Horse Racing Industry Trots Out Comments on Reporting Regs

We are writing on behalf of the National Thoroughbred Racing Association (the "NTRA") in response to the invitation by the Department of the Treasury (the "Treasury") and the Internal Revenue Service (the "Service") published in REG-132253-11 for comments on amending the regulations under Treas. Reg. sec. 31.3402(q)-1 for pari-mutuel wagering.

The NTRA is a broad-based coalition representing all segments of the Thoroughbred horse racing industry, including more than 100 horse racing organizations and thousands of individual stakeholders consisting of horseplayers, racetrack operators, owners, breeders, trainers and affiliated horse racing organizations.

Horse racing has been a part of the United States economy for more than 300 years. Today, nearly 40 states are home to horse racing tracks and nearly every state has racehorse breeding farms. The horse racing industry generates $10 billion for the U.S. economy and is responsible for tens of thousands of jobs. In addition, pari-mutuel wagering on horse racing produces hundreds of millions of dollars in tax revenue for states and localities in which racetracks are located.

We understand Treasury and the Service intend to amend the regulations under Treas. Reg. sec. 31.3402(q)-1 ("Section 31.3402(q)-1") in a manner consistent with the proposed regulations published in REG-132253-11.¹ We greatly appreciate the opportunity to comment on Section 31.3402(q)-1 in connection with the proposed regulation project. Section 31.3402(q)-1 needs to be modernized to ensure that both the withholding and reporting of winnings from pari-mutuel wagering accurately and fairly reflect the realities of wagering today. In particular, for the reasons discussed below, we respectfully request that Treasury and the Service amend Section 31.3402(q)-1 to make it clear that the definition of the "amount of the wager" reflects the total amount wagered by a bettor into a specific pari-mutuel pool for purposes of determining whether any wagering proceeds paid to the bettor from that pari-mutuel pool are subject to withholding and reporting.

1. What is pari-mutuel wagering?

Payoffs on winning wagers on U.S. horse races are determined through what is known as pari-mutuel wagering, a French term for betting "amongst ourselves." Because the players themselves establish the odds and payouts, the pari-mutuel aspect of wagering on horse racing differs from casino wagering, where the winning wagers are determined through fixed odds.

For most of its history up to the early 1980s, pari-mutuel horse racing faced very little competition from state lotteries or other forms of gambling. During that earlier period, the vast majority of all wagers were one of three "straight" wagers -- win, place or show. A "win" wager is one in which a single horse is picked to finish first. A wager that a single horse will finish first or second is a "place" wager. And a wager that a single horse will finish first, second or third is a "show" wager. The current withholding and reporting rules were developed during this earlier period when few, if any, straight wagers resulted in a winning payoff 300 times as large as the amount wagered -- a key threshold for tax withholding and reporting purposes. But as will be explained below, the pari-mutuel wagering environment has evolved and the tax withholding and reporting rules need to be modernized to reflect today's environment.

The industry's historic reliance on straight wagers changed in the late 1980s and 1990s as better technology and increases in state lottery and casino competition drove innovations in pari-mutuel wagering, including the development of multi-race or multi-horse wagers also known as "exotic" wagers. These wagering innovations offered the prospect for larger payoffs. First came the development of multi-horse exotic wagers like the exacta (horses finishing first and second in the exact order) and the trifecta (horses finishing first, second and third in the exact order). Then came the multi-race wagers such as the Pick 3 (picking winners in three consecutive races) and the Pick 6 (picking winners in six consecutive races).

Today, with a near-endless variety of multi-horse and multi-race bets, horse racing fans have steadily migrated away from straight win, place, and show bets toward exotic wagers like the exacta, the trifecta and the Pick 6 because they offer the prospect of larger odds and bigger pay-offs. To encourage the migration to exotic bet types, tracks offer exotic bettors the unique ability to "box" his or her wagers. A "boxed" wager is one in which the pari-mutuel wager includes all possible combinations of a group of horses in the same race (e.g., a three-horse exacta box where three horses are selected to finish first and second in any combination and order of finish). Bettors also can "key" a single horse in a single race by betting that horse in one position (e.g., to win) with all possible combinations of other selected horses (e.g., a trifecta key where a single horse is selected to win and other horses are selected to finish second and third in any order of finish). There also is a bet type known as a "wheel" which involves multiple horses in multiple combinations in multiple races (e.g., a Daily Double wheel where a single horse is selected to win in the first race with every horse selected in the second race).

