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Think your gambling winnings are tax-free? Don't bet on it

I'm not much of a gambler. Never have been. But I do recall the time a friend of mine and I went to a casino with 20 bucks each. We agreed that we'd leave if we lost that money. After about 25 minutes at the slot machines, I was out of cash. Not knowing where my friend had gone, I waited for him on a bench by the entrance.

About 45 minutes went by, when I saw him approaching me with a large bag of coins. "How'd you do?" I asked. "I hit it big" he told me. "I found an amazing machine way in the back. You can't lose! Every time I put a loonie in, four quarters came out!"

Okay, so the story isn't quite true. But I'll tell you what is true. Most gamblers don't really understand the tax implications of their winnings -- particularly poker players. And poker is almost as popular today as Wayne Gretzky was to an Edmontonian back in 1985.

The story

A good friend of mine called me a few weeks back. As it turns out, he had won -- big time -- playing poker on-line. Now, I knew that he was getting pretty good at it, and any time we play poker in person, he cleans up. In fact, my friend was invited to attend the East Europe Poker Championship in Moscow last month. He was beaten badly there, but that's beside the point.

The fact is, poker has taken off in popularity in the past few years. In June, 2005, PartyGaming, the parent company of the largest on-line card room, PartyPoker, went public on the London Stock Exchange, achieving an initial public offering market value in excess of $8-billion (U.S.). The on-line poker market is huge and growing, generating an estimated $2.4-billion in revenue in 2005 (compared with $500-million in 2003).

The rules

Canadian tax law works so that you'll generally face tax on all sources of income unless specifically exempted under a particular section of our Income Tax Act. The Canada Revenue Agency's Interpretation Bulletin IT-334R2 provides some guidance on how the taxman will view your gambling profits.

The CRA's view is that you may be subject to tax on income derived from gambling, including poker, if your gambling constitutes a business. Now, whether or not your gambling is a business is a question of fact that can only be answered by looking at your circumstances and course of conduct.

While no one factor is conclusive, the CRA looks at the following criteria to make a judgment call: The degree of organization that is present in your pursuit of the activity; the existence of special knowledge or inside information that enables you to reduce the element of chance; your intention to gamble for pleasure versus gambling for profit as a means of earning a living; and the extent of your gambling activities, including the number and frequency of bets.

Poker is the type of game where you can develop special knowledge that enables you to win more often. The more often you play, and particularly where you're playing for profit, and not just for fun, the more likely the taxman will call your winnings business income. In this case, you'll be entitled to deduct any costs associated with playing, including tournament entry and travel costs.

On the flip side, if you're losing more than you're winning, you may have a tough time convincing the CRA your gambling is a business, and so your losses may be denied. Where it's clear that your gambling is for fun and not for profit, your winnings should be tax free.

Tim Cestnick is a principal with WaterStreet Group Inc. and author of Winning the Tax Game, among other titles.

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