Tuesday, August 27, 2013

Podcast appearance: Thinking Poker Podcast, Episode 45

I was a guest on the Thinking Poker Podcast, a fantastic podcast which I highly recommend. On this episode, I joined Andrew and Nate to chat about my poker life, discuss the most interesting pieces from this blog, and help delve into some game theory and strategy analysis.

Check it out here: Thinking Poker Podcast, Episode 45: Mike Stein of Quantitative Poker.

Tuesday, August 20, 2013

QuadJacks article: Poker Still Needs the Skill Game Argument

I wrote a response article for QuadJacks defending the ongoing value of spreading awareness of poker as a skill game in the current political environment:

Check it out here: Poker Still Needs the Skill Game Argument.

Monday, July 8, 2013

Online Poker Report article: Post-Move Randomness in Poker: A Lesson from Game Design

I wrote an article for Online Poker Report on the applications to poker of broader game design perspectives on pre- and post-move randomness in games:

Check it out here: Post-Move Randomness in Poker: A Lesson from Game Design.

Friday, February 15, 2013

An open letter: A simple, sensible change to fix almost all amateur poker income tax inequities

To the IRS, and to the legislators, regulators, and operators of future US online poker markets:

A longstanding quirk of the US tax code relating to how non-professionals must report their poker income has persisted despite the explosion in poker's popularity over the past decade. This tax rule creates effective surtaxes on amateur poker play that vary wildly with a player's personal circumstances and very frequently exceed 100% of a player's actual earnings. It is long overdue, and more pressing now than ever as we stand on the verge of domestically-regulated internet poker, that our tax code catch up with modern poker by taxing its earnings in a reasonably consistent way.

The problem

Amateur poker players currently cannot simply report their net poker winnings. Instead, they must report the sum of their winning poker sessions (gross poker winnings) as income, taking the sum of their losing poker sessions as itemized deductions.

An amateur poker player's bottom-line income is correctly calculated as his or her net income for most tax considerations. However, there are several intermediate steps within the process of determining a taxpayer's income tax obligation that can trigger off of or otherwise treat as proxy for true income the taxpayer's Adjusted Gross Income (AGI), a figure which includes gross amateur poker winnings before losses are deducted.

Consider an amateur poker player who, for simplicity, alternates between winning $100 and losing $100 in a weekly poker game for a year. Although he has made no money, his poker play contributes $2,600 to his AGI, as he reports $2,600 in Gambling Winnings and takes $2,600 in Gambling Losses. There is no meaningful theoretical or practical sense in which gross poker winnings represent actual income. Not only is our example a net loser at the end of the year, but he or she certainly has not had $2,600 of any sort of income. He or she never even possessed that much money at any point during the year!

Having any aspect of the tax code consider this player to have $2,600 of some sort of income is akin to taxing corporate revenue as if it were its income, or to considering the holder of this stock to have had $1,000 in investment earnings over this year ($1,000 being the sum of returns only over days in which the stock increased in value).


Of course, this is not how taxes work on these sources of income, but this is the problem that amateur poker players face. Depending on an amateur poker player's level of play, choice of game, and frequency of beginning and ending sessions, his or her AGI can very easily exceed his or her true income by tens or even hundreds of thousands of dollars, with no upper limit to the potential AGI inflation for higher-stakes amateur players.

What are the impacts of an artificially-inflated AGI?

The tax code appears to be designed so as to consider AGI to be a reasonable measure of a taxpayer's income, and it seems that amateur poker play is one of the few common ways that a taxpayer's AGI can significantly exceed his or her actual income. An artificially-inflated AGI can bring about the following inequities for a taxpayer:
  1. Taxpayers who reside or play in one of about a dozen "bad poker tax states" owe state income tax on their gross wins, with no state deduction permitted for gambling losses.
  2. A taxpayer who would otherwise take the standard deduction will either be unable to take gambling losses as an itemized deduction, or will lose out on the difference between his or her "real" deductions and the standard deduction.
  3. That taxpayer's spouse also loses his or her standard deduction, even if filing separately.
  4. The deductibility of medical expenses is limited by AGI, which includes winning poker sessions before losing poker sessions are deducted.
  5. Roth IRA contributions cannot be made by taxpayers whose AGI exceeds $127,000. Traditional IRAs have similar limits in cases where the taxpayer is covered by an employer pension plan.
  6. The Free Application for Federal Student Aid uses AGI instead of net income in determining the financial capability of a family to pay for a child's college education.
  7. Most non-poker itemized deductions are phased out at certain AGI thresholds.
  8. ... as are exemptions.
  9. A 3.8% surtax is applied on the investment income of "high-income" taxpayers, again determined by AGI.
The first two of these have a broad reach and can have a significant impact for many amateur poker players. About 30% of the US population resides in the "bad poker tax states", and the majority of poker players within any game environment are net losers who will be getting hit with an effective tax on their losing if they take the standard deduction or fit into any of these other circumstances. My conservative estimate is that at least a million Americans currently owe a tax on their poker activity which exceeds their actual winnings.