The amount invested by bettors in these modern exotic wagers, especially those that are boxed, keyed or wheeled, is substantially more than traditional straight wagers, but bettors are willing to increase the amount of their wagers because such wagers cover more combinations, thereby increasing their chances of winning. It is this increased cost of the modern exotic wagers that necessitates the updated regulations we are seeking. This is because the full cost of exotic wagers is not currently being considered when applying the 300:1 ratio to such wagers under the current regulations.

And this antiquated policy is costing the horse racing industry a lot. Here is how one frequent bettor described the situation that currently exists for horseplayers in our business:

Instead, bettors are subjected to a set of rules that appears to be inconsistent with basic tax policy. Imagine buying shares of stock in a company and upon the sale of that stock, being told that your basis for tax purposes is the original cost of a single share of that stock, not the entire cost of your original investment in that company. This is actually the result under the current rules for pari-mutuel bettors. There is no logical basis for this disparity in treatment.

2. Current Withholding and Reporting Requirements

Section 31.3402(q)-1(c)(1)(ii) does address when amounts paid with respect to identical wagers are treated as paid with respect to a single wager for purposes of calculating the amount of proceeds from a wager. In this regard, the regulation states --

3. Issues Created by the Current Withholding and Reporting Rules

As discussed above, for both withholding and reporting purposes, to determine the amount of proceeds from a wager, the amount received is reduced by the "amount of the wager" and to determine if the 300:1 ratio has been met, the proceeds from a wager also must be at least 300 times as large as "the amount of the wager." However, since the IRC does not provide a definition of "amount of the wager" Treasury should use its regulatory authority to issue revised and updated regulations to define "amount of the wager" when multiple bets are placed in the same pool. As noted above, the current regulations provide limited guidance on what can constitute the "amount of the wager" by addressing the treatment of identical wagers. However, Treasury and the Service should provide a more comprehensive definition of "amount of the wager" to include the total amount wagered by a bettor into a specific pari-mutuel pool to reflect the current realities of wagering. In doing so, Treasury and the Service also should delete the discussion in the Instructions regarding the treatment of multiple wagers because the Instructions ignore the fact that even though the $12 box ticket represented the placing of a $2 bet on each of six different combinations, all of those wagered amounts were part of a single pari-mutuel pool.

By not including all amounts wagered by a taxpayer into the same pool for a particular bet as the "amount of the wager," the incidence of withholding and reporting have greatly increased with the growth of exotic wagering. This rapid rise in withholding and reporting of winning wagers has a detrimental effect on pari-mutuel wagering, pulling money out of circulation and depressing pari-mutuel wagering at a time when the industry needs more exotic wagering, not less, to remain competitive in a rapidly changing gaming and wagering environment.

What the pari-mutuel wagering industry needs is a modern and equitable approach to the determination of the "amount of the wager." Both prongs of the withholding and reporting rules applicable to pari-mutuel wagers -- the amount of the proceeds from a wager for purposes of determining the applicable threshold (amount received less the "amount of the wager") and the 300:1 ratio (amount of the proceeds from a wager must be at least 300 times as large as "the amount of the wager") -- are greatly affected by the way in which Treasury and the Service currently define "the amount of the wager" in the Instructions. Certainly, pari-mutuel wagering should be subject to fair and accurate taxation but the current antiquated methodology for determining "the amount of the wager" undermines our business because it fails to take into account the economic reality that our bettors are staking more money to win bigger payoffs. Instead, the current methodology subjects more bettors to tax withholding which mainly serves to pull money out of circulation during the course of a race day at a time when that money is needed most by a winning bettor who will likely re-bet the winning proceeds many times over. Such re-betting benefits all associated with pari-mutuel horse racing including the federal government which in the long run will gain more from increased wagering than from over-withholding from horse racing's bettors.

When the current regulations relating to reporting and withholding were enacted in the 1970s, approximately 90 percent of all pari-mutuel wagering occurred on straight win, place, and show wagers. Fast forward to today when approximately 67 percent of all pari-mutuel wagering now occurs on exotic wagers. For example, in 2014, the average $1.00 superfecta wager in which a customer tries to select the top four finishers in a single race returned $1,684.23. The average $1.00 trifecta wager in which a customer tries to select the top three finishers in a single race returned $242.47. That said, given the vast number of potential combinations involved, it is undoubtedly the case that each of the individuals holding those winning superfecta and trifecta tickets wagered far more into that pool than the $1.00 cost of the winning bet.

