Ok, here's the deal about this, once and for all. I'm going to make up numbers to help illustrate how things works.
In order to avoid that whole "Tax Evasion" thing that the IRS frowns upon for some crazy reason, you need to report every last dollar that you earned playing poker (and babysitting and mowing lawns and dancing at the local strip club, etc). The problem comes about in that you can't just report that you won $500 playing poker in 2005. Instead, the IRS wants you to report that you won $192,500 and lost $192,000 (note that the net is still $500).
No, this does not put you in a higher tax bracket, and yes, you still only end up paying taxes on $500 more than you would have had you not had any poker income to report.
However, the problem comes about because now, instead of having a $50,000 per year salary (from your hypothetical day job) + $500 in poker winnings = $50,500 that you need to pay taxes on, you actually have a $50,000 salary + $192,500 in poker winnings = $242,500 in total income, less $192,000 in poker losses = $50,500 that you need to pay taxes on.
Well, that doesn't look so bad. Note that the bold amounts still match, so the bottom line due to Uncle Sam should be exactly the same, right?
Wrong! Why? Because, when determining your eligibility for a number of other deductions/credits, the IRS looks at the BIG number (the one before the poker losses were written off - in this case, $242,500). So, while you really only earned $50,500 for the year, the IRS sees the $242,500 number and decides you have plenty of money and shouldn't be allowed to write off a number of things that you could otherwise. And that sucks.
Unfortunately, that's just the way it is.
Breaking this down a bit more, where does the data come from that makes up that $192,500 in wins and the $192,000 in losses I mentioned above? Well, those are your "session" totals from all your winning sessions and all your losing sessions. Yes, you need to add them all up and report the totals (I hope you are keeping good records!). Unfortunately, in this day and age and with online poker, the IRS's definition of a "session" doesn't really apply any more, and it's very vague at best. Playing online, you can easily play in 4, 5, 6, or even 12 games at once and easily be involved in 20+ different virtual tables without your physical ass ever leaving it's physical chair. So really, that was all one "session" for you.
This is where the script above comes in. By running it, you are able to combine your multiple virtual table sessions into more reasonable playing sessions. It groups them by day, which is not perfect, but is pretty good and (IMO anyway) very reasonable.
What's the net effect of this? Well, your $192,500 and $192,000 numbers will be reduced to something more like $68,500 and $68,000 (again, I'm totally making up these numbers). So now your total income will be your $50,000 salary + $68,500 in poker winnings = $118,500 in total income, less $68,000 in poker losses = $50,500 that you need to pay taxes on. Yes, we're still at the magical $50,500 number... BUT.... note that that big number went from $242,500 down to $118,500. Yes, this is still WAY higher than your actual $50,500 for the year (and this will still cost you), but this may allow you to keep some of those deductions that the larger number would have caused you to miss out on.
Overall, the system pretty much sucks. And because it's so ridiculous, I can see why so many people choose to ignore their poker income all together when reporting their taxes. This is a very big risk, of course, but when it's this much of a pain in the ass, can the IRS really blame people?
Anyway, that's that. Hopefully that helps explain things to those who are lost, which as best I can tell from this site and others that I've visited is pretty much everyone. I'm not an accountant or a tax advisor or anything like that, nor do I claim that everything written here is 100% accurate. This is simply my understanding of how things work.
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