They're not currently paying these taxes, of course. That the status quo has gone untouched for so long is almost certainly due to the low tax compliance rate on poker income, whether it be due to conscious tax evasion of unreported income or to a lack of awareness that a losing year of poker would have any tax implications at all.

A solution that covers all nine inequities

All nine inequities would be instantly and completely alleviated if amateur poker players could simply report their net annual poker winnings instead of reporting gross winnings and deducting gross losses.

This can be achieved by defining the length of a poker session to be an entire year of play. The definition of a poker session is currently lacking modern guidelines from the IRS anyway and will already require explicit or implicit clarification when the first domestically-licensed sites start reporting player results, so let's do it right.

Why is this a sensible solution?

To define a session as an entire year of play is actually quite appropriate for poker. Even many amateur poker players are, by the very nature of the game, quite businesslike in planning their financial risk, managing a segregated poker bankroll and focusing on long-term expectations for their play.

Reporting net instead of gross income for amateur poker players would also have the benefit of being consistent with what almost every reasonable American would expect and perhaps how many amateur poker players incorrectly report their poker income currently. There'd be no need to file any poker activity during a losing year, and, while contemporaneous records should still be required, the players who inevitably fail to keep proper session-by-session accounting would nonetheless have a reasonable chance of estimating their total win or loss at the end of a year.

Why should you care about fixing this problem?

IRS & Legislators: Fair public policy should never tax an activity at more than 100% of the income it generates. Even if you believe that there should be some sort of extra "sin tax" to discourage activities that may be resemble or enable gambling, the more appropriate way to address that should be a stable, flat fee that players could easily plan and account for.

Regulators: Proper consumer protection involves being transparent about the costs of using a service. Regulated online poker should absolutely involve compulsory reporting of winnings to the IRS, but to have that in place before repairing this issue is to set a trap that millions of Americans would unknowingly fall into and is an abdication of regulatory responsibilities.

Operators: Communicating the current state of amateur poker tax reporting to your online players would turn many customers (rightly) away, yet failure to do so will likely lead to a dramatic drop-off in your player base. A delayed-impact, often-unanticipated and occasionally-large annual fee for losing is not good for customer retention. This will have to be fixed eventually for your customer base to subsist and grow, so out of respect for your customers, please expend resources towards fixing it now.

Conclusion

This simple and sensible change will eliminate an undue and capricious tax burden on millions of present and future American amateur poker players. To fail to correct this prior to the spread of domestically-regulated internet poker is to ensure an inefficient outcome for all parties involved.

Frankly, this rationale applies to traditional gambling activities as well. However, the need for change is most crucial for poker, a competitive strategy game which naturally lends itself towards narrow edges over regularly-occurring play, compels conscious maintenance and management of a bankroll, and attracts intelligent, price-sensitive competitors.

I don't know exactly how the poker community goes about changing this part of the tax code. I suspect that players cannot do it alone. We need our industry to stay aware of this problem and to represent our mutual interests. Keep the dialogue going.


Sincerely,

Mike Stein

Wednesday, January 16, 2013

Cash Game Tax Planning Calculator - 2013 Update

I have updated the Cash Game Tax Planning Calculator for the new year, containing some brand-new potential negative tax effects which will impact certain amateur poker players.

If you haven't used the Cash Game Tax Planning Calculator before and you're a US poker player, especially if you're only playing part-time and don't file your taxes as a professional, now is the perfect time to start. The purpose of this spreadsheet is to calculate a player's after-tax expected value based on their intended poker play for the year. This is important to do in advance, as a few different negative tax effects can easily turn a winning player into a losing player. You'll also probably want to check out the older posts on the Cash Game Tax Planning Calculator, as I'll only discuss the 2013 changes here.

The new spreadsheet is freely available here, with continued thanks to pokerfuse.com for hosting:

(You may have to give permission for macros to run. There's nothing malicious or objectionable.)

