Examples of Gaming Taxation
Planning, Review & Preparation
Become a client here
Rank of Hands
Gambler's Tax Fraud
Fox News Story 2/24/2006
|Copyright© 2005 to 2011 Colin M. Cody, CPA and ProfessionalGamblerStatus.com, LLC, All Rights Reserved.|
The Ronald Andrew & Leslie Archer Mayo case January 25, 2011
The Linda Myers case November 19, 2007
The Jose Calvao case March 8, 2007
The Gloria Tschetschot case February 20, 2007
The Peter B Stone (Connecticut) case February 7, 2007
Curriculum vitae of Robert C. Hannum Ph.D., State's expert witness
The Jimmie Clemons case August 1, 2005
The Pansy Panages case Janyuary 4, 2005
The Edward Hamilton case July 12, 2004
The Ruthe Ohrman case October 29, 2003
The Leroy Vernon case September 10, 2001
The Paul Leblanc case June 22, 2001
The Eldron Erbs case June 13, 2001
The Juan Rodriguez case February 24, 2001
William T. and Deborah S. Praytor 8/31/2000
Summary of the decision: Gambling losses are deductible only to the extent of winnings. But in agreement with the position taken by ProfesssionalGamblerStatus.com, the operating expenses of the business, such as meals, lodging and transportation are not treated as wagering losses. Rather these costs are used to offset self-employment tax in other trades or businesses and current year federal and state income taxes, and further, they can create a net operating loss (NOL) and be carried back to offset prior year's federal and state income.
Offutt v. Commissioner, 16 T.C. 1214 (1951) interpreted that "Losses from wagering transactions" covers both the cost of wagers placed as well as the more general expenses incurrent in the conduct of a gambling business. This intrepretation has generally been followed by this Court in the 60 years since that case was decided, but no Court of Appeals (other than that for the 1st Circuit in Estate of Todisco) has had occasion to directly address it. This Court now has concluded that interpretation should no longer be followed.
KROUPA, Judge: This case was heard pursuant to the provisions of section 7463(1) of the Internal Revenue Code in effect at the time the petition was filed. Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case.
Respondent concedes that petitioner is not liable for the accuracy-related penalty under sec. 6662(a). Respondent determined a $5,266 deficiency in petitioner’s Federal income tax for 2003 and determined that petitioner was liable for a $1,055 accuracy-related penalty under section 6662(a). After concessions,(2) the sole issue for decision is whether petitioner was in the trade or business of gambling in 2003. We hold that she was.
Some of the facts have been stipulated and are so found. The stipulation of facts and the accompanying exhibits are incorporated by this reference. Petitioner resided in South Saint Paul, Minnesota, at the time she filed the petition.
Petitioner spent nearly all of her time during 2003 pursuing two activities, a trucking business that she owned and operated, and her gambling activity. She spent 25 to 35 hours per week working at the trucking business and about 40 hours per week on the gambling activity.
Petitioner oversaw the management and operations functions of her trucking business, which employed eleven drivers for eight trucks in 2003. She worked diligently to maintain the documentation required to run a successful trucking business, such as licenses, maintenance logs, and insurance matters. Petitioner retained an accountant to assist her with financial recordkeeping. Petitioner received a $28,000 salary and $36,000 nonemployee compensation from the trucking business in 2003. Petitioner’s gambling activity consumed the rest of her time. In fact, a typical day for petitioner involved working at the trucking business until 1 or 2 p.m., followed by a trip to the casino that typically lasted until 2 a.m. to 6 a.m. Petitioner would then return home and sleep for a little while before arising the next day to follow the same routine. Petitioner’s children, who had lost their father in an automobile accident, were extremely worried about petitioner’s early morning drives home from the casino, particularly in the wintertime. Nevertheless, petitioner gambled and made these late night trips home nearly every day.
Petitioner originally began gambling in 1992 after her husband’s death, focusing on the $1 slot machines. When she first began gambling, petitioner would occasionally talk with other gamblers. Petitioner became increasingly serious about her gambling pursuits as time progressed and as she became accustomed to the casinos and learned more about their operations. She considered herself a professional gambler by 2000. Petitioner viewed herself as a gambling expert but found no pleasure in gambling. Instead, she considered gambling stressful, tiring, and time consuming. She did not go to the casino with friends or companions and was focused on doing everything she could to win while she was there.
Petitioner developed certain strategies she felt would maximize her odds of winning. Petitioner’s primary strategy was essentially to locate and play those slot machines that were due to make a payout. Petitioner strategized that the more money put into a machine without a payout increased the odds of a payout. Petitioner would speak with the casino attendants upon arriving at the casino to determine which slot machines to play. The attendants would describe what had happened so far that day, which slot machines were played most heavily but had made no payouts, and which slot machines had made payouts. The attendants knew this information because they made the payouts by hand to gamblers who won over a certain amount. Petitioner also sometimes watched other gamblers playing slot machines to learn the slot machines’ patterns. After learning this information, petitioner identified those slot machines petitioner considered “ripe” for a payout and played them.
Petitioner gambled about $500 in each of five slot machines that she felt were good candidates to make payouts on a typical day at the casino. Petitioner would carefully watch the results of each machine once she began using it. If the slot machine began giving her free plays, doubles, or triples, she viewed that as a very good sign and an indication that the slot machine was about to make a large payout. These results validated petitioner’s choice of slot machine and convinced petitioner to continue playing that machine. Petitioner also strategized from her experience that a slot machine would stay “hot” for a few weeks once it started paying.
Documentation of the Gambling Activity
The casinos gave petitioner Forms W-2G, Certain Gambling Winnings, when she won $1,200 or more on the slot machines. The casinos also provided petitioner a player card that she could insert into the slot machines to track her activities. The player card, when inserted into the machine, would record the amounts petitioner gambled and the amounts she won. Each year, the casinos would process the player card information to generate an annual profit and loss statement for petitioner. While petitioner used her player card most of the time, she did not use it every single time. The profit and loss statements were thus not a complete reflection of petitioner’s gambling activities because they lacked any gambling petitioner did without the player card.
Petitioner was not interested in the non-recordkeeping benefits the player card offered, such as free lodging and meals. She only wanted it to track her profits. In fact, petitioner was disappointed when the casino offered her a free trip to Las Vegas because she thought she must have been losing too much money at her gambling activity for the casino to offer her such a trip and an opportunity to lose more.
Petitioner did not find it necessary to keep her own written set of separate gambling records. She knew in her head how much she had won or lost each day. In addition, the casinos documented her activities through the player card system. Petitioner did retain bank statements, canceled checks, credit card statements, the Forms W-2G, and the profit and loss statement, which documented the gambling activities. Petitioner did not make a budget for the gambling activity but generally knew how much she entered the casino with each time.
Success of Petitioner’s Gambling Activity
Petitioner did not report an overall profit from her gambling activities in the 3 years before and the year after the year at issue. She has won large jackpots several times, however, including $50,000 twice. She won jackpots of $1,200 or more over 300 times during 2003. Petitioner also has taken home as much as $45,000 profit from 1 day’s gambling. Despite the occasional large jackpots, petitioner was concerned that she continued to lose money. She changed her strategy accordingly. Petitioner tried to focus on winning a little bit at a time rather than try to earn back large losses in one night. For example, if petitioner won money early in the afternoon, petitioner would go home rather than stay at the casino and play more to try to recoup old losses.
Petitioner has treated herself as a professional gambler on her income tax returns since at least 2000. Petitioner used the same accountant that helped with the trucking business to assist her with matters related to the gambling activity and to prepare her individual returns.
While sec. 165(a) generally permits the deduction of losses from gross income, there is a special rule limiting the deduction of gambling losses. Losses from wagering transactions may only be deducted to the extent of gains from wagering transactions. Sec. 165(d).
Petitioner filed her return for 2003 reporting that she was in the trade or business of gambling. She deducted her gambling losses as an expense to the extent of her gambling winnings, totaling $1,408,740 in 2003. Respondent examined petitioner’s return for 2003 and issued a deficiency notice. Petitioner timely filed a petition.
The sole issue for decision is whether petitioner was in the trade or business of gambling in 2003. If petitioner was in the trade or business of gambling, she may deduct her wagering losses to the extent allowable in computing adjusted gross income.(3) See sec. 62. If petitioner was not in the trade or business of gambling, on the other hand, she may only deduct the wagering losses to the extent allowable as an itemized deduction to compute taxable income. See Calvao v. Commissioner, T.C. Memo. 2007-57.
All ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business are generally deductible. Sec. 162(a). An activity must be conducted with continuity, regularity, and the primary purpose of earning a profit to be considered a trade or business under section 162. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). Whether the taxpayer is carrying on a trade or business depends on the facts and circumstances.(4) Id. at 36.
Respondent has conceded that petitioner’s gambling activity was conducted with the required continuity and regularity during 2003. The parties dispute, however, whether petitioner’s primary purpose for engaging in the activity was to earn a profit. See id.; Miller v. Commissioner, T.C. Memo. 1998-463, affd. without published opinion 208 F.3d 214 (6th Cir. 2000). We examine whether the taxpayer engaged in the activity with the actual and honest objective of making a profit. See Evans v. Commissioner, 908 F.2d 369, 373 (8th Cir. 1990), revg. T.C. Memo. 1988-468; Keanini v. Commissioner, 94 T.C. 41, 46 (1990); Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income Tax Regs. While a taxpayer’s expectation of profit need not be reasonable, there must be a good faith objective of making a profit. Allen v. Commissioner, 72 T.C. 28, 33 (1979); sec. 1.183-2(a), Income Tax Regs. We give greater weight to objective facts than to a taxpayer’s statements of intent. Dreicer v. Commissioner, supra at 645; sec. 1.183-2(a), Income Tax Regs.
We structure our analysis around nine nonexclusive factors. Sec. 1.183-2(b), Income Tax Regs. The nine factors are:
No factor or set of factors is controlling, nor is the existence of a majority of factors favoring or disfavoring a profit objective necessarily controlling. Hendricks v. Commissioner, 32 F.3d 94, 98 (4th Cir. 1994), affg. T.C. Memo.
1993-396; Brannen v. Commissioner, 722 F.2d 695, 704 (11th Cir. 1984), affg. 78 T.C. 471 (1982); sec. 1.183-2(b), Income Tax Regs. The individual facts and circumstances of each case are the primary test. Keanini v. Commissioner, supra at 46; Allen v. Commissioner, supra at 34; sec. 1.183-2(b), Income Tax Regs.
We now examine each of the nine nonexclusive factors. Manner in Which the Taxpayer Carried On the Activity We begin by examining the manner in which petitioner carried on her gambling activity. The fact that a taxpayer carries on the activity in a businesslike manner may indicate a profit objective. Sec. 1.183-2(b)(1), Income Tax Regs. In determining whether a taxpayer conducted an activity in a businesslike manner, we consider whether the taxpayer maintained complete and accurate books and records, whether the taxpayer conducted the activity in a manner substantially similar to those of comparable businesses that are profitable, and whether the taxpayer attempted changes in an effort to earn a profit. Engdahl v. Commissioner, 72 T.C. 659, 666-667 (1979); sec. 1.183-2(b)(1), Income Tax Regs.
