Adam N. Michel
Millions of Americans will lose money this month. Some will drop $20 in the office March Madness pool. Others will wager on the ever-expanding number of betting apps. A few will win big. Most people will lose money.
Under longstanding tax rules, gambling winnings are taxable income. If you hit it lucky in your office March Madness pool, the Internal Revenue Service (IRS) expects its cut. The tax code has historically allowed professional gamblers and taxpayer who itemize to deduct their full losses against their winnings. This recognizes the basic principle that you should be taxed on your net income, not your gross receipts.
Starting this year—thanks to the One Big Beautiful Bill Act—gamblers can only deduct 90 percent of their losses. That means a gambler who breaks even over the year will still owe tax on income they never actually earned.
The gambling change may seem small, but for professional gamblers, it could be disastrous. It also reflects a broader feature of the rest of the US tax code, which systematically limits how taxpayers can use losses across the economy.
The Tax Code Makes Losing More Painful
A neutral tax system should measure and tax real income, which is what’s left after paying the costs of earning it. Those costs aren’t just wages, investments, and supplies; they are also the risk of loss. Gambling makes this intuition clear. If you win $10,000 on a lucky run but lose $10,000 over the rest of the year, your real income is zero. But under a rule that limits losses, the IRS still taxes you as if you came out ahead.
As with gambling, many investments lose money, leaving businesses and their investors in the red at the end of the year. Allowing full and immediate deduction of losses ensures the tax code treats good years and bad years symmetrically. Otherwise, the tax code could end up taxing profits that don’t actually exist yet, whether it’s a gambler who just breaks even over the year or a business that hasn’t yet recovered its start-up costs.
When loss deductions are delayed, capped, or denied, the government systematically overstates taxable income, effectively penalizing the risk-taking that generates the income in the first place.
Like gambling losses, business losses should be fully usable. In an ideal system, a start-up business that invests heavily in its first five years without turning a profit could bank those losses to fully offset future-year profits until the firm is truly profitable over its full lifecycle.
But current tax law limits the use of net operating losses (NOLs) from prior years. Following changes in 2017, most businesses can no longer carry losses back to prior profitable years and, instead, must carry them forward (without indexing for inflation). C corporations can only offset 80 percent of their taxable income with past losses. Pass-through businesses face limits that can be even more restrictive. The excess business loss rule caps the amount of loss that can offset other income in a given year, and the passive loss rules restrict the use of losses from certain activities against other income. Like gamblers down on their luck, any business that faces these limits will owe taxes on phantom profits before it has fully recovered losses.
A similar problem exists for individual investors. If a taxpayer sells an asset at a loss, those capital losses can offset capital gains in that year. But if losses exceed gains, only $3,000 of losses can be deducted against other sources of income each year. The rest must be carried forward.
In real terms, delayed deductions carried forward to future tax years lose value due to inflation and time. By not allowing losses to offset other sources of income and by not indexing carried forward losses, the IRS taxes profits immediately and fully, only partially recognizing losses. The longer losses must be carried forward, the less they are worth, which means start-up businesses that take longer to succeed face higher effective tax rates.
These rules can shape real economic behavior. Similar to gambling, entrepreneurship and investment are inherently risky. Often, multiple projects fail before one returns a profit. When the tax code limits loss recovery, it raises the effective tax rate on the riskiest activities. The ability to deduct losses fully and promptly is critical so the tax system does not discourage entrepreneurial risk-taking.
Fixing the Problem
Congress should reverse the limitation on gambling losses. Taxpayers should be allowed to deduct 100 percent of their losses.
But the real reform agenda should go much further. All forms of losses should be allowed to offset ordinary income, and any losses carried forward should be indexed for inflation. Businesses should also not face arbitrary limits on NOLs.
If policymakers are serious about growth, innovation, and economic dynamism, they should start by fixing how the tax code treats failure. Whether it’s a busted bracket in March or a failed start-up, the tax system shouldn’t just share in the upside; it should account for the downside too.