Runtime and efficiency

Note that this version of the sheet takes about 3-4 minutes per row for the default recommended loop size of N=1,000,000 when you hit the Calculate button. It's not frozen or broken! If you'd like to test it out to make sure it's working before you embark on a longer run, set N=100 in cell K6 for faster calculation, but keep in mind that the results will likely have significant error for N<1,000,000. Excel is really not an ideal platform for these calculations, but I find that it's not too much trouble to run them overnight. This certainly isn't commercial-grade software, it's merely something I've built for myself that I'm making freely available for the benefit of the poker community. (i.e. bear with it and thanks for your patience!) New tax considerations for 2013

The recent fiscal cliff compromise included a few ways to penalize high-income tax payers... but, as with many pieces of the tax code which attempt to assess income, these income thresholds look at Adjusted Gross Income rather than net income. AGI is a before-deductions figure which includes "phantom income" for amateur poker players resulting from the sum of all losing sessions they play throughout the year. Amateurs report the sum of their winning sessions as income and deduct the sum of their losing sessions (to the extent of their winnings) later as an itemized deduction.

Net taxable income is generally what ends up affecting the tax a player owes, but AGI is overinflated along the way, and that's what these three new rules consider. Thus these new effects will be triggered by many amateur players whose actual incomes are not high at all. (If you need a refresher on poker tax basics, check out the 2+2 tax sticky.)

  1. Phaseout of itemized deductions for "high-income taxpayers"

    The first new rule triggers for taxpayers whose AGI exceeds $250k for single taxpayers, $275k for heads of household, and $300k for those who are married and filing jointly. Once this threshold is exceeded, most itemized deductions are reduced ("phased out") by 3% of the amount of the excess of AGI to the threshold, up to a maximum phaseout of 80% of these deductions. Luckily, the deductions which are phased out do not include the gambling loss deduction, which would have resulted in a very costly direct surtax on gross amateur poker earnings, but essentially all other common types of itemized deductions are included. Further discussion and links can be found in this thread.

    This will create a negative tax effect on those amateur poker players whose phantom poker income pushes them over the $250k threshold. Professional players (who have no phantom income) and all other Americans should be mindful of this new threshold as well, but they get the privilege of having their AGI reasonably approximate their true income. Naturally, the biggest impact here will be on those with many non-poker itemized deductions.
  2. Phaseout of personal exemption for "high-income taxpayers"

    Similarly, using the same thresholds as the above effect, a taxpayer's personal exemptions are reduced by 2% for every $2,500 of AGI in excess of the threshold. This, again, impacts all amateur poker players with high gross winnings, and will hit the hardest on those with dependents who would take multiple personal exemptions.

    Personal exemptions were not considered at all in the 2012 build of this spreadsheet, but are accounted for in the new version to allow for this effect to be captured.
  3. 3.8% surtax on investment income for "high-income taxpayers"

    The final noteworthy change is a 3.8% surtax to fund Obamacare, applied to the excess of AGI over a certain threshold, but not exceeding the amount of one's investment income. For this rule, the threshold is $200k for single taxpayers, $250k for those who are married and filing jointly, and $125k for those who are married and filing separately.

    Poker winnings, be they amateur or professional, are not considered investment income, so this effect will only matter on players who happen to have significant income from traditional investments, but it hits very hard for those who do.
Other changes in this version include an update of the default tax brackets for 2013 and a bug fix regarding the way deductions were treated in some cases where itemized deductions and amateur gambling losses were less than the standard deduction.

New inputs & instructions

To account for these new tax considerations, there are 4 new inputs in the 2013 version, all of which are located in the Tax Rates tab at the bottom of the sheet. All other inputs are the same as the previous version, and everything else about the sheet, its backend, and its runtime should essentially be familiar.


  • Personal Exemption — The total amount of your personal exemptions. For 2013, this is $3,800 for a single person with no dependents. If you have dependents such that you take more than one exemption, this should be changed to $3,800 times the number of total exemptions you take.
  • Portion of salary which is investment income — The approximate amount of investment income you expect to have this year. Note that your Annual Salary figure on the main tab should also include this amount in its total, as the Annual Salary figure is intended to include all non-poker sources of income. This new field simply requests the portion of that total non-poker income which comes from investments so that the effect of the new investment surtax can be computed.
  • Phaseout Threshold — The threshold for the phaseout of itemized deductions and personal exemptions as described above. Set this equal to $250k if you are single, $275k for head of household, and $300k for married filing jointly.
  • Investment Tax Phaseout Threshold — The threshold for the phaseout of itemized deductions and personal exemptions as described above. $200k for single taxpayers, $250k for those who are married and filing jointly, and $125k for those who are married and filing separately.

