Nonresident's Slot Machine Winnings Taxed As Not Effectively Connected With A U.S. Business

Sang J. Park (2011), 136 TC No. 28

The Tax Court has held that a South Korean nonresident alien's gambling winnings from slot machines were taxable under Code Sec. 871(a) as U.S.-source that's not “effectively connected” with a U.S. business.

Background. A nonresident alien engaged in a U.S. business, at any time in the tax year, is taxed at regular U.S. rates on taxable income effectively connected with that business—i.e., the gross income effectively connected with the U.S. business, less allowable deductions. (Code Sec. 871(b))

On the other hand, a nonresident alien is taxed at a flat 30% (or lower treaty rate, if applicable) on certain U.S.-source that's not effectively connected with a U.S. business. (Code Sec. 871(a)) Income that is so taxed includes certain types of gambling winnings (but not winnings from blackjack, baccarat, craps, roulette or big six wheel, except to the extent provided in regs). (Code Sec. 871(j)) Income that is so taxed also includes interest (other than original issue discount (OID) and certain portfolio and bank account interest), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments and other fixed or determinable annual or periodical gains, profits and income. (Code Sec. 871(a)(1)(A))

Facts. Sang J. Park, a South Korean national and nonresident alien, had U.S. gambling winnings from slot machines and interest income that was not effectively connected with a U.S. trade or business.

During the years in issue, he traveled to the U.S. for vacation and to visit his family a number of times. During these trips, he often played the slot machines at the Pechanga Resort & Casino (Pechanga) in Temecula, California. He did not have a business plan and did not keep books and records with respect to the gambling activity. For 2006, he had total gambling winnings of $431,658, and losses that exceeded his winnings by $4,663. For 2007, he had total gambling winnings of $103,874, and losses that exceeded his winnings by $45,131.

He also received from sources within the U.S. other income that was not effectively connected with a U.S. trade or business in 2006: (1) Interest income of $6,585; (2) capital gain income of $52,792; and (3) dividend income of $7,471.

Court's conclusion. The Tax Court held that Sang J. Park's gambling activities weren't personal services or a U.S. trade or business. Accordingly, the gambling income wasn't considered income that was effectively connected with a U.S. trade or business. It was taxable under Code Sec. 871(a) as U.S.-source income that's not effectively connected with a U.S. business. Sang J. Park was liable for the accuracy-related penalties under Code Sec. 6662(a) and Code Sec. 6662(b)(1) or Code Sec. 6662(b)(2).

The Court reasoned that a nonresident alien generally can't deduct or offset gambling losses against gambling winnings. Thus, a nonresident alien who isn't engaged in gambling as a business within the U.S. is subject to tax under Code Sec. 871 on gross income from gambling without a deduction for gambling losses. Sang J. Park didn't exhibit the use of personal skills or strategies when he played the slot machines. Thus, his gambling activities weren't personal services. He also failed to show that he was involved in the gambling activity with continuity and regularity, with the primary purpose of generating income or profit. Thus, he didn't show that he was engaged in a trade or business.

The Court further held that the interest income reported by a third party U.S. national bank was excluded from income tax under Code Sec. 871(i)(1) and Code Sec. 871(i)(2) as income from bank deposits. Sang J. Park failed to shown that the remaining interest income was from deposits that qualified for U.S. tax exemption under Code Sec. 871(i).

The Tax Court also rejected Sang J. Park's claim that he was entitled to an exemption from U.S. tax on the gambling income under the applicable treaty. The Court held that the Treaty of Friendship, Commerce and Navigation, U.S.-S. Kor., art. XI, par. 5(b), Nov. 28, 1956, 8 U.S.T. 2217, provides exceptions to the most favored-nation treatment under art. XI, par. 3, and thus did not extend to South Korean nationals the more favorable treatment on exemption from U.S. income tax of gambling winnings (as provided for in some bilateral income tax treaties that the U.S. has entered into with other foreign countries).

References: For taxation of U.S.-source income not effectively connected with a U.S. business, see FTC 2d/FIN ¶O-10201; United States Tax Reporter ¶8714.02; TaxDesk ¶632,001; TG ¶30091.