I just receieved a notice from the IRS about self-employment tax

[Rainbow Warrior]

Did you read the links Lala gave - there's your answers

[ihate16]

I am not a poker player, and know about this area mostly from my experience as a Blackjack card-counter in B&M casinos, and also as an online bonus-hunter. But I find your post interesting, because I, and many other Blackjack card-counters, face the exact opposite problem: we file as professionals because, despite the self-employment tax, it is still much better than the alternative; and then we worry about whether the IRS will challenge our status as professionals.

I assume that your total winnings, that you reported on line 21, and your total losing sessions, that you deducted on schedule A, were both very large amounts; much larger than your $5500 net wins. If that is the case, then consider that if you do as the IRS requires you, and amend your return to file as a professional, this would have the following effects:

1. Since you would now be deducting your losing sessions on schedule C, if you don't have other large deductions you will no longer need to itemize, and will be able to take the standard deduction.

2. If you *do* have other large deductions, some of them are probably limited based on your AGI; with your losing sessions deducted on schedule C, your AGI will be much smaller, allowing you to increase some of your other deductions.

3. Depending on what state you live in, there may some limit on the size of your deductions, and you may not be able to deduct all of your losing sessions for your state income tax on schedule A; if you file schedule C, that will solve that problem.

4. As a professional you are entitled to open a SEP-IRA account, contribute 20% of your net profit into it, and get a tax-deduction on that contribution (to get that deduction for 2006, you would need to set up the account and make the contribution by April 15, 2007).

I am curious whether you've considered all of these advantages of filing as a professional, and whether they don't offset the need to pay self-employment tax.

The one serious drawback of filing as a professional is that the IRS may challenge your status, and claim you're a hobbyist. But in your case, since the IRS have already told you that they consider you a professional, that's not an issue.

[Poker CPA]

#4 is a BIGGIE and you can extend payment to October 15th, if you file an entension. And SS taxes, if your reaching retirement, can make a big difference. Way to go "Ihate16".

[Hans Gruber]

When I filed my taxes, I considered filing as a professional, but I was under the impression that the IRS would not let me do so, especially since 90% of my income does not come from poker. Can I still file as a professional if this is the case?

I am going to make substantially more money this year playing poker, so filing as a professional is something that I will more strongly consider next year. I will be having a CPA do my taxes for me next time as well.

[ihate16]

>When I filed my taxes, I considered filing as a professional, but I was under the impression that the IRS would not let me do so, especially since 90% of my income does not come from poker. Can I still file as a professional if this is the case?

No one knows the answer to that for sure. People do run small businesses of other types that give them a small amount of income, and still file schedule C; but there are no clear precedents on whether gamblers are allowed to do the same. There are many people who do file schedule C for small amounts of net gambling income relative to their main job; but so far there haven't been any precedent-setting decisions on whether they're actually allowed to do so.

In your case, however, it looks like the IRS have already told you their opinion; they think you should file as a professional. It's probably a good idea for you to consult a CPA before taking the next step; but from what you've told us, it looks like you have two options:

1. Write the IRS a letter stating that you disagree with their requirement for self-employment tax, and explaining why you consider yourself a hobbyist.

2. Comply with their requirement to pay self-employment tax. To do that you would need to file an amended return as a professional, including schedule C and schedule SE. In that case you might also want to open a SEP-IRA account, and deduct your contribution to it on your amended return. (Since you already files your 2006 return, you can't get an extension, so you'd need to make that contribution by April 15.)

Option 2 is what the IRS have asked you to do. If you can comply and end up with *less* total tax liability for 2006 than you had before, so you end up getting some money back from them - well, looks like that would clearly be your best option.

[Little_Luck]

It appears with #4 that it only applies if you have a gross of $25k or less and is only 10 pct for incomes 16-25k. Also, if you are a full-time student you don't qualify.

Yet, I am sure the IRS will still want me to pay SE tax even though I am a full-time student.

[gurgeh]

This sounds like an error at the IRS to me. I process dozens of returns a day, and am more than familiar with the rules as they pertain to gambling winnings on line 21. Did you have any other income on line 21 other than from poker, or did you claim any poker-related deductions besides losses (travel, meals, utilities, etc.)?

[Wongboy]

You might want to consider not fighting them on this. Since they think that you are a professional gambler, you should be able to file a schedule C which will allow you to effectively net your winning and losing sessions on the same line in the 1040 (this may be huge for you and definately will become huge as your income rises and you start to lose itemized deductions). In addition, as others have mentioned, you should be able to deduct a decent amount of business expenses.

I also recommend contacting a CPA before you respond to the IRS. Their interpretation may save you $$ now and definately will save you $$ in the future. You may not want to fight them on this point.

For example, if you bought a computer or monitor that you use in your poker business, then you can write off the full cost under IRS code section 179 (I believe the limitation is $25K). In addition, any place of business needs an office, and since you are self employed, you should be able to take a home office deduction. Internet access is a reasonable and necessary expense for any internet related business (obviously). Since your business presumably includes both online and live play, you also have travel costs to get to poker rooms. After all, they are a place of business for any poker pro.

Self employment tax is only for businesses, not hobbies, right? In other words, you could have a net loss from your business that will offset your ordinary income (for this reason, the IRS usually tries to classify activities as hobbies instead of businesses). If you really only netted $5,500, then your net income after expenses may well be close to zero.

[Parlay Slow]

My understanding was the IRS is happy to not have you file as a professional. After all there were many legal battles to get the RIGHT to file as a professional gambler. Is it possible that the IRS can force you to file as a professional?

[Hans Gruber]

[ QUOTE ]
This sounds like an error at the IRS to me. I process dozens of returns a day, and am more than familiar with the rules as they pertain to gambling winnings on line 21. Did you have any other income on line 21 other than from poker, or did you claim any poker-related deductions besides losses (travel, meals, utilities, etc.)?

[/ QUOTE ]

Nope, my line 21 was strictly poker gross winnings, and my deductions were strictly poker gross losses.

I ended up sending them a letter outlining my situation. Perhaps this was the wrong thing to do, since it may be better for me in the long run to file as a professional. But let's face it, I'm not a poker pro. I'm a software developer who occasionally plays poker in his spare time.

We'll see what they say.