2013 new trouble case #1: High-Volume Amateur

Each of these new effects will only unduly impact amateur players, due to the AGI inflation from their phantom poker winnings; high-income professional players will be paying higher taxes as well, but only when their legitimate winnings exceed the income thresholds. With that in mind, we first look at the case of an amateur player with high phantom poker winnings and thus significant overinflation of AGI.

Consider a high-volume amateur poker player, perhaps a full-time student playing poker on the side as his primary source of income. He has $80k net worth, non-poker income of $3k per year, all of which is from investments, and $3k in non-poker itemized deductions (state taxes paid last year, perhaps). Let's say that he plays in certain poker games such that he has an hourly rate of $40 and a standard deviation of $1,800 per hour, and that he typically plays for 2 hours per session. I'm envisioning a solid winner at multitabling small/mid stakes online here, which is not currently relevant to very many American taxpayers, but I've chosen a higher-variance and higher-volume profile to highlight the potential impact of the new rules.


This player will certainly put in enough volume to avoid the classic negative tax effects of the risk of a losing year or the risk of being unable to deduct losses due to not hitting the standard deduction, so we don't worry about that in the graph. However, once his number of sessions increases to about 250 for the year, his expected AGI from the sum of his winning sessions starts to hit the threshold and the effects of the investment surtax and exemption/deduction phaseout start to cut into his profits, leveling off at a maximum effective loss of $2,500 when these are all fully phased out.

The new tax rules won't turn this high-volume amateur from a winning player into a losing player, but they will take a rather high percentage of his average after-tax profit at certain volume levels.

2013 new trouble case #2: Wealthy Amateur

Some low-volume amateur players will already be at or above the income thresholds from their non-poker income, in which case even a single poker session will produce phantom income that will cut directly into the new tax rules. These players are in much worse shape than those in the first case.

Consider a upper-middle-class person with a successful career outside of poker who enjoys occasionally playing poker for fun, but still cares about winning, or at least not losing money in her poker career. Let's say she has $1M net worth, and non-poker income of $250k per year, $20k of which is from investments, and $15k in non-poker itemized deductions. For simplicity, let's say that her choice of game and her winrate profile is the same as that of the high-volume amateur, except that the wealthy amateur fits in far fewer of these 2-hour sessions each year.


The impact on expected after-tax winnings is dramatic. In 2012, she would have had to play about 40 sessions per year to break even (due primarily to the classic negative tax effect of having a losing year). In 2013, she now must play three times as much volume to break even after-tax, and her earnings are increasingly divergent from what they would have been in 2012. The gap between the earnings lines would continue to grow until all investment earnings were met with the 3.8% surtax and all deductions and exemptions were phased out to their maximum.

Any amateur poker player whose income is at, over, or near the thresholds for the new tax rules will have to be very careful. Depending on their winrate profile and the amount of investment income and deductions they expect to have, many will be forced out of the game.

A brief note on a third potential trouble case (it could happen to you)

Many amateur poker players will not fall into either of the above two cases. However, if such a player happens to run well enough during the first portion of 2013, perhaps by spiking a big tournament score, such that the likelihood of hitting the thresholds goes on to become significant, they will suddenly find themselves impacted by these effects.

The spreadsheet is designed to be used on an ongoing basis after every session is played, or at least after any big wins or losses. As another example, a large early realized loss will mitigate the negative tax effect of having losses which, along with other deductions don't exceed the itemized deduction, which will benefit the profitability of future sessions during the year. Running this calculator often will make sure you always know the costs of these new negative tax effects as well as the ones that have always been around.


Everybody's situation will be different, particularly under these new rules, since they are sensitive to the particular amounts of investment income and non-poker itemized deductions you expect to have. If you're a responsible player, you should check out the calculator and to use it to compute the after-tax expectations for your individual situation. Here's hoping that you'll still be +EV after-tax, but if not, it's better to determine that now rather than putting in your year of play and getting hit with an excessive tax bill at the end.

As usual, I am eager to hear your feedback, suggestions, questions, bug reports, etc.

I'm also working on coding a version of the calculator in [R], mostly for my own edification as I learn the language and for my own use. It won't be as pretty or user-friendly, and I am not planning to ever be able to compile it into something palatable to the general public, but it will be faster and more flexible if you're comfortable with code. Feel free to email me if you want to mess around with it.

See also:
Cash Game Tax Planning Calculator - Instructions (2012)
Examples, charts, and general results
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