Gamblers Face Tax Liabilities on Phantom Income

THE TREATMENT OF GAMBLING LOSSES UNDER THE OBBBA
Gamblers Face Tax Liabilities on Phantom Income

Under Code section 61, gambling income is fully taxable. It has been forever. Code section 165(d) controls the extent to which gambling losses are deductible. The law currently provides that gambling losses “shall be allowed only to the extent of gains” from gambling transactions. IRC §165(d).

To illustrate this, suppose one has gambling winnings of $10,000 in a year, and gambling losses of $8,000. At that, taxable gambling income is limited to the $2,000 difference. Now suppose one incurs $11,000 of losses against $10,000 of winnings. In that case, there is no taxable income, as the losses offset the gains. However, the remaining $1,000 loss is not deductible.

That will change under a provision of the One Big Beautiful Bill Act (OBBBA). An amendment was made to section 165(d) that further limits the deductibility of gambling losses. The new law, effective January 1, 2026, adds an additional layer of limitation to the deductibility of gambling losses. The amendment provides that not only are losses limited to gains, but they are further limited to “90 percent of the amount of losses during” the tax year in question. IRC §165(d)(1)(A), as amended.

To illustrate, suppose you have $10,000 of winnings against $10,000 of losses. Under the new law you’ll be able to deduct only $9,000 of the losses. In that case, you’ll have to recognize $1,000 of income, even though you just broke even on your winnings and losses over the course of the year.

Even worse, if your total losses exceed income, you could still end up owing money. Suppose you have $10,000 of income and $11,000 of losses. Under the new section 165(d)(1)(A), you’re allowed just 90 percent of gambling losses, which is $9,900. Since you are allowed to deduct losses only to the extent of income, you would have to pay taxes on $100 of income, even though you actually had a net loss over the course of the year.

Both of these scenarios illustrate that even in the cases of break-even or loss scenarios, one could very well end up paying taxes on phantom income. Apparently, Congress is attempting to balance the budget on the backs of gamblers.

On the other hand, OBBBA made a positive change to the information reporting requirements for slot machine operators. Current law requires that any slot jackpot of $1,200 or more must be reported to the IRS on form W2G. This has been the threshold since 1977. Gambling organizations urged Congress to increase the threshold substantially because the $1,200 amount has not kept pace with inflation. Proposals were introduced in Congress for years to push the threshold to $5,000, but they consistently failed.

A provision of the OBBBA amended section 6041 of the Code, pushing the threshold to $2,000. This is a far cry from the $5,000 statutory floor that was proposed in the past, but it is nevertheless a move in the right direction in the sense that it will reduce the flow of paperwork to the IRS, thus reducing the agency’s processing load.

That said, it is important to note that the consent judgment in this case – even if accepted by the court – does not repeal the Johnson Amendment. Only Congress can do that. Nor does it otherwise strike down the provision as unconstitutional across the board. The agreement merely (and importantly) allows 501(c)(3) organizations to express their opinions on political issues and candidates as they relate to the religious views held by such organization.

We predict that this will be a turning point in American culture.

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