Taxes

Well, it being tax day, I thought I'd finally drag out a calculation to see what the tax rate on my poker playing is. I am doing this calculation for the first time in this post, so I don't quite know what the number will be, but it will be quite high.

So, why isn't this calculation trivial? Why can't I just take my Federal marginal tax rate (25%) and my state marginal rate (4.35%) to get 29.35%? Ah, if only it were that simple. The problem is that poker income is counted by "session" whereby all winning sessions are added to your Adjusted Gross Income (AGI), and all your losing sessions are taken as Schedule A deductions, much like mortgage interest and property tax. Gory details in a previous post I made in the topic here. Why does this matter?

1. Certain deductions and tax credits start to "phase out" as you increase your AGI, regardless of what your actual taxable income winds up being.
2. Michigan does not count Schedule A deductions in your taxes - they pretty much tax you on your Federal AGI only.

The combination of these two items will raise my marginal poker-tax-rate, which I will calculate as the amount of extra tax I paid due to the fact I played poker divided by the amount of money I made.

The way my year wound up, I made a profit of $4,725.62, broken up as

• $2,035.62 through play at the tables
• $2,690.00 through bonus

But as mentioned, I have to "break up" that $2,035.62 into winning and losing sessions for tax purposes, then add back in the amount of the bonus as a giant winning session. When looked at this way, the numbers are:

• $16,041.34 in winning sessions
• $11,315.72 in losing sessions

Note that the difference between those two numbers is exactly my profit of $4,725.62 as expected.

So, let's start with the easy part. The amount of Federal tax I will pay on this is simply my Federal marginal tax rate times my profit, since I do get to claim my Schedule A deductions. I thus pay $4,725.62 * 25% = $1,181.41 in Federal tax.

Next, the specific credit in my case is a loss of $50 in tax credit for every increase of $1,000 in AGI, or 5%. Therefore, since my AGI increased by over $16K, the amount of tax credit my poker playing cost me is $802.07 ($16,041.34 * 5%). And, no, this is not double counting anything, as this is a (lost) tax credit which is calculated after tax rates have already been applied.

Next, as mentioned Michigan taxes only on AGI, so the amount of extra Michigan tax I pay due to pokering is $16,041.34 * 4.35% = $697.80.

Adding these numbers up, my tax bill is sobering $2,681.28 larger than it would be if I didn't play at all, resulting in a marginal tax rate of 56.7% on my poker winnings. Looked at another way, all the bonus I cleared in 2008 was almost exactly enough to cover my tax bill, leaving me with "just" my profit from the tables. Believe it or not, this number is somewhere in the ballpark of what I thought it would be when I started the calculation (I had thought 50-mid 60%).

It really does give me pause on whether I should even bother to play at all. The way the tax law is set up (and due to the wacky Michigan taxation), it is entirely possible that I could wind up owing more taxes at the end of a year than I made profit.

Three quick examples:

1. Breakeven year at tables, profitable overall: $17K in winnings, $17K in losses, $2K in bonus would have me with a $2K profit for the year but stuck with a incremental tax bill of $2,277. Admittedly, I'd probably make more than $2K in bonus if I put in that much action, but it at least shows that it is possible. This is a best case scenario out of the three examples, actually.
2. Breakeven year overall: (losses at tables, make it up in bonus): $17K in winnings, $20K in losses, $3K in bonuses leaves me breakeven for the year but stuck with a tax bill of $1,870.
3. Losing year overall: $17K in winnings, $22K in losses, $3K in bonuses leaves me in the hole by $2K for the year and stuck with a tax bill of $1,870.

Is it worth it? Having over half your money taken away as a (solidly?) winning player, with the risk of more-than-all your money being taken? Especially for a game that drives me crazy half the time?