Back in the 60s if you wanted to “gamble” you went to Las Vegas. Then Atlantic City opened up shop in the 70s as did many State Lottery games. After President Reagan signed the Indian Gaming Regulatory Act (IGRA) you even had more choices in the 80s. More recently in the early 21st century internet gambling opened up for business. According to the American Gaming Association, Americans now gamble over $50 billion annually with no end in sight. With all these new gaming venues, more and more Americans are trying their luck at games of chance, and chances are good you will win, at least every so often. When you win be prepared to be issued by the Casino or State form W2-G and be prepared to pay income tax on those winnings. But I am betting you just might have gambling losses you can offset against your winnings. So if you have the good fortune to have substantial gambling winnings in 2014 or plan to in 2015, stay tuned to TaxView with Chris Moss CPA to learn how to properly document your gambling losses to save you taxes.
The Revenue Act of 1934, limited gambling losses to gambling winnings as per Code Section 165(d) to encourage, according to the House Committee Report on Prevention of Tax Avoidance, gamers to report their winnings. Fifty years later, the US Supreme Court carved out a “professional gambler” (PG) designation as a full time business trade in Groetzinger 480 US 23 (1987). Today you are either a Professional Gambler (PG) or like most of us a hobby gamer (HG). IRS regulations 31.3402-1 requires both types of gamers to be issued Form W2-Gs with tax withheld generally from winnings in excess of $5000. Seems easy enough? That what Las Vegas Hobby Gamer (HG) Francis Gagliardi thought back in the late 90s as evidenced in Gagliardi v IRS, US Tax Court (2008).
Gagliardi (HG) was audited by the IRS for 1999-2001 with the IRS disallowing most of his gambling losses as not adequately substantiated. Gagliardi appealed to US Tax Court in Gagliardi v IRS, US Tax Court (2008). The court noted that Gagliardi submitted bank statements, cash withdrawals at casinos, credit card statements, and gambling calendars showing most of Gagliardi’s gaming activity from 1999-2001 in addition to supplemental Players Club Card records issued by the Casino. Judge Vasquez heard credible testimony from Gagliardi’s tax preparer, Mr. Hunner, as well as Hunner’s presentation of cash flow and net worth analysis. The Court concluded that Gagliardi’s expenses were creditable. Gagliardi wins, IRS loses.
Ronald Lutz (HG) was not so lucky in Lutz v IRS, US Tax Court (2002). Lutz, like Gagliardi was an HG, and gambled for many years in Mississippi and Louisiana casinos. Lutz filed his 1996 tax return without reporting any gambling activity. The IRS audited Lutz and determined $91,000 of unreported gambling winnings based on 18 W-2G forms that had been filed by the Casinos. Lutz appealed to US Tax Court in Lutz v IRS US Tax Court (2002) claiming his losses offset his winnings. The Court found that Lutz did not keep good records like Gagliardi. Lutz did not take advantage of casino based tracking system records based on the use of a “Players’ Club Card” as did Gagliardi. While the Court noted that use of a Players Club Card is not in itself enough to substantiate gambling losses, citing Mayer v IRS US Tax Court 2000-295 (2000), the Players Club Card could be an important supplement to a daily gambling log as used in Gagliardi.
Judge Thornton also noted that Lutz failed to produce a net worth analysis like Gagliardi did. Furthermore, Lutz’s own testimony was not credible. Finally, the Government showed that Lutz had purchased new cars in 1996 and showed other increases in net worth that year, evidence that his winnings were greater than his losses. The Court then admonished Lutz noting he could have avoided losing by keeping daily records of his gambling activity and actively using the Casino issued Players Club Cards at least to supplement his own records. IRS Wins, Lutz loses.