The casinos maintained profit and loss tallies for petitioner through the player card system. Petitioner thus did not find it necessary to keep separate books and records to track this information. She used her player card most of the time to enable the casino to perform this tracking function. Petitioner also did not keep a separate bank account for her gambling activities but kept a tally of the amount she had with her when she went to the casino. See Canale v. Commissioner, T.C. Memo. 1989-619; cf. Calvao v. Commissioner, T.C. Memo. 2007-57 (taxpayer claimed he kept daily records of gambling activity but failed to offer any records into evidence). Petitioner also had no written budget or business plan, although she had a strategy she felt would enable her to win. She explained her strategy in detail to the Court. Petitioner’s strategy was to identify and play slot machines that were due for a payout. She implemented the strategy by carefully gathering information about the playing history of the slot machines in the casino and studying their patterns to determine which slot machines were likely to pay out. Moreover, petitioner testified that after some initial losses she changed her strategy to help her win. She decided to try to win just a little at a time rather than to try to recoup old losses all at once. See Engdahl v. Commissioner, supra at 669. If petitioner won some money early in the day, she would take the winnings and return home, rather than continue to gamble with the money she had just won and risk losing it. We find that this factor favors petitioner. Expertise of Taxpayer or His or Her Advisers We next consider petitioner’s expertise (or the expertise of her advisers) in the gambling activity. Preparing for the activity by extensive study of its accepted business, economic, and scientific practices, and consulting with experts in these matters may indicate that a taxpayer has a profit objective when the taxpayer follows that advice. Sec. 1.183-2(b)(2), Income Tax Regs.
Petitioner considers herself a gambling expert and has gambled for over 10 years. The continuity and regularity of her gambling activity strongly suggest that she is an expert at slot machines. Petitioner also consulted regularly with casino employees to further her gambling strategy and watched other gamblers to understand what she believed to be slot machine payout patterns. We find that this factor favors petitioner.
Time and Effort Expended by the Taxpayer in Carrying On the Activity We next consider the time and effort petitioner expended in carrying on the gambling activity. A taxpayer’s devotion of much time and effort to conducting an activity, particularly if the activity does not have substantial personal or recreational aspects, may indicate an intention to derive a profit. Sec. 1.183-2(b)(3), Income Tax Regs.
Petitioner spent at least 40 hours per week gambling at the casinos. Petitioner would often gamble for 12 to 15 hours at a time, often as late as 2 a.m. to 6 a.m. We acknowledge that gambling activities are often viewed as recreational, enjoyable pursuits upon which many people enjoy spending significant time. See, e.g., Calvao v. Commissioner, T.C. Memo. 2007-57. Petitioner testified credibly, however, that she did not view gambling as a mere recreational pursuit. She credibly testified that she found no pleasure in gambling. Moreover, petitioner did not go to the casino with others and while there, was focused on winning as much money as possible. We find that this factor favors petitioner.
Expectation That the Assets Used in the Activity May Appreciate in Value Another factor to be considered is the expectation that the assets used in the activity may appreciate in value. Sec. 1.183-2(b)(4), Income Tax Regs. The parties agree that this factor does not apply.
Success of the Taxpayer in Carrying On Other Similar or Dissimilar Activities We next examine petitioner’s success in carrying on other similar or dissimilar activities. If a taxpayer has previously engaged in similar activities and made them profitable, this success may show that the taxpayer has a profit objective, even though the current activity is presently unprofitable. Sec. 1.183-2(b)(5), Income Tax Regs. A taxpayer’s success in other, unrelated activities also may indicate a profit objective. Daugherty v. Commissioner, T.C. Memo. 1983-188. A taxpayer’s success in a different business enterprise may be evidence of a profit objective where the taxpayer relied on diligence, initiative, foresight, and other qualities that generally lead to success in business activities. Id.
Petitioner has shown that she was capable of running a successful business through her ownership and operation of the trucking business. Petitioner’s success with the trucking business indicates that she had the skills to operate a business successfully. She relied on the same accountant for her gambling activities and relied on her player card to track her winnings. We find this factor favors petitioner.
Taxpayer’s History of Income or Loss With Respect to the Activity We next examine petitioner’s history of income or loss with respect to the gambling activity. A history of substantial losses may indicate that the taxpayer did not conduct the activity for profit. Golanty v. Commissioner, 72 T.C. 411, 427 (1979), affd. without published opinion 647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(b)(6), Income Tax Regs. Losses during the initial or startup stage of an activity do not necessarily indicate, however, that the taxpayer did not conduct the activity for profit, but losses that continue to be sustained beyond the period that is customarily necessary to bring the operation to profitable status may indicate the taxpayer did not engage in the activity for profit. Engdahl v. Commissioner, 72 T.C. at 668; sec. 1.183-2(b)(6), Income Tax Regs. Abandoning an activity after indications that the activity will be unprofitable signifies that the taxpayer engaged in the activity for profit. Canale v. Commissioner, T.C. Memo. 1989-619. Petitioner has not shown a profit from her gambling activity for the 3 years before and the year after the year at issue. Petitioner persisted in the activity despite the ongoing pattern of losses, although she did change her strategy to some extent. This factor favors respondent.
Amount of Occasional Profits, If Any, Which Are Earned We next consider the amounts of occasional profits, if any, that petitioner earned. Occasional profits the taxpayer earned from the activity, in relation to the amount of losses incurred, the amount of the taxpayer’s investment, and the value of the assets used in the activity provide useful criteria in determining the taxpayer’s intent. Sec. 1.183-2(b)(7), Income Tax Regs. A practical possibility that a taxpayer could earn enough money in a year to exceed expenses also can indicate a profit objective. Bolt v. Commissioner, 50 T.C. 1007, 1014-1015 (1968).
Petitioner has occasionally won jackpots as large as $50,000 from her gambling activity. Petitioner won sums of $1,200 or more over 300 times in 2003. Her frequent wins and occasional big wins indicate the possibility that petitioner could have earned enough to cover her expenses in a year. This factor favors petitioner.
Financial Status of the Taxpayer
We next examine petitioner’s financial status. If a taxpayer does not have substantial income or capital from sources other than the activity in question, it may indicate that the taxpayer engages in the activity for profit. Sec. 1.183-2(b)(8), Income Tax Regs. Conversely, substantial income from sources other than the activity, especially if the losses generate large tax benefits, may indicate that the taxpayer is not conducting the activity for profit. Id. Those with substantial income from other sources have a much greater tax incentive to incur large expenditures in a hobby type of business. Jackson v. Commissioner, 59 T.C. 312, 317 (1972). Petitioner earned $64,000 from the trucking business in 2003. Merely because petitioner had another source of income in 2003 is not dispositive, however. See Calvao v. Commissioner, supra. None of petitioner’s income from the trucking business could be offset by gambling losses due to the limitation on deducting gambling losses only to the extent of winnings. See sec. 165(d). Petitioner thus had no tax incentive to engage in the gambling activity to shield income from other endeavors. We conclude that this factor is neutral.
Whether Elements of Personal Pleasure or Recreation Are Involved We next examine whether elements of personal pleasure or recreation were involved in the gambling activity. The presence of recreational or pleasurable motives in conducting an activity may indicate that the taxpayer is not conducting the activity for profit. Sec. 1.183-2(b)(9), Income Tax Regs.; see Calvao v. Commissioner, T.C. Memo. 2007-57 (taxpayer’s gambling strategy and desire to win found consistent with gambling for entertainment or recreational purposes). That the taxpayer derives personal pleasure from engaging in the activity is insufficient to cause the activity to be classified as not engaged in for profit if other factors show that the activity is conducted for profit. Jackson v. Commissioner, supra; sec. 1.183-2(b)(9), Income Tax Regs.
We acknowledge that gambling at a casino is an activity commonly understood to be a pleasant amusement. Petitioner testified credibly, however, that she found no pleasure in gambling. It was work. Petitioner testified that she found gambling to be stressful, tiring, and time consuming. She further testified that she always went to the casino alone and that no friends or family members accompanied her to add any entertainment element to her activities. We find her testimony thoughtful and credible. On balance, we find this factor favors petitioner.
Taking into account the above factors and considering the facts and circumstances relating to petitioner’s gambling activity, we conclude that petitioner engaged in the gambling activity with the actual and honest objective of making a profit in 2003. As the parties have agreed that petitioner conducted the gambling activity with continuity and regularity, we conclude that petitioner was in the trade or business of gambling during 2003. Accordingly, petitioner may deduct her gambling expenses under section 162(a) to the extent allowable under section 165(d).
To reflect the foregoing, Decision will be entered for petitioner.
(1) All section references are to the Internal Revenue
Code in effect for the year at issue, unless otherwise indicated.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined a deficiency in petitioner’s 2002 Federal income tax of $17,096 and an accuracy related penalty under section 6662(a) of $3,419.(1) The issues for decision are whether petitioner was in the trade or business of gambling during 2002, and whether petitioner is liable for an accuracy-related penalty under section 6662(a).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time he filed his petition, petitioner resided in Tiverton, Rhode Island.
Prior to 1993, petitioner was an operations manager for a textile firm called Prim/Dritz Corporation. In 1993, petitioner started Caltex Corporation (Caltex), an S corporation. Caltex is a textile firm which sells embroidered T-shirts, caps, and other similar products. Sometime before 1999, Caltex hired petitioner’s brother with the goal that, once petitioner’s brother learned about the textile business, petitioner could reduce his involvement in Caltex. In 1999, petitioner’s brother took over the day-to-day operations of Caltex. During 2002, petitioner was the president and 100-percent owner of Caltex and worked at Caltex 20 to 25 hours per week providing “consulting services”. In 2002, petitioner received a salary of $42,000 and a distribution of income of $99,790 from Caltex.
During 2002, petitioner played the slot machines at several casinos throughout the United States.(2) Petitioner spent most of his time at Foxwoods Resort and Casino in Connecticut, which was approximately 100 miles from his home. The casinos issued petitioner Forms W-2G, Certain Gambling Winnings, for 2002, reflecting gross winnings of $132,800. Prior to filing his 2002 Federal income tax return, petitioner prepared a summary of his gambling activity (the gambling summary). The gambling summary reflected that petitioner gambled on 24 separate occasions, won a total of $132,800, and lost a total of $180,300. Petitioner timely filed his 2002 Federal income tax return.(3) Petitioner reported the following sources of income: (1) Wage income from Caltex of $42,000; (2) taxable interest of $7,676; (3) ordinary dividends of $3,176; (4) taxable State income tax refund of $3,224; and (5) income from rental real estate, S corporations, and trusts of $109,403.(4) On an attached Schedule C, Profit or Loss From Business, petitioner reported that his principal business or profession was professional gambling. Petitioner reported gross receipts of $132,800, cost of goods sold of $180,300, and deducted $3,150 in travel expenses, for a net Schedule C loss of $50,650. After deducting the Schedule C loss and a net operating loss carryover of $1,106, petitioner reported total income of $113,723. Petitioner claimed itemized deductions of $14,077 and a personal exemption of $3,000, resulting in taxable income of $96,646 and total tax of $23,303. On March 21, 2005, respondent issued petitioner a notice of deficiency. Respondent determined petitioner was not engaged in the trade or business of gambling during 2002 and therefore could not deduct his gambling losses on Schedule C. Instead, respondent determined petitioner could deduct the gambling losses as an itemized deduction, but only to the extent of his gambling winnings.(5) Based on the above, respondent determined the amount of tax required to be shown on petitioner’s 2002 return was $40,399, resulting in a deficiency of $17,096. Respondent also determined petitioner was liable for an accuracy-related penalty under section 6662(a) of $3,419.
In response to the notice of deficiency, petitioner filed his petition with this Court on April 18, 2005.
I. Petitioner’s Gambling Activity
Respondent determined petitioner was not in the trade or business of gambling during 2002 and thus could not claim his gambling losses as a Schedule C deduction. Petitioner argues he was in the trade or business of gambling because he pursued the activity full time, in good faith, with regularity, and for the production of income.(6) Section 162(a) allows deductions for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. If a taxpayer were engaged in the trade or business of gambling, losses would be deductible from gross income in arriving at the adjusted gross income. See sec. 62. However, if the taxpayer were not in the trade or business of gambling, his losses would be deductible as an itemized deduction in arriving at taxable income. See sec. 63(a). Regardless of whether the gambling activity constituted a trade or business, section 165(d) provides: “Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” See also sec. 1.165-10, Income Tax Regs. Although petitioner deducted gambling losses exceeding his gambling winnings by $50,650, petitioner does not dispute that section 165(d) limits his gambling loss deduction to the amount of his gambling winnings.
