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  • D.C. Circuit Rules for Unlucky Korean Gambler
    July 2013

    Individuals who are "nonresident aliens" of the United States are subject to a gross basis U.S. tax on their U.S. source fixed or determinable annual or periodical (or “FDAP") income.[1] This tax is typically collected by withholding at source. Nonresident aliens are also subject to tax, on a net basis, on their income that is effectively connected with the conduct of a U.S. trade or business.[2] Gains from gambling generally are considered FDAP income, and so are taxable on a gross basis.[3]
    On July 9, 2013 the Court of Appeals for the D.C. Circuit, reversing the Tax Court, issued an opinion in favor of the taxpayers in the case of Sang J. Park and Won Kyung O v. Commissioner.[4] The issue in Park was how to compute the Korean taxpayers’ gains from playing slot machines in the United States. Overall Mr. Park lost money playing slot machines while in the United States, but the IRS asserted Mr. Park was taxable on each bet he had won, with no deduction for his many lost bets.  The government argued that because nonresident aliens are taxed on a gross basis on their FDAP income (i.e., they are denied deductions) this was the correct result.
    Reasoning of the court
    This appellate opinion is relatively brief.  The court begins by observing that in the case of U.S. citizens and residents, section 165(d) allows a deduction for “wagering losses,” but only to the extent of wagering gains. The IRS position, in the case of citizens and residents, is that gains and losses during a single gambling session may be netted for purposes of section 165(d).  The opinion refers to an IRS memorandum discussing section 165(d).[5] It argues in favor of allowing gain or loss to be calculated over a series of separate bets (in the case of citizens and residents).  The memorandum cited by the court states: “We think that the fluctuating wins and losses left in play are not accessions to wealth until the taxpayer redeems her tokens and can definitively calculate” his net gains.
    The court next reasons that there was no justification for treating nonresident aliens differently when computing gambling gains:
    The IRS's only real response [to its interpretation of section 165(d)] is that the Tax Code does not allow non-resident aliens to deduct recreational gambling losses from their income on their tax returns. See 26 U.S.C. §873. In other words, once wins and losses are calculated – whether on a per -bet or per-session basis – non-resident aliens may not deduct losses from wins when doing their annual income taxes. The IRS therefore concludes that non-resident aliens should be required to pay taxes on each winning pull of the slot machine lever. The IRS's reasoning is a non sequitur. What the IRS says about deductions for non-resident aliens is certainly accurate as far as it goes, but the point has nothing to do with the issue in this case. The fact that non-resident aliens may not deduct gambling losses from gambling winnings does not tell us how to measure those losses and winnings in the first place.
    The D.C. Circuit concludes that it was not persuaded that a per-bet approach was better than a per-session approach for nonresident aliens: “We thus decline the IRS's invitation to read the term ‘gains’ in Section 871 to mean something different from what it has been interpreted to mean in Section 165(d).”
    [1] Section 871(a).
    [2] Section 871(b).
    [3] The “other income” article of some U.S. income tax treaties may eliminate U.S. tax on gambling winnings. Also, section 871(j) exempt nonresident aliens from tax on gains from from most "table games" -blackjack, baccarat, craps, roulette and big-6 wheel.
    [4] No. 12-01058, decided July 9, 2013 (“Park”).
    [5] Memorandum AM2008-11, Office of Chief Counsel, Internal Revenue Service (2008).
    KEYWORD: FDAP Income