Are a Poker Player’s Bad Debts a Tax Deduction?

As the WSOP comes to a close, two poker players ended up losing money in an unexpected fashion. We covered the first last week, and will focus on the second of those players today.

Ethan Yau (better known as “Rampage Poker”) recently tweeted a story indicating he established a loan with an individual earlier this year. He now believes the $450,000 loan will not be repaid. If this is the case, he could have a bad debt from his failed loan. Let’s take a look at how the IRS treats bad debts.

Nonbusiness Bad Debts

A nonbusiness bad debt is “any debt other than one created or acquired in connection with the taxpayer’s trade or business.” In order for a nonbusiness bad debt to be deductible, the entire debt must be declared uncollectible. A debt becomes uncollectible once every reasonable attempt to collect has been unsuccessful. 

If a nonbusiness debt is considered uncollectible, it can be deducted via Form 8949 in the year the debt becomes completely worthless.

Nonbusiness bad debts are considered short-term capital losses. They can offset other net capital gains from stock, cryptocurrency or property sales. However, once those gains are exhausted in the current tax year, only $3,000 per year can be deducted against ordinary income (wages, interest, etc.). Any unused loss carries forward to the next year.

Any recreational gambler that loans money to another player will be subject to nonbusiness bad debt reporting. This also applies to professional gamblers that loan money to others for personal reasons.

Business Bad Debt

A business bad debt is “a loss from the worthlessness of a debt that was created or acquired in a trade or business.” A business bad debt can be deductible when it is either partially or totally uncollectible. 

If a business bad debt is considered uncollectible, it can be deducted on Schedule C (if a sole proprietor) or on the associated business tax return of an entity.

Business bad debts are considered a direct business expense. They can be used to offset business income, other ordinary income or generate a Net Operating Loss, which can be carried into future years. 

Certain professional gamblers that loan money to others, especially those in the business of backing other players, may qualify for business bad debt reporting.

Is It Deductible?

If the loan is deemed uncollectible, Mr. Yau will receive a deduction of some kind. Without knowing the nature and purpose of the loan, it is hard to determine if this qualifies as a business or nonbusiness bad debt. 

Key Considerations

As a reminder, documentation is key when loaning money to a friend, relative, acquaintance or business associate. In all instances, you must be able to show proof of a legal debt. Each loan should include:

• Formal loan document with terms (duration, interest rate, payment periods, etc.)

• Interest rates substantially below market rates could be treated as a gift. You are not eligible for a bad debt deduction if the loan is considered a gift.

• Name and address of the debtor

• Records showing your basis in the loan

• Documented efforts to collect on the debt

• Phone calls, texts, letters, formal legal proceedings, etc.

• Additional information supporting the worthless debt