To be engaged in a trade or business within the meaning of section 162(a), an individual taxpayer must be involved in the activity with continuity, regularity, and with the primary purpose of deriving income and profit. Commissioner v.Groetzinger, 480 U.S. 23, 35 (1987). Whether the taxpayer is carrying on a trade or business requires an examination of all the facts in each case. Id. at 36; Higgins v. Commissioner, 312 U.S. 212, 217 (1941).
In Groetzinger, the Supreme Court addressed the issue of whether a taxpayer’s gambling activity was a trade or business within the meaning of section 162(a). The taxpayer devoted 60 to 80 hours each week for 48 weeks to parimutuel wagering, primarily on greyhound races. Commissioner v. Groetzinger, supra at 24. The taxpayer gambled at racetracks 6 days a week and spent a substantial amount of time studying racing forms, programs, and other materials. Id. While the taxpayer received $6,498 in income from other sources during the year, the taxpayer had no other profession or type of employment during the 48 weeks he devoted to gambling. Id. at 24-25. The Supreme Court stated:
Id. at 35-36. The Supreme Court affirmed the judgment of the Court of Appeals for the Seventh Circuit, finding the taxpayer was engaged in the trade or business of gambling. Id. at 36.
Petitioner argues the facts of Groetzinger are similar to the facts of this case, and, like the Supreme Court in Groetzinger, we should find petitioner was engaged in the trade or business of gambling. After carefully considering the facts in this case, we disagree.
Petitioner argues, like the taxpayer in Groetzinger, he spent a substantial amount of time preparing for his trips to the casino and developed a strategy for his gambling:
Petitioner also argues that he bought a slot machine, spent a significant amount of time studying how the “chips” and cycles of slot machines worked, subscribed to a gambling magazine, and read “probably about 20” books on playing the slot machines. Petitioner’s efforts and strategy are consistent with the desire to win money playing the slot machines. However, we find petitioner’s desire to win money and his strategy for doing so is also consistent with gambling purely for its entertainment or recreational aspects. The time petitioner spent and the strategy he developed, by themselves, do not establish petitioner was engaged in the trade or business of gambling. Petitioner testified he maintained daily records of his gambling activity and argues on brief his record keeping is indicative of a trade or business. Petitioner did not provide respondent with these records, nor did he introduce the records into evidence. Given the lack of evidence, we do not find that petitioner maintained daily records of his gambling activity.
Petitioner argues that he spent “approximately 2,206.5 hours” gambling at various casinos, “where he focused primarily on slot machines such as the ‘Double Diamond’”, and that the amount of time devoted to his gambling activity is indicative of a trade or business. Petitioner relies on a schedule of gambling wins and losses to establish the hours spent gambling. The schedule of gambling wins and losses reflects petitioner’s attempt to reconstruct the dates he gambled, the amount of money won or lost, and the amount of time spent gambling each day. However, the schedule was not provided to respondent until January 4, 2006, and there is no evidence in the record indicating when the schedule was prepared. This evidence was not contemporaneously maintained, and it is inaccurate and unreliable.(7) Petitioner did not provide his purported daily records, nor did he provide other evidence corroborating the amount of time he devoted to gambling during 2002. Given the lack of reliable evidence, we cannot determine how much time petitioner devoted to gambling during 2002. Unlike the taxpayer in Groetzinger, petitioner spent approximately 20 to 25 hours per week working for Caltex.
Additionally, petitioner’s livelihood did not depend on playing the slot machines. His primary income came from his salary of $42,000 and the passthrough of income of $99,790 from Caltex, of which he was president and 100-percent owner during 2002. By themselves, these facts do not preclude petitioner from being engaged in the trade or business of gambling. However, such factors were considered by the Supreme Court in Groetzinger and are relevant to our determination. See Commissioner v. Groetzinger, 480 U.S. at 24-25, 35-36. We find that these facts weigh against petitioner’s being engaged in the trade or business of gambling. See Jones v. Commissioner, T.C. Memo. 1988-393. Taking into consideration all of the above, we find petitioner was not engaged in the trade or business of gambling in 2002. Therefore, petitioner is not entitled to report his gambling activity on Schedule C. Instead, petitioner must claim his gambling losses as an itemized deduction on Schedule A, as determined by respondent. We sustain respondent’s determination that the amount of tax required to be shown on petitioner’s 2002 Federal income tax return was $40,399, resulting in a deficiency of $17,096.
II. Accuracy-Related Penalty Under Section 6662(a)
Respondent determined petitioner is liable for an accuracy related penalty under section 6662(a) for 2002 of $3,419. Petitioner argues he is not liable for an accuracy-related penalty because he reasonably relied upon the advice of his accountant. Section 6662(a) imposes a penalty in the amount of 20 percent of the portion of the underpayment to which section 6662 applies. As relevant to this case, the penalty applies to any portion of the underpayment that is attributable to any substantial understatement of income tax. Sec. 6662(b)(2).
There is a “substantial understatement of income tax” if the amount of the understatement exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. Sec.6662(d)(1).
The Commissioner bears the burden of production with respect to penalties. Sec. 7491©; Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). Once the burden of production is met, the taxpayer must come forward with evidence sufficient to show that the penalty does not apply. Higbee v. Commissioner, supra at 447.
The tax required to be shown on petitioner’s tax return was $40,399. Ten percent of that amount is less than $5,000. Thus, petitioner’s understatement is substantial if it exceeds $5,000. Petitioner reported an income tax liability of $23,303, resulting in an understatement of $17,096. Respondent has satisfied his burden of production by showing that petitioner’s understatement of tax was substantial.
The accuracy-related penalty is not imposed, however, with respect to any portion of the understatement if the taxpayer can establish he acted with reasonable cause and in good faith. Sec. 6664(c)(1). Reliance upon the advice of a professional may demonstrate a taxpayer acted with reasonable cause and in good faith. Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 98-99 (2000), affd. 299 F.2d 221 (3d Cir. 2002); Freytag v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991); see sec. 1.6664-4©(1), Income Tax Regs. However, a taxpayer’s reliance upon the advice of a professional does not automatically constitute reasonable cause. Neonatology Associates v. Commissioner, supra at 98-99; see sec. 1.6664-4©(1), Income Tax Regs. For a taxpayer to reasonably rely on the advice of a professional, the taxpayer must show: (1) The adviser was a competent professional who had sufficient expertise to justify reliance; (2) the taxpayer provided necessary and accurate information to the adviser; and (3) the taxpayer actually relied in good faith on the adviser’s judgment. Neonatology Associates v. Commissioner, supra at 98-99.
Petitioner testified he relied on his accountant, Mr. Beauregard, to prepare his return, and Mr. Beauregard had prepared his returns since 1993 without incident. However, petitioner did not call Mr. Beauregard as a witness, nor did he introduce evidence which would establish that Mr. Beauregard possessed the requisite expertise.(8) Because petitioner has not established that Mr. Beauregard was a competent professional who had sufficient expertise to justify reliance, petitioner has not shown that he acted with reasonable cause and in good faith. See sec. 6664(c)(1); Neonatology Associates v. Commissioner, supra at 98-99. Therefore, we find petitioner is liable for an accuracy related penalty under section 6662(a) of $3,419.
Petitioner was not engaged in the trade or business of gambling in 2002. For all of the foregoing reasons, we hold petitioner is liable for a deficiency in his 2002 Federal income tax of $17,096 and an accuracy-related penalty under section 6662(a) of $3,419.
In reaching our holdings, we have considered all arguments made, and, to the extent not mentioned, we conclude that they are moot, irrelevant, or without merit.
To reflect the foregoing, Decision will be entered for respondent.
(1) Unless otherwise indicated, all section references
are to the Internal Revenue Code, as amended. All amounts are rounded to
the nearest dollar.
Gloria Tschetschot, pro se. J. Anthony Hoefer, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
ARMEN, Special Trial Judge:
Respondent determined a deficiency in petitioners’ Federal income tax
for the taxable year 2000 of $10,071, as well as an accuracy-related
penalty for a substantial understatement of income tax of $2,014. The
grounds for the deficiency were the limitations of section 165(d)as
applied to Gloria Tschetschot’s (Mrs. Tschetschot) professional
tournament poker playing and George E. Tschetschot’s (Mr. Tschetschot)
status as a nonprofessional gambler.(1) At trial, petitioners conceded that
Mr. Tschetschot was not a professional gambler but argued that Mrs.
Tschetschot’s professional tournament poker playing is not gambling and
thus not subject to the limitations of section 165(d) on losses from
gambling. Respondent conceded that Mrs. Tschetschot’s
business expenses related to her professional gambling activity were
deductible [ed. note: against other current-year
income only(7)]. Thus, the
two issues for decision are: (1) Whether Mrs. Tschetschot’s tournament
poker losses are limited by section165(d) to the amount of her
tournament poker winnings, and (2) whether a penalty under section 6662(a) for a substantial
understatement of income tax is appropriate.
Mrs. Tschetschot is a database project engineer. She was also a professional tournament poker player in 2000. (2) Mr.Tschetschot is not a professional gambler but occasionally plays slot machines and blackjack while accompanying his wife on her poker tournament trips.
Tournament poker is somewhat different from “live-action”poker. A poker tournament consists of a series of individual events hosted by a casino, and it can last anywhere from several days to 2 weeks. Unlike live-action poker, tournament participants cannot exit the game by cashing out partway through the tournament; tournaments are played until there is one player left with all of the chips.
All tournaments have a “buy-in”, or entrance fee, that is paid by the tournament participants to the tournament organizer. A portion of this amount is an administrative fee kept by the casino hosting the event, and the remainder goes directly into the prize fund “pot” that will ultimately be paid out to the .tournament’s winners. No portion of the administration fee is included in the prize fund, and the entire prize fund is dispersed to winning participants. The buy-in may or may not correlate dollar-for-dollar with the amount of chips received at the start of the tournament, and the chips themselves have no intrinsic monetary value. Although “re-buys” are sometimes allowed, tournament play contemplates that each player has only a fixed number of chips and that each player begins the tournament with the same number of chips. When a player runs out of chips, he or she is out of the game. Cash prizes are awarded to a predetermined number of finishing places in the tournament. Because of the buy-in system, the only monetary loss a tournament participant may incur will be the amount of the buy-ins and any re-buys the participant might make; no participant will be able to bet--or subsequently lose--any greater amount. Similar to live-action poker, however, a player’s tournament success depends on a combination of both luck and skill. (3) A player might have a decent hand, but as Kenny Rogers tells us in “The Gambler”, he or she would still have to “know when to hold ‘em, know when to fold‘em, know when to walk away and know when to run” to actually be a success.
For 2000, the taxable year in issue, Mrs. Tschetschot earned approximately $49,000 in wages. She also participated in nine poker tournament series, winning in excess of $11,000. (4)
Mrs. Tschetschot claimed a net loss of $29,933 from her "professional gambler” activity in 2000 on her Schedule C, Profit or Loss From Business. Mr. Tschetschot claimed a net loss of $9,000 from his “professional gambler” activity in 2000 on his Schedule C.
Respondent determined a deficiency of $10,071 based on the view that the deductions claimed by petitioners related to their gambling activities were not appropriately Schedule C deductions, but rather deductions allowable on Schedule A, Itemized Deductions, but only to the extent of petitioners’ winnings. Respondent also determined an accuracy-related penalty under section 6662(a) of $2,014.
