Article: Gambling and Taxes

[nukeduke]

For those of you who like pin head tax stuff

I've bolded what I think are the interesting parts, nearer to the end.


Win or Lose, Gambling Activity May Affect Your Tax Return


By E. Lynn Nichols, CPA

The proliferation of Casinos, seen by many state and local governments as revenue raisers that are more palatable than new taxes, has brought a parallel increase in tax disputes between taxpayers and the IRS on two issues:

(1) The amounts of taxable winnings and deductible losses;

(2) The classification of the gambling activity as recreation, or a business undertaken with a profit motive.

Let's take the easy issue first. Gambling income is fully taxable . . . gambling losses may not exceed gambling winnings, and unless the taxpayer is engaged in the business of gambling those losses are not deductible in determining adjusted gross income. Recordkeeping is made somewhat easier by the computerized records maintained by many casinos for their slot players' activity cards. But what if all the wagering is not in a casino where the player is registered? The taxpayer is supposed to maintain a “contemporaneous record” of gambling activity to substantiate losses. But what if that wasn't done ? A recent decision of the U.S. Tax Court, Francis M. Gagliardi v. Commissioner, T.C. Memo. 2008-10, relied in part on withdrawals from ATM machines along with the testimony of credible witnesses to establish that Mr. Gagliardi gambled as much as 20 hours a day, for as many as 250 days per year, and not always in casinos where he had a player's card. The court allowed all of his claimed losses.

In another recent dispute, the taxpayer was not able to prove she was entitled to more losses than the IRS allowed (in which the Service had given her the benefit of the doubt based on fragmented records). Kathleen Jackson had no contemporaneous record, no credible witnesses, and no argument other than that she must have lost more than she won, because she was deeper in debt at the end of the year than the beginning. (Kathleen Jackson v. Commissioner, T.C. Memo. 2007-373).

So . . . the first lesson for tax preparers is that the taxpayer should have reliable contemporaneous records to substantiate gambling losses. Without those records, supporting claimed losses will be an uphill battle.

The second issue is more complex. Is the taxpayer engaged in gambling as a trade or business ? The seminal decision . . . cited in all that have followed . . . is the Supreme Court's 1987 holding in Commissioner v. Groetzinger, 480 U.S. 23. Mr. Groetzinger had no other job than playing the horses. He spent up to 60 hours per week reading the Racing Form and attending races where he placed wagers, either at the track or off-track betting facility. The most recent taxpayer victory on this issue is Linda M. Myers v. Commissioner, T.C. Summ. Op. 2007-194. Unlike Mr. Groetzinger, she had other work, but only for about 25 hours per week. She spent 40 or more hours per week at various casinos playing slot machines. She had player's club records to support most of that activity. The Court applied the “nine factor” test usually reserved for Section 183 “hobby loss” disputes to find that Ms. Myers was engaged in her gambling activity with a profit motive.

How important is that determination ? Well, if the taxpayer is engaged in gambling as a business (with a profit motive) then gambling losses can be deducted against gambling winnings when determining adjusted gross income (AGI) instead of as itemized deductions where the losses would be subject to other limitations.

One final point . . . in a number of cases involving gambling income, the taxpayer has reported only amounts from Forms W-2G as income. Various Tax Court Judges, in particular, have insisted that there must be OTHER winnings as well. The theory being that anyone who gambles enough to win a major jackpot has probably won some minor jackpots as well.

The lesson for tax preparers in all this is that we should advise our clients of the rules, the winning arguments and the losers, and prepare returns that are supported by the client's records.