As illustrated by the examples that follow, the current practice of not treating all wagers made by a bettor into the same pool as the "amount of the wager" produces pari-mutuel winnings that are exaggerated and unfairness can often be the result.

Today approximately 30 million Americans wager on pari-mutuel horse racing each year. Due to the growing popularity of exotic wagering across all fan groups, virtually any horseplayer may find himself or herself standing in the "IRS line" at a racetrack. Every one of horse racing's 1,200+ wagering service sites must calculate, track, withhold and forward to the Service any federal tax due on winnings of more than $5,000. This process requires the expenditure of thousands of man-hours processing withholding obligations and producing Forms W-2G.

In addition to the time spent processing withholding and reporting, the current withholding rules reduce revenues and economic benefits generated by the racetrack. Statistics show that each pari-mutuel dollar returned to the bettor in the form of winnings is re-bet seven times throughout the course of a day. Tax withholding reduces the amount of re-betting, which not only has an effect on the bettor and the track, but also serves to reduce the collection of additional tax revenues that are paid by each racetrack operator on its net revenues.

5. Proposed Change

In light of the foregoing, we respectfully request that Treasury use its regulatory authority to revise and update Section 31.3402(q)-1 to reflect innovations and changes in today's modern pari-mutuel wagering strategies by providing a definition of "amount of the wager" that includes the total amount wagered by a bettor into a specific pari-mutuel pool for purposes of determining whether wagering proceeds from that specific pari-mutuel pool are subject to withholding and reporting. We further request that Treasury and the Service revise the discussion in the Instructions regarding the treatment of multiple wagers in a manner that includes the total amount wagered by a bettor into a specific pari-mutuel pool when determining whether wagering proceeds are subject to withholding.

6. Summary

The current regulations relating to pari-mutuel reporting and withholding need to be updated for the following reasons:

• In the absence of a specific regulation concerning the definition of the "amount of the wager," the horse industry is forced to rely on the Instructions for Forms W-2G and 5754. The guidance provided by these Instructions does not reflect today's wagering strategies in which the vast majority of wagers are multi-horse and multi-race exotic bet types but instead reflects a bygone era when almost all wagers were straight win, place or show bets that had virtually no chance of exceeding the 300:1 ratio of wagering proceeds to "the amount of the wager;"

• The Instructions assume that a bettor has won more than he or she has actually won based on a calculation of "the amount of the wager" that ignores the actual investment in a single pari-mutuel pool;

• Due to this outdated and unfair method of calculating the "amount of the wager," excessive withholding and reporting are taking bettors' winnings out of circulation -- money that otherwise would be repeatedly re-bet;

• Undue withholding and reporting of winnings and the resulting lack of re-betting, depresses pari-mutuel wagering and the benefits that wagering supplies to all stakeholders including federal and state governments, which derive significant tax revenue from pari-mutuel wagering, as well as the nationwide agri-business that pari-mutuel wagering supports;

• An update to the regulations to reflect today's pari-mutuel wagering strategies will result in more accurate reporting and withholding by taxpayers and is consistent with IRC Section 3402(q) and basic tax policy; and

• Modernization will reduce burdensome and needless paperwork system-wide.

If you have any questions, or if we can be of any assistance in your consideration of the issues summarized above, please do not hesitate to contact the undersigned at the NTRA offices: 859-422-2602 or awaldrop@ntra.com.

Finally, we respectfully request the opportunity to appear before any hearing held by Treasury or the Service related to the proposed regulation project (REG-132253-11) to speak in support of these proposed changes to Section 31.3402(q)-1.

² IRC section 3402(q)(3)(C)(ii).

³ IRC section 3402(q)(4)(A).

⁴ Treas. Reg. sec. 31.3406(g)-2(d)(2).

⁵See Treas. Reg. sec. 31.3406(g)-2(d)(3); see also 2015 Instructions for Forms W-2G and 5754.

⁶ The Service adopted a similar position in PLR 7823066 (March 13, 1978).

⁷ If the individual itemized when filing his or her tax return, the individual may be able to get back the over-withholding by claiming the balance of what was bet on the Trifecta as a miscellaneous itemized deduction on his or her tax return unless the individual is subject to the Alternative Minimum Tax (AMT). Of course, this would not be available to an individual who does not itemize when filing his or her return. Also, many states limit the gross amount of itemized deductions for state tax purposes, even when these deductions are legitimate claims of loss against profits.