At trial, petitioners conceded the issue as to Mr.Tschetschot but disputed the determination as to Mrs.Tschetschot. Respondent conceded Mrs. Tschetschot’s status as a professional, as well as the corresponding treatment of certain expenses related to her professional gambling activity.
Respondent maintains that section 165(d) limits Mrs. Tschetschot’s losses and that petitioners remain liable for an accuracy-related penalty. Petitioners contend that Mrs. Tschetschot’s professional tournament poker playing activity is more properly classified as “entertainment and professional sports” than professional gambling and should bear the resulting tax treatment; i.e., that her net loss should not be limited by section 165(d) restricting losses from wagering activities. Petitioners also contend that they do not meet the threshold amount for the imposition of an accuracy-related penalty based on a substantial understatement of income tax.
Tournament Poker (5)
Central to petitioners’ contention is the thesis that tournament poker, unlike other types of poker, is not a wagering activity.
The term “wagering” has different meanings depending on the context in which the term is used. More often than not, and as it is used in the Internal Revenue Code, the term is synonymous with “gambling”. (6)
Congress has made a policy decision such that, while section165 generally allows losses to be deducted from gross income, “[l]osses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” (7) Sec. 165(d); see also sec. 165(a). However, neither the Internal Revenue Code nor the regulations define what constitutes a wagering activity.
When a term is not defined, we must apply the term’s “plain,obvious, and rational meaning.” Liddle v. Commissioner, 103 T.C.285, 293 n.4 (1994), affd. 65 F.3d 329 (3d Cir. 1995); see also Boyd v. United States, 762 F.2d 1369, 1373 (9th Cir. 1985). According to the dictionary, a “wager” is defined as “something risked or staked on an uncertain event” or “a bet”. Random House College Dictionary (1968). Similarly, “to wager” is defined as: (1) Something risked or staked on an uncertain event; bet; (2) the act of betting. Random House College Dictionary (1973). Courts have often had to differentiate between wagering and related activities on the one hand and those activities not falling into that category on the other. See, e.g., Allen v. U.S. Govt. Dept. of Treas., 976 F.2d 975 (5th Cir.1992) (“tokes” paid as tips to casino dealers are not gains from wagering transactions); Offutt v. Commissioner, 16 T.C. 1214(1951) (betting on horse races is wagering); Libutti v. Commissioner, T.C. Memo. 1996-108 (gambler’s receipt of complimentary goods from a casino was sufficiently tied to gambling participation that they were gains from wagering transactions); Whitten v. Commissioner, T.C. Memo. 1995-508(expenses incurred to be a contestant on Wheel of Fortune were not wagering expenses); Heide v. Commissioner, 2 B.T.A. 451(1925) (playing bridge for stakes is wagering). However, courts have routinely held that poker is a wagering activity. See, e.g., Boyd v. United States, supra. But here, petitioners ask us to treat tournament poker differently than other kinds of poker.
After a careful review of the record, it is clear that while there are differences between tournament poker and other types of poker, (8) none rise to the level of meaningful, substantive differences that would warrant different tax treatment under the current Internal Revenue Code.
A. Tournament Poker as a Sporting Event
Petitioners argue that tournament poker is conducted in much the same way as other professional sporting tournaments. Participants pay an entry fee and compete to win prizes through their good fortune and superior skill. But simply because a sport or activity is played or conducted in a tournament setting does not transform the underlying activity into something different. (9)
Tournament poker play, much like live-action poker, necessitates the use of the word “bet” or “wager” even to describe how the game is played. Petitioners argue that the usage of the word “bet” in this context is insignificant. The Court sees it differently.
Betting is so intrinsic to poker that it is nearly impossible to avoid using a word that implies gambling in any way when discussing the topic. Bets are placed on each hand, and each round of betting has consequences. Whether or not the chips being used to make these bets have immediate and tangible monetary value does not change the fact that the players are still placing bets, hoping to win. This is true even in a tournament setting.
Petitioners agree that the first poker tournaments held were, in fact, “wagering events”. For example, in those early games, “Each participant put up $10,000 and received $10,000 in chips.” The fact that the chips being used to place bets in tournament poker today only bear some fractional relationship to the dollar values of the prizes and/or entry fees does not change the basic nature of the game as a wagering activity.
B. Professional Tournament Poker as a Business
Petitioners also raise an equal protection argument and argue that there is no valid reason to treat tournament poker differently, for tax purposes, from tournament golf or tennis. Petitioners argue that the benefits of being able to offset "exaggerated income” from very successful years by losses sustained in less successful years should be available to professional tournament poker players as much as they are to other professions.
Congress made a policy decision to treat businesses based on wagering activities differently. In the absence of Congressional action, we are not free to correct any perceived unfairness stemming from a rationally based policy choice. In Valenti v. Commissioner, T.C. Memo. 1994-483, the Court noted that treating businesses based on wagering and gambling differently from other businesses is a rational differentiation and not one that rises to the level of being violative of due process or equal protection. See also Steward Mach. Co. v. Davis, 301 U.S. 548,584 (1937) (holding that Congress, like the states, has the freedom to tax businesses differently). Thus, it has been held:
Valenti v. Commissioner, supra (quoting Carmichael v. Southern Coal Co., 301 U.S. 495 (1937)).
II. Substantial Understatement of Tax
With respect to a taxpayer’s liability for any penalty, section 7491(c) places on the Commissioner the burden of production, thereby requiring the Commissioner to come forward with sufficient evidence indicating that it is appropriate to impose the penalty. See Higbee v. Commissioner, 116 T.C. 438,446-447 (2001). Once the Commissioner meets his burden of production, the taxpayer must come forward with persuasive evidence that the Commissioner’s determination is incorrect. See id. at 447; see also Rule 142(a); Welch v. Helvering, 290 U.S.111, 115 (1933).
Section 6662(a) imposes a penalty equal to 20 percent of the amount of any underpayment attributable to a substantial understatement of income tax. Sec. 6662(b)(2). An understatement is the amount by which the correct tax exceeds the tax reported on the return. Sec. 6662(d). The understatement is substantial if it exceeds the greater of $5,000 or 10 percent of the tax required to be shown on the return. Sec.6662(d)(1)(A)(i) and (ii).
Section 6664(c)(1) provides that no penalty shall be imposed if the taxpayer demonstrates that there was reasonable cause for the underpayment and the taxpayer acted in good faith. The determination of whether a taxpayer acted with reasonable cause and in good faith depends on the facts and circumstances of the situation and includes an “honest misunderstanding of fact or law”. Sec. 1.6664-4(b)(1)(c), Income Tax Regs. Insofar as Mr.Tschetschot is concerned, petitioners have not demonstrated either good faith or that there was reasonable cause for their position. As to Mrs. Tschetschot, petitioners were clearly aware of the mandate of section 165(d); their wish that it be inapplicable to tournament poker does not constitute the type of misunderstanding contemplated by the statutes or the regulations.
An understatement is reduced by the portion of the understatement that is attributable to the tax treatment of an item for which there is substantial authority or with respect to which there is adequate disclosure and a reasonable basis. See sec. 6662(d)(2)(B); sec. 1.6662-4(a), Income Tax Regs. However, no substantial authority exists to support petitioners’ position as to either the inapplicability of section 165(d) to tournament poker or Mr. Tschetschot’s status as a professional gambler. Substantial “authority [exists] for the tax treatment of an item only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment.” Sec. 1.6662-4(d)(3)(i), Income Tax Regs. Types of authority on which a taxpayer may rely include the Internal Revenue Code and regulations, revenue rulings and procedures, technical advice memoranda, and private letter rulings. See sec. 1.6662-4(d)(3)(iii), Income Tax Regs. Additionally, whether or not there was adequate disclosure, there is no reasonable basis to support petitioners’ position on tournament poker given the clear mandate of section 165(d) and the existing case law interpreting it. Accordingly, we are not permitted to make a reduction in the understatement attributable to respondent’s determination on that issue.
In view of respondent’s concession that Mrs. Tschetschot’s expenses are deductible, it is unclear whether there exists a substantial understatement of income tax. We therefore leave for the parties to determine as part of the Rule 155 computation whether there was, in fact, a substantial understatement for the taxable year in issue. If a substantial understatement exists for the year in issue, petitioners are liable for the accuracy-related penalty.
The moral climate surrounding gambling has changed since the tax provisions concerning wagering were enacted many years ago. Not only has tournament poker become a nationally televised event, but casinos or lotteries can be found in many States. Further, the ability for the Internal Revenue Service to accurately track money being lost and won has improved, and some of the substantiation concerns, particularly for professionals, no longer exist. That said, the Tax Court is not free to rewrite the Internal Revenue Code and regulations. We are bound by the law as it currently exists, and we are without the ability to speculate on what it should be. Accordingly, we hold that tournament poker is a wagering activity subject to the limitations of section 165(d).
To reflect the foregoing, Decision will be entered under Rule
(1) Unless otherwise indicated, all section references
are to the Internal Revenue Code of 1986, as amended, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
MEMORANDUM OF DECISION
The plaintiff, Peter B. Stone (Stone), brings this appeal contesting the decision of the commissioner of revenue services (commissioner) disallowing the plaintiff’s deduction of gambling losses against gambling winnings and the imposition of additional income tax assessments against the plaintiff for the calendar years 1998 and 1999 (hereinafter the taxable years).
During the taxable years, the plaintiff resided in New Milford, Connecticut and was a full-time salaried employee of Xerox Corporation until his retirement in October 1999. The plaintiff also was a sole proprietor of Peter Stone Canvas, a part-time seasonal business which manufactured, repaired and installed canvas products. The plaintiff further owned and managed commercial income-producing real estate.
The plaintiff claims to be a professional gambler, a person who is in the trade or business of gambling, and indicated so when he filed Schedule C1(1) of his 1998 and 1999 federal income tax return forms 1040. See Plaintiff’s Exhibits 1 and 3.
During the taxable year 1998, the plaintiff played slot machines at various casinos for a total of 43 days and was issued forms W-2G(2) by casinos reporting slot machine winnings. On Schedule C of his 1998 federal return, the plaintiff reported gambling gross receipts of $44,464 and expenses of $44,464 resulting in $0 net profit. See Plaintiff’s Exhibit 1.
During the taxable year 1999, the plaintiff played slot machines at various casinos for a total of 22 days and was issued forms W-2G.(3) On Schedule C for his 1999 federal return, the plaintiff reported gambling gross receipts of $120,170 and expenses of $120,170 resulting in $0 net profit. See Plaintiff’s Exhibit 3.
On his Connecticut state income tax return, form CT-1040, Stone reported both his federal adjusted gross income and Connecticut adjusted gross income for 1998 as $83,748.(4) See Plaintiff’s Exhibit 2. For 1999, Stone reported his federal adjusted gross income and Connecticut adjusted gross income as $27,888 on form CT-1040. See Plaintiff’s Exhibit 4.
The plaintiff testified that he gambled regularly on slot machines at various New Jersey and Connecticut casinos where he typically placed five to ten bets per minute on $5 slot machines. The plaintiff’s friend Kathryn Ruzek (Ruzek) accompanied Stone on all of his gambling trips and kept detailed records of his gambling activities on post-it notes. Ruzek recorded the dates and hours of Stone’s attendance at the various casinos and the specific slot machines he played, the amount of money he spent, including all checks and ATM withdrawals made, and the amount of jackpots. Following each gambling trip, Ruzak placed the post-it notes in a manila envelope. During the tax filing season, Ruzak entered the information written on the post-it notes(5), forms W-2G, credit card records and checks into a computer spreadsheet. The plaintiff’s accountant then used the spreadsheet to prepare the plaintiff’s federal and state income tax return forms.