Our next case involves Professional Gambler (PG) William Praytor who bet that Section 165(a) was broader in scope than the Courts had previously recognized. On Schedule C of his 1994-1996 tax returns Praytor deducted over $41K of expenses in addition to his gambling losses. The IRS audited those years and disallowed all those other losses because in accordance with Section 165(d) gambling losses are only allowed to the extent of gains.” Praytor (PG) appealed to US Tax Court in Praytor v IRS US Tax Court (2000). Judge Carluzzo, citing Offutt v IRS US Tax Court (1951) notes that Courts have disallowed all expenses in connection with gaming over and above winnings. Also citing Todisco v IRS 757 F.2d 1 (Ist Cir 1985), Kochevar v IRS US Tax Court (1995), Valenti v IRS, US Tax Court (1994) and Kozma v IRS US Tax Court (1986) clearly establishing that Congressional intent was to “force taxpayers to report their gambling winnings” as per H. Report 704 73rd Congress (1934). IRS wins, Praytor loses. Bad luck and timing for Praytor, because by 2011 Offutt and all the above related cases were overturned by Mayo.
Mayo, a California PG filed his 2001 tax return with not only gaming wager losses but some additional expense in connection with his horse racing gambling business resulting in a business loss of $22,265 in excess of gambling winnings. Included in this loss was car and truck, meals and other routine office expense. The IRS audited Mayo and disallowed all excess loss in accordance with IRS Section 165(d). Mayo appealed to US Tax Court in Mayo v IRS US Tax Court (2011), citing US Supreme Court case Groetzinger 480 US 23 (1987) allowing for an interplay between Section 165(d) and Section 162(a). In a surprise ruling Judge Gale overruled the Offutt v IRS 1951 US Tax Court and similar lines of cases which held Section 165(d) does not provide for any loss over winnings, even if the loss was created by normal Section 162(a) expenses like auto, office rent, insurance and supplies. Judge Gale notes that the legislative history of Section 165(d) does not specifically address whether or not additional expenses are deductible to create a “loss” in excess of winnings, and therefore the Court held that Offutt v IRS US Tax Court 1951 will no longer be followed. Mayo wins big, IRS loses.
Our final case post Mayo just decided in 2014 is Lakhani v IRS US Tax Court (2014), a California CPA who turned professional gambler to offset his profitable accounting practice with gambling losses from California pari-mutuel wagering on horse races on his 2006-2009 tax returns. The IRS audited and disallowed all losses in excess of winnings. Lakhani appealed to US Tax Court in Lakhani v IRS US Tax Court (2014).
Just so you know, pari-mutuel wagering creates a “handle” or betting pool from all bets. From the pool a share or “takeout” generally ranges from 15% to 25% of total receipts. The “takeout” will change depending on whether the bet is “straight” or “conventional” “win”, “place” or “show” or “exotic”. What remains from the takeout constitute the track profit. After track expenses remains what is paid to the winning bettors.
Lakhani argued that in extracting “takeout” from betting pools, the race track managers were acting as his fiduciary similar to that of an employer collecting payroll taxes. Citing Mayo v IRS US Tax Court (2011), Lakhani asserted that his losses were not from gambling but were simply his pro rata share of the takeout and therefore not subject to the limitations of Section 165(d).
Unfortunately for Lakhani, who was acting Pro-Se, Judge Halperin raised the stakes in the game noting that in California “the takeout cannot add to the loss of the losing gambler.” A gamer loses the same $2 bet whether the takeout is 10%, 15% or 20% of the “handle”. Therefore Judge Halperin concluded the “takeout” does not qualify as Lakhani’s deductible nonwagering business expense, citing the same case Lakhani cited Mayo v IRS US Tax Court (2011). IRS had the winning hand, Lakhani folded.
So how should AGs and PGs plan their year-end 2014 tax strategy to save taxes? If you are just an AG and happen to win the big lottery jackpot, make sure you can prove all your losses to offset those winnings. First use the Casino Players Club Card to keep track of your gains and losses. Make sure your gains match up to your W-2G. Second keep your own extemporaneous daily logs including bank and credit card statements of winnings and losses so you can fully take advantage of Section 165(d) and save taxes on your winnings. If you are claiming total offset of gains and losses have your CPA work with your tax attorney to prepare a net worth and cash flow analysis for inclusion in your tax return. Finally, if you’re a PG review the Mayo ruling with your tax attorney. While not fully settled in all Circuits, based on the Government conceding in the 9th Circuit to Mayo in 2012, I would bet you have favorable odds to deduct normal Section 162(a) expenses for you PG business.
Merry Christmas to all and a Happy 2015 New Year from TaxView with Chris Moss CPA.
Thank you for joining us on TaxView,
See you all next year in 2015.
Chris Moss CPA