Casino Enterprise Management

“Black Friday” for Internet-based poker (i-poker) arrived on April 15, 2011, in the United States. The date April 15 is an infamous date wedded in the cultural fabric of Americans. America has a strong anti-tax tradition, and April 15 is the date annual federal income returns are required to be filed in the United States. Thus, the irony was likely not lost on the United States Attorney for the Southern District of New York, Preet Bharara, when he announced the criminal indictments of 11 individuals who are alleged to have operated illegal i-gaming sites. Included in the persons indicted were the founders and senior executives of major i-poker operators PokerStars, Full Tilt Poker and Absolute Poker.

The i-poker indictments have captured the attention of the gaming community. The indictments came on the heels of the formation of alliances between major land-based casino operators and i-gaming operators. Just weeks before the i-poker indictments were publicly announced, Caesars Entertainment, Wynn Resorts and Fertitta Interactive (which is owned the by Fertitta brothers, who are the principals of Station Casinos as well as the highly successful Ultimate Fighting Championship brand) had disclosed alliances with major i-gaming operators, including PokerStars and Full Tilt Poker. In the days following the i-poker indictments, the discussion has focused on what the indictments mean for i-poker in the United States and the prospect that Congress and/or individual state legislatures will act to authorize i-gaming.

The i-poker indictments were coupled with the United States seizing the U.S.-based domain names of PokerStars, Full Tilt Poker and Absolute Poker. The United States government also seized bank accounts of the i-poker operators. As a result, questions quickly arose whether U.S.-based i-poker players would be able to recover funds on deposit with the i-poker operators. In the days following the announcement of the i-poker indictments, PokerStars and Full Tilt Poker quickly reached an agreement with the United States Attorney providing for the return of the sites’ respective domain names. The purpose of the agreement to return the domain names was to facilitate the ability of U.S.-based i-poker players to recover funds on deposit with the sites.

Lost in the wake of the indictments are the potential tax consequences that may arise for U.S.-based i-poker players. The i-poker sites are based offshore. As a result, the flow of funds to the i-poker operators will necessarily involve offshore financial transactions. Generally, U.S.-based i-poker players would deposit funds in offshore bank accounts. As a result, the U.S.-based i-poker players likely had control over an offshore bank account, potentially for several years. In order for the U.S.-based i-poker players to recover funds on deposit with the i-poker operators, it may be necessary to repatriate the funds from the offshore accounts.

The presence of the offshore accounts raises considerable U.S. federal tax issues for i-poker players. The U.S. federal tax law issues are related to a series of laws that require U.S. taxpayers to report certain foreign financial assets. To place the federal tax law issues into perspective for the i-poker player, consider the following scenario:

A U.S. citizen deposits $10,000 in 2005 with an i-poker site. Over the course of the next five years, the U.S. citizen deposits an additional $10,000 per year. The U.S. citizen has in aggregate deposited $60,000 with the i-poker site. This i-poker player may be a pretty good card player, so assume that after six years of playing online poker, his account has blossomed to an aggregate value of $80,000. Assuming that this player’s account was opened with an operator that was indicted in the U.S., as discussed in this article, our i-poker player may face considerable U.S. tax law issues.

While this article examines the U.S. tax law considerations for i-poker players, the lessons discussed are equally applicable to other participants within the gaming industry. For example, a casino operator with offshore operations may have control over an offshore bank account. Similarly, a tribal government may hold offshore investments that could constitute an offshore financial account for U.S. reporting purposes.

Reporting and Disclosure
A series of U.S. laws impose reporting obligations with respect to both inbound and outbound financial transactions. Generally, the reporting obligations run the gamut from certain currency transactions to certain offshore financial assets and offshore bank accounts. For the i-poker player, the obligation to disclose offshore bank accounts may be implicated.

Under U.S. law, each U.S. person who has either a financial interest, signature or other authority over a financial account that exceeds $10,000 during any part of a year must file a Report of Foreign Bank and Financial Account. The report is colloquially known as an “FBAR.” An FBAR is not filed with a U.S. income tax return. Rather, individuals who are required to file an FBAR must separately file the return by June 30 for any account that is subject to reporting during the immediately preceding year.

An examination of the meaning of certain terms used in the formulation of the legal rule allows for a determination whether a U.S. person must file an FBAR. Initially, a “U.S. person,” for purposes of filing an FBAR, means a United States citizen, a resident alien or a domestic business entity (e.g., U.S. domestically organized limited liability companies, corporations or partnerships). “Financial account” is broadly defined to include not only bank accounts, but also securities accounts, insurance or annuity policies with a cash value, mutual fund interests, debit cards, and in certain circumstances, credit cards.

An FBAR is merely an information return, not a return in which a person will report income. Furthermore, a person filing an FBAR does not send a payment of tax when filing the FBAR with the Internal Revenue Service. Thus, from a basic level, a legitimate question is raised with respect to why the FBAR merits so much attention. The simple answer is the harsh penalties Congress provided for failures to file an FBAR. The policy rational is all too familiar for the gaming industry: offshore bank accounts have historically been viewed as tools to launder money and evade U.S. taxation. Consequently, U.S. tax authorities have become acutely interested in offshore financial assets.