The plaintiff testified that he read gambling instructional materials and periodicals to study slot machines, especially the payouts from different types of slot machines. During the taxable years, the plaintiff was rated in the top 1-2% of gambling patrons by New Jersey and Connecticut casinos. According to the plaintiff, the casinos rate players based upon the total amount of money gambled and treat rated players with “respect” by providing them with privileges such as access to lounge areas, food and parking. In 4 addition, the plaintiff was invited to play in slot machine casino tournaments during the taxable years.
“Income derived from wagering transactions is includible in gross income under the provisions of section 61 of the Internal Revenue Code.” Rev. Proc. 77-29, 1977-2 CB 538. Section 165 (d) of the Internal Revenue Code provides that “[l]osses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” 26 U.S.C. 165 (d).
On the federal level, gambling winnings and losses are reported on form 1040 in one of two ways. If the taxpayer is engaged in the business of gambling, the taxpayer files Schedule C to form 1040 and reports the business income or loss from gambling on line 12 of form 1040. If the taxpayer is not a professional gambler, the taxpayer reports gambling winnings on line 21 of form 1040 and files Schedule A to form 1040 in order to itemize deductions attributable to gambling losses to the extent of gambling winnings.
It is the commissioner’s position that the plaintiff (1) was not a professional gambler during the taxable years, (2) was not eligible to file Schedule C to form 1040 and to report zero income on line 12 of form 1040 and (3) owes additional income tax on the plaintiff’s gambling winnings.
As an example, the plaintiff reported on his 1998 federal form 1040 that he was a professional gambler and that his adjusted gross income was $83,748. See Plaintiff’s Exhibit 1. If the plaintiff was not a professional gambler during the taxable year 1998 and therefore, not eligible to file Schedule C, he would have reported his gambling winnings in the amount of $44,464 on line 21 of his 1998 federal form 1040 and increase his adjusted gross income to $128, 212.
In contrast to the federal level, non-professional gamblers filing their Connecticut state income tax returns must report all winnings as gross income. Connecticut income tax liability starts with a taxpayer’s “properly reported” federal adjusted gross income. General Statutes § 12-701 (a) (19) provides, in relevant part, as follows: “‘Adjusted gross income’ means the adjusted gross income of a natural person with respect to any taxable year, as determined for federal income tax purposes and as properly reported on such person’s federal income tax return.” (Emphasis added.)
Taking the federal adjusted gross income, §12-701 (a) (20) allows taxpayers to modify their Connecticut adjusted gross income with a list of additions and subtractions. Unless taxpayers filing Connecticut income tax returns have a trade or business from which to deduct business expenses, ordinary gambling losses cannot be deducted from a taxpayer’s Connecticut adjusted gross income, unless specifically allowed by statute. This is so “[b]ecause deductions and exemptions from otherwise taxable income are matters of legislative grace . . . .” D. A. Pincus & Co. v. Meehan, 235 Conn. 865, 873, 670 A.2d 1278 (1996).
Having outlined the factual background and statutory context, the issue in this case is whether the plaintiff’s gambling activities during the taxable years constituted a trade or business that would have permitted the plaintiff to file a Schedule C to his federal return and deduct his gambling losses to the extent of his gambling winnings. The resolution of this issue is fact-oriented. See Commissioner v. Groetzinger, 480 U.S. 23, 35-36, 107 S. Ct. 980, 94 L. Ed. 2d 25 (1987) (60-80 hours per week, 48 weeks per year devoted to parimutuel wagering on dog races constitutes professional gambling). See also Pacific Indemnity Ins. Co. v. Aetna Casualty & Surety Co., 240 Conn. 26, 31, 688 A.2d 319 (1997) (“business pursuits means a continued or regular activity that is conducted for the purpose of profit, such as a trade, profession or occupation”).
In Groetzinger, the court determined that the term “trade or business” was difficult to define under the Internal Revenue Code. The court further stated that “the difficulty rests in the Code’s wide utilization in various contexts of the term ‘trade or business,’ in the absence of an all-purpose definition by statute or regulation, and in our concern that an attempt judicially to formulate and impose a test for all situations would be counter productive, unhelpful, and even somewhat precarious for the overall integrity of the Code.” Groetzinger, 480 U.S. 36. Recognizing that cases of this nature should be decided on the facts, the Groetzinger court considered the following factors in its analysis of whether the taxpayer’s gambling activities rose to the level of a trade or business: “if one’s gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business within the meaning of the statutes with which we are here concerned.” Id., 35. The commissioner has adopted the Groetzinger factors for the purpose of determining whether a person is a professional gambler.
The facts in the present case are not as clear as those in Groetzinger because the plaintiff Stone was employed full-time by Xerox Corporation until October 1, 1999, conducted a part-time seasonal canvas products business, owned income-producing real estate and spent 43 days in 1998 and 22 days in 1999 casino slot machines gambling.
The commissioner argues that the plaintiff must be engaged in gambling full-time and pursue gambling to produce income for a livelihood in order for the plaintiff to be engaged in gambling as a trade or business. However, in Connecticut, it is not necessary that a business activity be the principal occupation rather than a part-time or supplemental activity. See Pacific Indemnity Ins. Co. v. Aetna Casualty & Surety Co., 240 Conn. 32.
The court is mindful that the Groetzinger court recognized that the term “trade or business” is difficult to define. The lesson learned from Groetzinger is that no formulae or test can be developed that can be applied universally to all cases. In fact, the Groetzinger court stated that “the Code has never contained a definition of the words ‘trade or business’ for general application, and no regulation has been issued expounding its meaning for all purposes. Neither has a broadly applicable authoritative judicial definition emerged. . . .” Groetzinger, 480 U.S. 27.
The Treasury Regulations (regulations), in effect pursuant to §183 of the Internal Revenue Code, provide that “[t]he determination whether an activity is engaged in for profit is to be made by reference to objective standards, taking into account all of the facts and circumstances of each case. Although a reasonable expectation of profit is not required, the facts and circumstances must indicate that the taxpayer entered into the activity, or continued the activity, with the objective of making a profit. . . . In determining whether an activity is engaged in for profit, greater weight is given to objective facts than to the taxpayer’s mere statement of his intent.” Treas. Reg. § 1.183-2 (a).(6)
The facts and circumstances in the present case indicate that the taxpayer was engaged in gambling activity with the objective of making a profit. The plaintiff testified that he believed he was pursuing an income goal for a livelihood and kept track of his wagering for this purpose.
With regard to what factors contribute to whether a taxpayer engages in an activity for profit, the regulations under § 183 provide nine factors to consider: “
In consideration of the second factor listed in the regulations, the plaintiff argues that skill is involved in order to successfully play casino slot machines. The commissioner produced as an expert witness, Professor Robert Hannum (Professor Hannum), a full professor of statistics at the University of Denver with a special interest in the mathematics of gambling. Professor Hannum testified that the playing of slot machines requires no skill since skill requires an exercise of judgment that affects the outcome of the play. As discussed above, the plaintiff studied gambling techniques and slot machines; however, playing slot machines is squarely a game of chance without the player affecting his success each time the slot machine is engaged.
Professor Hannum discussed how there is a house advantage in playing casino slot machines and that there is a mathematical advantage programmed into the slot machines by the casino operators. According to Professor Hannum, a 92% payback to the player is average; therefore, a slot machine player can expect to lose approximately $8 out of every $100 played. Professor Hannum also noted that a player can be a winner at slot machines over a shot period of time, but in the long-term, a player will lose. In Professor Hannum’s opinion, a slot machine player cannot be a professional gambler because he or she would not have the expectation of making a profit. Under Professor Hannum’s theory, a slot machine player can never have a profit motive.
The plaintiff contends that he had a profit motive because he exhibited an expectation of winning at slot machines in the taxable years 1998 and 1999. In those years, the plaintiff reported slot machine winnings of $44,464 and $120,174, respectively. However, Professor Hannum’s opinion, that a slot machine player cannot win over the long-term, is supported by the plaintiff’s tax returns for 1998 and 1999. In those taxable years, the plaintiff had gambling losses equal to or greater than his gambling winnings.
During the taxable year 1998, the plaintiff had $83,748 listed as federal adjusted gross income on his federal and Connecticut income tax return forms consisting of $46,902 in wages, $373 in taxable interest, a business loss of $3,193 from the canvas operation and a taxable portion for pensions and annuities of $39,666. See Plaintiff’s Exhibits 1 and 2. For the taxable year 1999, the plaintiff had $27,888 listed as federal adjusted gross income on his federal and Connecticut income tax returns consisting of $45,821 in wages, $61 in taxable interest, a business loss of $5,494 from the canvas operation and a loss of $12,500 from the real estate rental.
The court accepts Professor Hannum’s opinion as credible that, regardless of a player’s study of slot machine payouts and instructional materials, a gambler cannot exercise such skill as to affect the payout of slot machines because the machines are programmed to cause the player to lose in the long run. Furthermore, the key test here for determining whether a taxpayer is engaged in the trade or business of gambling is not skill when playing slot machines, but the expectation of winning or having “profit motive”.
Although the plaintiff believes he will be successful playing slot machines and this belief is unrealistic from a statistical basis, it is difficult for the court to find that a slot machine gambler has no subjective expectation of winning. See, e.g., Busch v. Commissioner of Revenue, 713 N.W.2d 337, 349 (Minn. 2006), where the Minnesota Supreme Court reversed the decision of the Minnesota Tax Court and held that “the taxpayer’s expectation of profit from a given activity need not always be reasonable for the activity to qualify as a trade or business.”(7)
In addressing the first profit motive indicator listed in the regulations, the plaintiff did conduct his gambling activities in a businesslike manner by keeping detailed records of the days he gambled, the types and numbers of machines played and his winnings and losses.
The third indicator, time and effort expended, does not support a finding that the plaintiff’s gambling activities were conducted in such depth and with adequate continuity and regularity because the plaintiff gambled only 43 days in 1998 and 22 days in 1999. The court concurs with the commissioner that the plaintiff’s visits to the casinos were irregular and infrequent during the taxable years and that the plaintiff’s time was limited by his full-time work for Xerox and the approximately 350 hours devoted to his canvas business.(8)
As to the fourth indicator, there was no evidence offered to show that the plaintiff had an expectation that assets used for his gambling would appreciate in value. As to the fifth and sixth indicators, there is nothing to support the plaintiff’s contention that he has a successful history of winning while playing slot machines during the taxable years. Although the plaintiff reported substantial jackpots in the years 2000 through 2003, the present issue is whether the plaintiff was engaged in a trade or business as a gambler in the taxable years 1998 and 1999. The plaintiff’s financial status during the taxable years, as represented by his pension income, wages, canvas business earnings, and rental income, was sufficient to maintain a gambling lifestyle. It was not the winnings from gambling at the slot machines that sustained the plaintiff’s lifestyle, but his other income which was unrelated to gambling.
For the seventh and eighth indicators, the plaintiff did not make a profit and his financial status does not appear to have changed. As to the final indicator, there is no evidence to support a finding that the plaintiff considered his gambling activities during the taxable year to be a hobby or purely for pleasure. While the plaintiff’s gambling activities did not rise to the level of being engaged in a trade or business, his subjective intent appears to be more like a compulsion to gamble rather than just a hobby.
Upon review of all the indicators and the court’s analysis of each, it is necessary to consider the standard of proof needed by the plaintiff to be successful in this appeal. In Leonard v. Commissioner of Revenue Services, 264 Conn. 302, the Supreme Court has recognized that, in a taxpayer’s challenge of the commissioner’s imposition of a deficiency assessment in tax matters, it is the taxpayer’s burden to prove that a deficiency assessment is in error by presenting clear and convincing evidence. See also Gavigan v. Commissioner of Revenue Services, 89 Conn. App. 111, 114, 871 A.2d 1101 (2005), citing Leonard.
