The tax situation in many states is even worse than you describe -- I know for certain that in Indiana and Illinois, state income tax is on gross winnings, with no offset for losses. So if you report $40,000 in winnings (either because you have that in W2Gs, or because you are honestly reporting all your winning sessions) and $50,000 in losses on your federal return, you would owe no federal tax, but would pay state gross income tax on $40,000.
This first REALLY sank in on me when I was playing much higher stakes than I do now (after retirement), and on $10 machines, was getting W2Gs for every quad or higher. W2Gs are why you sometimes see 249 payout for straight flushes instead of 250 on some $5 machines.
The "solution" to give the casino "action" at a higher level while not generating W2Gs (and assuming you do NOT report all your gambling income as required, but ONLY W2Gs) is to play quarters, but on multi-line machines. e.g., 10-play $0.25 machine is $12.50 a hand, as if it were a one-line $2.50 machine, but (1) you have less volatility, and (2) your royals will be less than the amount to generate a W2G - unless dealt, of course.
The downside is you never get to take home a really big jackpot relative to the amount you're betting, unless you get it dealt to you.
Taxes have been discussed at length here before, and the bottom line is that those who tax us are not sympathetic to the realities of gambling income and losses.
--BG
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