI Affects Other Tax-Related Items
Here are some of the items that MAGI affects:
- Your eligibility to make a Roth IRA contribution (or deductible IRA contribution if you are also a participant in a company sponsored retirement plan). Too much MAGI and you are not eligible to make a Roth IRA contribution.
- The amount of your Social Security benefits subject to taxation. A larger MAGI means more of your Social Security can be included as taxable income.
- The amount of Medicare Part B premiums that you pay. Too much MAGI and you will pay a larger Medicare Part B premium.
- Phaseouts of exemptions and itemized deductions. Higher MAGI means you may lose some of your exemptions and deductions.
- Applicability of the 3.8% Medicare surtax on investment income. If your MAGI is high enough, you will pay an additional tax on investment income.
- Your eligibility for a tax credit/subsidy for the purpose of purchasing health insurance. If your MAGI remains low enough you may qualify for a tax credit. Gambling winnings could make you ineligible for this.
Let’s take a look at an example of how gambling winnings affected some of the items above for one retired man in his early 70’s.
Example of the Gambling Tax in Retirement
David (name changed for privacy) is in his early 70s and lost his wife many years ago. He still works part-time in his business which is now primarily run by his son, and by the looks of his tax return, I am guessing he spends the rest of his time at the local casino.
Why would I guess this?
Last year he reported over $550,000 of gambling winnings on his tax return. Lucky guy, right? Not really. He reported the same amount in losses.
David’s MAGI would have been less than $80,000 without gambling. Instead, it was over $630,000. Rather than paying Medicare Part B premiums at $105 a month he’ll be paying $335 a month; an increase of $2,760 per year. In 2013 this MAGI level caused him to lose about $11,400 of his itemized deductions, costing him another $2,850 in taxes (at the 25% marginal rate).
Even if his gambling habit is a wash, it will be costing David thousands extra each year in taxes. This hidden gambling tax can affect both lower income and higher income retirees but in different ways.
- For lower-income retirees, a hidden gambling tax can occur because increased MAGI increases the amount of your Social Security benefits subject to taxation and reduces your eligibility for a tax credit on health insurance.
- For higher-income retirees, the hidden gambling tax may come in the form of a loss of deductions due to the phaseout limits, increased Medicare Part B premiums, and/or the applicability of the 3.8% Medicare surtax on investment income.
Keep in mind, a well-designed withdrawal strategy in retirement can help make sure you don’t pay any more taxes than you have to – but one trip to the casino can throw the plan off track.
Gambling can be fun, but it may come with a hidden tax that can hit retirees hard. Here's how gambling affects your tax return in retirement.
Lottery winnings won’t affect Social Security benefit: Ask the expert
Matt Olver, portfolio manager, Spero-Smith Investment Advisers Inc., Beachwood
Credentials: Certified financial planner
Experience: 12 years
Assets under management: $280 million
As told to Plain Dealer reporter Teresa Dixon Murray
Q. If someone wins the lottery (like a lot of money), does that affect his Social Security for that year?
A: In this very difficult economic environment, it is a nice change of pace to answer such an optimistic question — although we remind clients that planning to win the lottery is not a good retirement planning strategy!
Generally, if you are receiving Social Security retirement benefits before you reach your full retirement age (66 for current retirees), then your benefit will be reduced to offset earned income above a certain limit. Note that we’re talking about earned income.
Currently, the annual earned income limit is $14,160 in the years before your full retirement age and $37,680 in the year of your full retirement age, with no limit on earnings beginning in the month you reach your full retirement age.
Wages and net earnings from self-employment are considered earned income, but lottery winnings are not earned income. As a result, your Social Security retirement benefit would not be affected, either now or in the future. However, there are other consequences.
While lottery winnings will not reduce your benefit, they are fully taxable and must be reported on your income tax return (line 21 of your 1040).
Besides that, there are other potential effects. First, lottery winnings could influence the taxation of your Social Security benefit. If the total of half of your benefits and all your other income added together is more than $34,000 for single filers ($44,000 if you are married, filing jointly), then up to 85 percent of your benefit becomes taxable. On the other hand, none of your benefit is taxable if this amount is below $25,000 for single filers ($32,000 for married, filing jointly).
Lottery winnings could also impact other tax deductions, exemptions or credits that are based on your adjusted gross income. These include, but are by no means limited to, the deductibility of medical costs and education expenses, your overall itemized deductions, your personal exemptions, the tax credit for the elderly and the child tax credit.
Hitting the lottery jackpot could also affect your Medicare Part B monthly premium. The standard premium amount is $96.40 for single filers with total incomes below $85,000 ($170,000 if married, filing jointly). However, your monthly premium will jump to $308.30 in the following year if your income is above $213,000 ($426,000 married, filing jointly).
Finally, they could essentially eliminate any eligibility for needs-based government assistance, like Supplemental Security Income, which is for disabled individuals and/or people over 65 with very limited financial resources.
If you’re fortunate enough to have a lottery windfall, I encourage you to assemble a team of qualified professionals (attorney, accountant, financial planner, insurance agent) before you claim your prize. They can be very helpful in addressing the tax, estate and other implications of winning a lot of money and developing a strategy for spending and investing it wisely.
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Lottery winnings won’t affect Social Security benefit: Ask the expert Matt Olver, portfolio manager, Spero-Smith Investment Advisers Inc., Beachwood Credentials: Certified financial planner