Under the court’s analysis of the facts, the plaintiff has met two of the nine indicators listed above in the regulations, namely, profit motive and conducting gambling activities in a businesslike manner. Under these circumstances and with the high standard of proof required of the plaintiff to show the commissioner’s error, the court concludes that the plaintiff has not sustained his burden.(9) The plaintiff has failed to prove that he was a professional gambler operating in the trade or business of gambling sufficient to claim his gambling losses against his gambling winnings during the taxable years.
The plaintiff raises a constitutional issue that the plaintiff’s equal protection rights have been violated under the Fourteenth Amendment of the United States constitution and article first, §20, of the Connecticut constitution. As a result of the commissioner classifying the plaintiff as a non-professional gambler, it is the plaintiff’s contention that the commissioner gives unequal treatment to the gambling winnings of professional and non-professional gamblers. The plaintiff argues that there is no rational basis for the commissioner to discriminate against non-professional gamblers by taxing them on gross gambling winnings, while professional gamblers are taxed on net winnings, and cites Stewart Dry Goods Co. v. Lewis, 294 U.S. 550, 566, 55 S. Ct. 525, 79 L. Ed. 1054 (1935) (Kentucky tax law unconstitutional by imposing higher tax rate on retailers with large gross sales and lower tax rate on retailers with lower gross sales).
The constitutional issue here is not the disparity in taxing one taxpayer from another based on the size of gambling winnings. Instead, there is a rational basis for the legislature to impose a tax on professional gamblers that is different from how nonprofessional gamblers are treated. Professional gamblers and non-professional gamblers are simply not in the same class. See the distinction discussed above, on the federal level, of a professional gambler filing Schedule C to form 1040 to report gambling winnings and losses versus a non-professional gambler filing Schedule A to form 1040.
Accordingly, judgment may enter in favor of the defendant denying the plaintiff’s appeal for the taxable years, without costs to either party.
Arnold W. Aronson
Jeanne Gramling and Blake W. Ferguson, for respondent. GOLDBERG, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect at the time the petition was filed. The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Respondent determined a deficiency in petitioner’s Federal income tax of $1,601 for the taxable year 2001.(1) After concessions,(2) the issue for decision is whether petitioner must include in his gross income gambling winnings of $44,833 for taxable year 2001.(3) The amount of petitioner’s Social Security benefits received during taxable year 2001 that must be included in his 2001 gross income is a computational matter and will be resolved by our decision on the unreported gambling income issue.
(1) At trial, respondent conceded that the amount of the deficiency for taxable year 2001 set forth in the notice of deficiency was not correct. Instead, respondent claims that the correct deficiency is $1,046.
(2) At trial, respondent conceded that petitioner was entitled to Schedule A deductions for taxable year 2001 of $44,833 and $500 for gambling losses and charitable contributions, respectively.
(3) If the $44,833 gambling winnings are included in petitioner’s gross income, he must also include Social Security benefits received of $8,690 in his gross income for taxable year 2001 pursuant to sec. 86.
Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioner resided in Flat Rock, North Carolina, on the date the petition was filed in this case.
Petitioner timely filed his Federal income tax return for the 2001 taxable year. On Form 1040, U.S. Individual Income Tax Return, for taxable year 2001, petitioner reported capital gain income of $1,663.13. Petitioner did not report any other income. Petitioner also claimed a personal exemption and the standard deduction. Petitioner did not attach a Schedule A, Itemized Deductions, to his Form 1040.
During taxable year 2001, petitioner was retired. Petitioner gambled at Harrah’s Cherokee Smokey Mountain Casino (Cherokee Casino), and during taxable year 2001, petitioner received gambling winnings of $44,833 from Cherokee Casino. Both petitioner and respondent received seven Forms W-2G, Certain Gambling Winnings, for taxable year 2001, all seven of which were from Cherokee Casino in the amounts of $16,000, $2,500, $4,000, $4,000, $4,500, $12,583, and $1,250, for a total of $44,833. Petitioner attached these Forms W-2G to his 2001 Form 1040, but, as previously stated, he did not report the amounts as gross income. From these Forms W-2G, respondent determined that petitioner had unreported gambling income of $44,833 for taxable year 2001.
Accordingly, in the notice of deficiency for taxable year 2001, dated November 3, 2003, respondent determined that petitioner must include gambling winnings in the amount of $44,833 in his gross income. Respondent also determined that - 4 - petitioner was entitled to Schedule A itemized miscellaneous deductions in the amount of $44,523, rather than the standard deduction, and respondent further determined that petitioner must include taxable Social Security benefits of $8,690 in his gross income for taxable year 2001. The taxable Social Security income was computed at 85 percent of the total amount of $10,244, which petitioner received as Social Security benefits during taxable year 2001.
After the issuance of the notice of deficiency, but before trial, respondent conceded that he failed to allow petitioner a personal exemption and understated the allowable itemized miscellaneous deductions in his computation of the deficiency reflected in the notice of deficiency.
As previously noted, at trial, respondent conceded that petitioner was entitled to Schedule A itemized miscellaneous deductions of $45,333, consisting of $44,833 for gambling losses incurred by petitioner during taxable year 2001 and $500 for charitable contributions made by petitioner during taxable year 2001. Respondent also conceded, at trial, that the correct amount of the deficiency for taxable year 2001 was $1,046.
As a general rule, the determinations of the Commissioner in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving the Commissioner’s determinations to - 5 - be in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). As one exception to this rule, section 7491(a) places upon the Commissioner the burden of proof with respect to any factual issue relating to liability for tax if the taxpayer maintained adequate records, satisfied the substantiation requirements, cooperated with the Commissioner, and introduced during the Court proceeding credible evidence with respect to the factual issue. We decide the issue in this case without regard to the burden of proof. Accordingly, we need not decide whether the general rule of section 7491(a)(1) is applicable in this case. See Higbee v. Commissioner, 116 T.C. 438 (2001).
Petitioner contends that his $44,833 gambling winnings need not be included in his gross income because he had gambling losses to offset these winnings. Respondent, however, contends that petitioner must include his gambling winnings in his gross income and is then entitled to a Schedule A miscellaneous itemized deduction for his gambling losses.
The present problem seems to be that petitioner steadfastly rejects or ignores certain basic principles of the Federal income tax laws. Petitioner wishes to net his winnings and losses and, on his tax return, report in gross income only the amount of any net gambling winnings. Petitioner considers as “actual income” only his capital gain proceeds and any net gambling winnings. Petitioner is in error.
Section 61(a) defines gross income as “all income from whatever source derived,” including gambling, unless otherwise provided. McClanahan v. United States, 292 F.2d 630, 631-632 (5th Cir. 1961). The Supreme Court has consistently given this definition of gross income a liberal construction “in recognition of the intention of Congress to tax all gains except those specifically exempted.” Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430 (1955); see also Roemer v. Commissioner, 716 F.2d 693, 696 (9th Cir. 1983) (all realized accessions to wealth are presumed taxable income, unless the taxpayer can demonstrate that an acquisition is specifically exempted from taxation), revg. 79 T.C. 398 (1982).
Section 62 defines adjusted gross income and allows expenses of a trade or business and certain employee business expenses to be deducted from gross income. These deductions are sometimes referred to as deductions “above the line,” meaning simply that they are deducted from gross income to arrive at “adjusted gross income.” Gamblers who are engaged in a trade or business of gambling may be able to deduct their gambling losses above the line; indeed, courts have based their decisions in some cases on the proposition that such a professional gambler may net losses against winnings for purposes of determining what is includable in gross income. See Winkler v. United States, 230 F.2d 766 (1st - 7 - Cir. 1956); Green v. Commissioner, 66 T.C. 538 (1976). This is not the present case.
In the case of a taxpayer not engaged in the trade or business of gambling, gambling losses are allowable as a miscellaneous itemized deduction, but only to the extent of gains from such transactions. See sec. 165(d); McClanahan v. United States, supra; Winkler v. United States, supra; Gajewski v. Commissioner, 84 T.C. 980 (1985); Lutz v. Commissioner, T.C. Memo. 2002-89; see also Stein v. Commissioner, T.C. Memo. 1984-403; Umstead v. Commissioner, T.C. Memo. 1982-573.
The parties agree that, during taxable year 2001, petitioner received gambling winnings of $44,833 at the Cherokee Casino. The parties further agree that petitioner incurred gambling losses, during taxable year 2001, in excess of $44,833. Petitioner did not report the aforesaid gambling winnings as gross income on his 2001 Federal income tax return. Instead, petitioner merely offset his gambling income with his sustained gambling losses and did not report either of these amounts on his 2001 Federal income tax return.
Petitioner presented no evidence to show that he was a professional gambler, nor did he contend that he was a professional gambler. On the basis of the evidence in the record, we conclude that petitioner was a recreational gambler and not a professional gambler. Therefore, the gambling losses incurred by petitioner during taxable year 2001 are allowable only as an miscellaneous itemized deduction on Schedule A, to the extent of gains from gambling. See sec. 165(d); sec. 1.165-10, Income Tax Regs. Thus, petitioner must include his gambling winnings in his adjusted gross income and is entitled only then to a Schedule A miscellaneous itemized deduction, to the extent of his gains from gambling, for his gambling losses. See sec. 165(d); sec. 1.165-10, Income Tax Regs.
Reviewed and adopted as the report of the Small
Tax Case Division.
COUVILLION, Special Trial Judge: This case was heard pursuant to section 7463 in effect when the petition was filed.(1) The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority.
(1) Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the year at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Respondent determined a deficiency of $6,161 in petitioner’s Federal income tax for 2001, and a section 6662(a) penalty of $1,232.
The issues for decision are: (1) Whether petitioner’s gambling activity amounted to a trade or business under section 162, thereby allowing her to deduct gambling losses on Schedule C, Profit or Loss From Business, of her Federal income tax return, and (2) whether petitioner is liable for the section 6662(a) penalty.
Some of the facts were stipulated. Those facts, with the exhibits annexed thereto, are so found and are made part hereof. Petitioner’s legal residence at the time the petition was filed was Sparks, Nevada.
Before entering the flower business, petitioner completed her freshman year of high school and had some floral industry training. Petitioner then opened a flower shop in Reno, Nevada. The Flower Bucket Florist (flower shop) was organized as a corporation with petitioner as the sole stockholder. At the time of trial, petitioner’s flower shop was open 12 hours a day, Monday through Saturday, and a few hours on Sunday. The flower shop paid petitioner a $66,310 salary during 2001.
In addition, petitioner operated as sole stockholder another business, F.B. Wholesale, Inc. (F.B. Wholesale), which was a wholesale market that purchased flowers from growers and brokers and then resold the flowers to retail florists. The flower shop is one of F.B. Wholesale’s customers. F.B. Wholesale paid petitioner a $7,200 salary during 2001. Finally, petitioner earned $26,160 in rent from two other businesses and $4,848 in the lease of a portion of her home to an elderly lady.
During the year in issue, petitioner was nearly 70 years of age and had begun making plans for retirement. As a result, she began training her two daughters to assume control of the flower shop; however, petitioner was still actively involved in the flower shop during 2001. Because petitioner planned to hand over management of the flower shop to her daughters, when she turned 65, she began looking for other ways to supplement her monthly Social Security benefits.
Petitioner believed she had a talent for winning at slot machines and began playing the machines at different locations. She eventually gambled almost exclusively at one grocery store (Smith’s) that had the type of machines she liked, known as progressive machines. She began cultivating relationships with some of the grocery employees and started “tipping” them so they would alert her to what machines had not “paid out” recently.