The significant penalties imposed for failing to file an FBAR start with a penalty of an amount not to exceed $10,000 for a non-willful violation. The willful failure to file an FBAR is subject to a civil monetary penalty in an amount not to exceed the greater of $100,000 or 50 percent of the account balance. Criminal penalties for willful failures to file an FBAR include monetary fines of not more than $250,000 and/or imprisonment of not more than five years. In other words, Congress was not in a humorous mood when it established the penalties for failing to file an FBAR, and the penalties are a strong indication of how serious the federal government is about the disclosure of offshore financial assets.

Options for I-Poker Players
At the outset, doing nothing is likely not a prudent option for an i-poker player with an offshore bank account. During the course of the i-poker operator prosecutions, the U.S. Department of Justice will likely have access to a list of all U.S. i-poker players, if it does not already have such a list. Therefore, it could merely be a matter of time before the IRS comes knocking on the door of U.S. i-poker players, looking for FBARs and the reporting of any previously unreported income.

The IRS has recently announced the commencement of the 2011 Offshore Voluntary Disclosure Initiative (OVDI). To participate in the 2011 OVDI, a taxpayer must submit certain information to the IRS on or before Aug. 31, 2011. As a side note, the push by the IRS to increase the incidence of disclosure of offshore bank accounts is not a new development. Rather, the subject has been quite popular the last few years. In 2009, the IRS implemented an offshore voluntary disclosure initiative. The IRS enforcement efforts, including voluntary disclosure programs, directed at offshore accounts has been the subject of considerable attention in both the mainstream media and the professional tax bar.

The stated goal of the 2011 OVDI, like its predecessor initiatives, is to bring taxpayers with offshore accounts into compliance with U.S. tax laws. The primary motive in encouraging the disclosure of offshore bank accounts is that the funds held in offshore accounts have often not been subject to U.S. income tax. In other words, the amount initially deposited may represent pre-tax funds, or untaxed income may have been earned on the amount held in the account. It is the untaxed funds that the IRS is most keenly interested in.

The benefit of participating in the 2011 OVDI is that a taxpayer with an undisclosed offshore account can avoid criminal prosecution. A highly criticized component of the recent offshore voluntary disclosure initiatives is that the IRS has taken an inflexible approach by applying uniform penalties. The 2011 OVDI appears to be no different; the IRS has publicly stated in announcing the 2011 OVDI that IRS revenue agents do not have any discretion to settle matters for less than what is properly due and owing. As a result, for many taxpayers participating in the 2011 OVDI program, the IRS will not differentiate from its preset penalty structure.

The standard penalty under the 2011 OVDI is a penalty equal to 25 percent of the highest aggregate account balance. The 25 percent penalty is in addition to the 20 percent accuracy-related penalty based on the amount of underpayment of tax and failure to file and/or failure to pay penalties. In certain limited circumstances, a 12.5 percent or 5 percent penalty may be available in lieu of the 25 percent penalty.1 The 12.5 percent penalty is applicable when the offshore account balance is less than $75,000 for each of the years covered by the voluntary disclosure.

Practical Considerations
Returning to our hypothetical U.S. i-poker player, what are his U.S. federal tax considerations? At the outset, there are several potential transactions that could trigger a tax issue. These transactions include not only the prospect that our i-poker play has unreported income arising from winnings receiving from playing i-poker, but the account such funds are deposited in may constitute an offshore bank account.

The 2011 OVDI is a tax amnesty program that may be available to i-poker players. As outlined above, to the extent that an i-poker player has unreported income attributable to an offshore financial account, the 2011 OVDI is likely available. It should be noted that individuals with undisclosed offshore bank accounts who reported all income need not participate in the 2011 OVDI. Rather, “[t]he purpose for the [2011 OVDI program] is to provide a way for taxpayers who did not report taxable income in the past to come forward and voluntary resolve their tax matters.”2 Thus, for taxpayers who have reported all their income, but simply not filed FBARs, the taxpayers are instructed to file late FBARs with an explanation.3

Final Thoughts
The U.S. criminal indictments of i-poker operators have garnered significant attention throughout the gaming community. The indictments have stirred the discussion with respect to the continuing viability of the i-poker industry in the United States. Further, the indictments have spawned greater focus on federal and state legislative initiatives to authorize i-gaming in the U.S. The effect to U.S.-based

i-poker players has been largely ignored, save for the efforts of the players to recover their funds on deposit with the indicted i-poker operators. U.S. i-poker players, however, face significant tax issues. These tax issues include not only the prospect for having unreported income, but also having to deal with the morass of potentially having control over a previously undisclosed offshore bank account. As outlined in this article, the tax consequences can be severe.

Footnotes
1 It has been our experience that the 5 percent penalty is available only in extremely rare circumstances, if at all.
2 See IRS 2011 Offshore Voluntary Disclosure Initiative – Frequently Asked Questions and Answers, FAQ-17 (Feb. 8, 2011).
3 See id.

Peter J. Kulick is a tax and gaming attorney with Dickinson Wright PLLC, which has an international gaming law practice with offices in Michigan, Nashville,  Washington, D.C., Toronto and Phoenix. He received his LL.M in tax law from New York University. Kulick may be reached at pkulick[at]dickinsonwright.com.