Petitioner usually played the machine or machines that had gone the longest without a winner. On her 2001 tax return, she deducted as business expenses $6,000 in tips she paid grocery employees for that information. Petitioner estimated she spent 20 to 25 hours a week playing the slot machines at Smith’s. All of her gambling occurred after the flower shop was closed for the evening. Smith’s was on the route petitioner traveled from the flower shop to her home.
During 2000, petitioner contacted an Internal Revenue Service (IRS) agent for information on how to file her income tax return as a professional gambler. Petitioner never sought information from other professional gamblers as to what was required to become a professional gambler for tax purposes. She was reluctant to publicize her status as a professional gambler because of a perceived stigma attached to that occupation. She discussed her tax status as a professional gambler only on one occasion with an IRS agent. She was advised by the agent to simply file a Schedule C with her income tax return and was advised of her responsibility to pay self-employment taxes on any profit realized. Because petitioner reported a loss on her 2001 return, she did not pay any self-employment taxes.(2)
(2) There is no evidence in the record that, in her quest to qualify as a professional gambler, petitioner inquired or received any information that a basic and fundamental requisite of a trade or business, including that of a professional gambler, is that the activity be engaged in for profit.
On Schedule C of her 2001 return, petitioner listed “Professional Gambler” as her principal business and reported negative income of $5,050 and $8,129 in expenses for a total loss of $13,179. Petitioner kept records verifying the exact dates and amounts of her winnings, tips, and ATM charges and attached those records to her Schedule C. Respondent agreed at trial that petitioner kept meticulous records. Nevertheless, on her Form 1040, U.S. Individual Income Tax Return, petitioner listed her occupation as “Floral Manager”.
For gambling to reach the level of a trade or business activity it must be “pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and * * not a mere hobby”. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). The Supreme Court, in Groetzinger, held that a taxpayer who spent between 60 and 80 hours per week at dog races qualified as a professional gambler even though the taxpayer received income during the year from interest, dividends, capital gains, and salary earned before his job was terminated. Likewise, a taxpayer who spent 35 hours a week at a horse track after losing his job as a salesman and who was seeking a new sales job qualified as a professional gambler for purposes of section 162. Rusnak v. Commissioner, T.C. Memo. 1987-249.
Unlike the taxpayers in the cited cases, petitioner did not pursue gambling full time. She gambled regularly but only after she finished working at her flower shop. She frequently stopped at Smith’s to play the slot machines on her way home from work. As she reported on her tax return, her occupation was “floral manager”. The fact that petitioner earned income from investments and rent does not in and of itself bar her from being a professional gambler. Petitioner, however, does not qualify as a professional gambler because her situation does not satisfy the test laid out by the Supreme Court. In Commissioner v. Groetzinger, supra at 33, the Court stated that, if a taxpayer “devotes his full-time activity to gambling, and it is his intended livelihood source, it would seem that basic concepts of fairness * * * demand that his activity be regarded as a trade or business”. Petitioner’s livelihood was not her winnings from slot machines; instead, her primary income came from her flower shop. Her gambling was not a trade or business under section 162. Consequently, petitioner may not deduct her losses on a Schedule C but must itemize them.(3)
(3)If petitioner qualified as a professional gambler forpurposes of sec. 162, she still could claim her losses only to the extent she had gains. Sec. 165(d); Praytor v. Commissioner, T.C. Memo. 2000-282. Because petitioner does not qualify as a professional gambler, it is not necessary to address whether petitioner may deduct ATM charges and tips to grocery store employees as expenses because her slot machine losses alone exceeded her winnings; therefore, she may not deduct the charges or tips. In the notice of deficiency, respondent disallowed all of petitioner’s claimed deductions for gambling losses and other expenses in excess of gambling income. That computation is sustained by the Court.
Respondent determined a section 6662(a) penalty of $1,232 against petitioner. Section 6662(a) provides for a 20-percent addition to tax for any underpayment to which the section applies. Respondent determined that section 6662(b) applies to petitioner because (1) petitioner was negligent or disregarded rules or regulations, or (2) petitioner’s deficiency represented a substantial understatement of income tax.
Negligence is defined as “any failure to make a reasonable attempt to comply with the provisions of this title”, and disregard includes “careless, reckless, or intentional disregard.” Sec. 6662©. The Court holds that petitioner was not negligent, nor did she disregard rules or regulations when she filed as a professional gambler on her 2001 tax return. She consulted with an IRS agent and inquired as to how to file her tax returns as a professional gambler. She then followed the guidelines of the agent, which were simply to include a Schedule C with her income tax return. The Court finds petitioner’s testimony credible. Petitioner kept adequate records verifying her level of gambling activity and attached the records to her Schedule C. In addition, once petitioner received the notice of deficiency from respondent, she ceased her gambling activity while awaiting a decision by this Court. Petitioner’s actions amount to reasonableness under section 6662('c) and her actions are not considered by the Court to be “careless, reckless, or intentional disregard.”
Section 6662(b) also provides an addition to tax in the amount of 20 percent for any “substantial understatement of income tax.” A substantial understatement is defined as the 4 At trial, respondent agreed that, if the Court held that petitioner was not a professional gambler, she could deduct her gambling expenses as itemized deductions. In addition, respondent conceded that petitioner was also entitled to itemized deductions of $200, $458, and $1,376, respectively, for charitable contributions, taxes, and interest. greater of 10 percent of the tax required to be shown on the return or $5,000. Sec. 6662(d)(1)(A). Petitioner’s understatement does amount to more than $5,000; however, she qualifies for a reduction of the understatement. Sec. 6662(d)(1)(B). Section 6662(d) provides for a reduction of the understatement if the taxpayer supplied the relevant facts affecting the tax treatment on the return and if there was a reasonable basis for the tax treatment. Sec. 6662(d)(2)(B)(ii). As previously discussed, petitioner attached adequate records to her 2001 income tax return, and she had a reasonable basis for believing she qualified as a professional gambler simply by filing a Schedule C. Therefore, petitioner’s understatement for purposes of determining whether it amounts to a “substantial understatement of income tax” is reduced to zero. Sec. 6662(d)(1)(A). Petitioner is not liable for the section 6662(a) penalty.4
Reviewed and adopted as the report of the Small Tax Case Division. Decision will be entered under Rule 155.
Angelique M. Neal, for respondent.
LARO, Judge: This case is before the Court for decision without trial. See Rule 122.(1) Petitioners petitioned the Court to redetermine an $8,793 deficiency in their 2000 Federal income tax. We decide whether petitioners’ lottery winnings are includable in their adjusted gross income for purposes of applying the $25,000 offset of section 469(i). We hold they are.(2)
(1)Rule references are to the Tax Court Rules of Practice and Procedure. Section references are to the applicable versions of the Internal Revenue Code.
(2)We decide this case on its merits and without regard to which party bears the burden of proof
The facts in this background section are obtained from the parties’ stipulation of facts and the exhibits submitted therewith. Petitioners resided in Los Angeles, California, when their petition was filed.
Petitioners filed a joint 2000 Form 1040, U.S. Individual Income Tax Return. They reported on that return the following items of income (loss) which they realized during 2000:
The rental real estate is a “passive activity”, sec. 469©(2), in which petitioners actively participated.
Respondent determined that the phase-out rules of section 469(i)(3) preclude petitioners from currently deducting any of their rental real estate loss. Under that section, individual taxpayers such as petitioners who actively participate in a rental real estate activity and who may otherwise deduct up to $25,000 of a rental real estate loss, see sec. 469(i)(1) and (2), must reduce that $25,000 figure by 50 percent of the amount by which their adjusted gross income exceeds $100,000, see sec. 469(i)(3). We understand petitioners to be making three arguments in support of their claim that respondent’s determination is wrong. First, petitioners argue that their lottery winnings are not includable in their 2000 gross income because they are neither professional nor part-time gamblers. Second, petitioners argue that their lottery winnings are not includable in their adjusted gross income for purposes of section 469(i)(3). Third, petitioners argue that, if their first two arguments are wrong, the Court should recognize that they are in a tight financial bind and apply equitable principles to allow them to deduct at least half of their rental real estate loss.
We disagree with petitioners’ first argument that their 2000 gross income does not include their lottery winnings. The wide reach of section 61(a) brings within a taxpayer’s gross income all accessions to wealth, United States v. Burke, 504 U.S. 229, 233 (1992), and an accession to wealth on account of gambling winnings is no exception, see, e.g., Lyszkowski v. Commissioner, T.C. Memo. 1995-235 (and cases cited therein), affd. without published opinion 79 F.3d 1138 (3d Cir. 1996). Contrary to petitioners’ claim, an accession to wealth on account of gambling winnings is includable in an individual taxpayer’s gross income whether he or she is a professional gambler, a part-time gambler, or simply a onetime gambler. Id.
Nor do we agree with petitioners’ second argument that their adjusted gross income under section 469(i)(3) does not include their lottery winnings. For purposes of the income tax provisions of the Internal Revenue Code, the term “adjusted gross income” is defined by section 62 as gross income less certain enumerated deductions, none of which is relevant here. While section 469(i)(3)(F) also enumerates certain other adjustments which affect that term for purposes of section 469(i)(3), all of those enumerated adjustments are inapplicable as well.
We conclude that petitioners’ lottery winnings are includable in their adjusted gross income for purposes of section 469(i)(3). Although petitioners as a third argument essentially invite this Court to apply some principle of equity to arrive at a contrary result, we decline to do so. This Court is not authorized to ignore such a clear expression of Congress’ intent as applies here. Flight Attendants Against UAL Offset v. Commissioner, 165 F.3d 572, 578 (7th Cir. 1999).
All arguments for a contrary holding have been considered, and those arguments not discussed herein have been found to be without merit. Accordingly, Decision will be entered for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: This proceeding was commenced under section
6015 for review of respondent’s determination that petitioner is not entitled to relief from joint and several liability for 1999 with respect to a joint return filed with Steven F. Ohrman (Mr. Ohrman). The issues for decision are: (1) Whether petitioner is eligible for relief from joint and several liability under section 6015(b); (2) whether petitioner is liable under section 6015)('c)(4) to the extent she received disqualifiedassets notwithstanding a valid election under section 6015('c) and (3) whether respondent abused his discretion in denying petitioner’s request for relief from joint and several liabilityunder section 6015(f).
Unless otherwise indicated, all section references are tothe Internal Revenue Code in effect for the year in issue. Alldollar amounts have been rounded to the nearest dollar.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. At the time the petition in this case was filed, petitioner resided in Portland, Oregon.
Petitioner and Mr. Ohrman were married in Seattle,Washington, on March 26, 1988. On September 9, 1994, petitionerand Mr. Ohrman purchased a personal residence on Birdshill Roadin Portland, Oregon (Birdshill residence). At the time of trialin March 2003, petitioner was 53 years old and Mr. Ohrman was56 years old.
Petitioner attended college for at least 2 years and worked towards a teaching degree, but she did not graduate. From 1985 to 1995, petitioner worked as a lending officer at two large banks. While working as a lending officer, petitioner dealt withreal estate agents and reviewed mortgage loan applications.Petitioner became a full-time homemaker when her grandniece Alexamoved into her home in 1995.
Mr. Ohrman has worked for Spicers Paper, Inc. (Spicers Paper), in Gresham, Oregon, as its regional manager for the Portland, Oregon, and Seattle, Washington, divisions for several years including 1999. As of the time of trial, Mr. Ohrman’s salary was $135,000 per year, and his take-home pay was approximately $6,800 per month.
Mr. Ohrman’s Gambling Addiction
Mr. Ohrman has an admitted gambling addiction. Petitionerfirst became aware of Mr. Ohrman’s gambling in 1993. In 1998,Mr. Ohrman enrolled in Project STOP (the State of Oregon gamblingtreatment center) to seek treatment for his gambling addiction.Petitioner participated in Project STOP’s “significant other”program to support Mr. Ohrman. While participating in ProjectSTOP, Mr. Ohrman revealed to petitioner that he had accruedapproximately $200,000 in outstanding gambling debts on variousjoint credit cards held in Mr. Ohrman’s and petitioner’s names.Mr. Ohrman graduated from Project STOP on December 19, 1998, andreceived a Certificate of Achievement.
During the Project STOP program, petitioner was advised to block Mr. Ohrman’s ability to obtain money. Pursuant to this advice, petitioner took control of the family finances in 1999.Petitioner wrote checks to pay the bills, reviewed monthly bankstatements, and maintained a file drawer in the Birdshillresidence where she kept the family’s financial records. Inaddition, petitioner removed Mr. Ohrman’s name from their jointchecking account at U.S. Bank (U.S. Bank checking account) aswell as from their joint money market savings account at U.S.Bank. Petitioner also obtained quarterly credit reports underher name to check for inquiries and new credit during 1999.Petitioner, however, did not remove Mr. Ohrman’s name from eitherthe $60,000 home equity line of credit held by petitioner andMr. Ohrman with Wells Fargo Bank (Wells Fargo home equity line ofcredit) or the joint checking account petitioner and Mr. Ohrmanmaintained at Key Bank in Seattle.
After she took control of the family finances, petitionerhad Mr. Ohrman’s wages from Spicers Paper deposited directly intoher U.S. Bank checking account during 1999. Petitioner was theonly authorized signer on the U.S. Bank checking account, andMr. Ohrman had no access to this account. Mr. Ohrman’s wagesprovided the only income source from which petitioner paid herfamily’s ongoing living expenses, including Mr. Ohrman’s pre-1998gambling debts. Despite petitioner’s efforts, Mr. Ohrman’sgambling addiction persisted through 1999.
· 5 -
Mr. Ohrman’s Early Withdrawals From His Retirement AccountDuring 1999, Mr. Ohrman was the owner of an individualretirement account (IRA) at Dean Witter Reynolds (Dean Witteraccount). The Dean Witter account was a rollover account set upby petitioner and Mr. Ohrman in 1997. Petitioner was presentwith Mr. Ohrman when the Dean Witter account was established.
Thereafter, petitioner maintained a file for the Dean Witter account and placed the monthly account statements into a notebook. As of February 28, 1999, the Dean Witter account had a total asset value of $454,406.
Petitioner was the designated beneficiary of the Dean Witter account, but her written consent was not required to make anearly withdrawal. Petitioner was aware of how much money was inthe Dean Witter account in 1998 and 1999, and she believed therewas approximately $700,000 in the account at one point in 1998.Because of the size of the Dean Witter account, petitionersolicited promises from Mr. Ohrman before and during 1999 that hewould not use any of the funds in the Dean Witter account forgambling.
Despite his promises to petitioner, Mr. Ohrman withdrew $79,000 in early distributions from the Dean Witter account in 11 separate transactions from March 19 to December 21, 1999, to fund his gambling addiction. Petitioner neither knew about nor consented to these early distributions, nor did petitioner sign any of the IRA distribution request forms. Mr. Ohrman was theonly person who endorsed the distribution checks.
Statements for the months of March, April, May, June, July,and August 1999 for the Dean Witter account were received at theBirdshill residence. These monthly statements showed thatwithdrawals totaling $44,000 were taken from the Dean Witteraccount in the following amounts: March, $5,000; April, $5,000;
May, $8,000; June, $5,000; July, $13,000; and August, $8,000. InSeptember 1999, Mr. Ohrman changed the address on the Dean Witteraccount statements from the Birdshill residence to his workaddress at Spicers Paper. Consequently, the monthly statementsfor September, October, November, and December 1999 for the DeanWitter account were sent to Mr. Ohrman’s work address.Mr. Ohrman opened an individual checking account at WellsFargo Bank (Wells Fargo checking account) prior to December 8,1998, and he used this checking account throughout 1999 inconnection with his gambling. Mr. Ohrman opened the Wells Fargochecking account without petitioner’s knowledge or consent.Mr. Ohrman also obtained credit cards in his name alone aftergraduating from Project STOP. These credit cards were used tofund his gambling addiction and were not known to petitioneruntil June 2001. The early withdrawals taken by Mr. Ohrman fromthe Dean Witter account during 1999 were used at least in part topay down the gambling debt attributable to these credit cards.
· 7 -
On April 15, 2000, petitioner and Mr. Ohrman filed a joint1999 Federal income tax return (joint 1999 return), Form 1040,U.S. Individual Income Tax Return, and attachments. Petitionerprepared the joint 1999 return on her home computer using TurboTax, a tax preparation program. Although two Forms 1099-R,Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for 1999 weresent to Mr. Ohrman at the Birdshill residenceone indicating agross distribution and taxable amount of $71,000 from the DeanWitter account and the other indicating a gross distribution andtaxable amount of $8,000 from the Dean Witter accountthe$79,000 in distributions withdrawn by Mr. Ohrman from his DeanWitter account was not reported on the joint 1999 return filed bypetitioner and Mr. Ohrman.
The $79,000 withdrawn by Mr. Ohrman from the Dean Witteraccount was taxable income, the omission of which from the joint1999 return resulted in an understatement of tax attributable toan erroneous item of Mr. Ohrman. At the time petitioner signedthe joint 1999 return, she did not have actual knowledge of theearly distributions from the Dean Witter account.
On May 29, 2001, respondent issued a letter of proposed changes to petitioner’s and Mr. Ohrman’s reported tax liability for 1999. This letter proposed that petitioner and Mr. Ohrman owed an additional $42,927 (consisting of $32,217 in deficiency, $6,443 in accuracy-related penalty, and $4,267 in interest) for1999. The letter of proposed changes was received by petitionerat the Birdshill residence in early June 2001. Within a few daysafter receiving respondent’s letter of proposed changes,petitioner confronted Mr. Ohrman and learned of the earlydistributions from the Dean Witter account.
Legal Separation Proceedings and Transfer of Assets
Within 1 week after receipt of respondent’s letter of proposed changes, petitioner met with Laura Rackner (Rackner), anattorney in Portland who specializes in divorce and family law,for advice. During this meeting, petitioner told Rackner thatshe received respondent’s letter of proposed changes for 1999.In addition, petitioner told Rackner that Mr. Ohrman was acompulsive gambler and that she wanted to be protected from hisgambling-related debt.
Rackner informed petitioner that there was a possibility that she could obtain relief from joint and several liability for the 1999 tax deficiency. After hearing Rackner’s advice, petitioner told Rackner that she wanted a financial separation from Mr. Ohrman. Accordingly, petitioner provided assets and liabilities information to Rackner, including the value of the Birdshill residence and the value of the funds in Mr. Ohrman’s Dean Witter account and in his 401(k) retirement account. On June 21, 2001, petitioner filed for a legal separation fromMr. Ohrman in Clackamas County (Oregon) Circuit Court.On June 25, 2001, petitioner and Mr. Ohrman signed aStipulated Judgment for Unlimited Separation (separationagreement), and Mr. Ohrman conveyed his interest in the Birdshillresidence to petitioner. Rackner drafted the separationagreement for petitioner.
On July 3, 2001, Circuit Court Judge Patrick D. Gilroysigned the separation agreement in the matter of Ohrman v.Ohrman, Case No. DR0106592. Mr. Ohrman was not represented atany point during the proceedings for legal separation. Uponexecution of the separation agreement, Mr. Ohrman conveyed topetitioner his interest in the Birdshill residence. Petitioneralso received ownership of a 1998 Lexus automobile, the DeanWitter account, and a 401(k) retirement account that had beenheld in Mr. Ohrman’s name. In addition, Mr. Ohrman was requiredto pay to petitioner spousal support as follows: (1) $6,000 permonth, commencing on July 1, 2001, until the Birdshill residencewas sold and the sales transaction was completed; (2) $5,000 permonth for 12 months thereafter; (3) $4,000 per month for 66months thereafter; and then (4) $1,500 per month indefinitely.
Pursuant to the separation agreement, Mr. Ohrman has been required to maintain medical, dental, and hospital insurance on petitioner. He has also been required to maintain life insurance through his employer and through Transamerica with petitioner asbeneficiary. Additionally, Mr. Ohrman was required to pay,defend, indemnify, and hold harmless petitioner for 19 specifiedcredit cards held in his name in addition to all other creditcards, loans, debts, notes, encumbrances, credit lines, equitylines, or other financial obligations in his name, with theexception of an Alaska Airlines Visa account.
Finally, Mr. Ohrman agreed to:
pay, defend, indemnify and hold * * * [petitioner] harmless from any claim made by any taxing agency arising out of tax returns previously filed by the parties. * * * [Mr. Ohrman] shall be liable, indemnify and hold * * * [petitioner] harmless from the tax liabilities resulting for 1999, 2000 and 2001. * * *
[Mr. Ohrman] shall be responsible for communicatingwith the taxing agencies and do all that is necessaryto protect * * * [petitioner] from the tax obligation.
Excluding the right to spousal support, insurance coverages, and the 1998 Lexus, petitioner received assets with an approximate fair market value of $782,000 under the separation agreement. The fair market value of the Birdshill residence as of June 2001 was approximately $500,000. The true and actual stated consideration in the Bargain and Sale Deed transferring Mr. Ohrman’s interest in the Birdshill residence to petitioner was $0. The 401(k) retirement account had a value of $36,581 on March 31, 2001. The Dean Witter account had a value of $246,234 on May 31, 2001. Under the separation agreement, Mr. Ohrman retained only his personal belongings, which consisted of clothing, items stored in the garage of the Birdshill residence,his tools, and a 1997 Honda automobile.
Petitioner’s and Mr. Ohrman’s Relationship After Their “Financial
Although petitioner and Mr. Ohrman were legally separated as of July 2001, they continued to reside together. They remainedat the Birdshill residence until June 20, 2002. On June 10,2002, petitioner sold the Birdshill residence for $520,000.Petitioner received $63,087 in proceeds from the sale of theBirdshill residence.
After the sale of the Birdshill residence, petitioner andMr. Ohrman rented a room together at a hotel in Portland fromJune 21, 2002, through July 15, 2002. On July 15, 2002,petitioner purchased a new personal residence on Carlton Streetin Portland (Carlton residence) for $363,000. Petitioner made adownpayment of $79,438 to purchase the Carlton residence. Inpetitioner’s Uniform Residential Loan Application for thepurchase of the Carlton residence, dated July 17, 2002,petitioner listed assets with a total value of $940,000 andreported a net worth of $525,373. Petitioner and Mr. Ohrman haveresided together at the Carlton residence from July 20, 2002, toat least March 2003.
In addition to residing together, petitioner and Mr. Ohrmanhave been raising their grandniece Alexa together as parents.
Petitioner and Mr. Ohrman were awarded full custody of Alexa on
· 12 -
February 24, 2002. Petitioner and Mr. Ohrman have also continuedto socialize together as a couple since their legal separation.Petitioner has remained in control of the family financessince the legal separation and has used Mr. Ohrman’s monthlysupport payments to pay her family’s ongoing living expenses,consisting of the monthly mortgage payment on the Carltonresidence, the utilities, the monthly payment due on her AlaskaAirlines Visa credit card, the house and car insurance premiums,and groceries for Mr. Ohrman, Alexa, and herself. In addition tomaking the monthly support payments to petitioner, Mr. Ohrmanpays at least an additional $1,800 per month for Alexa’sschooling, his gambling debt, health insurance for petitioner andAlexa, and life insurance.
Revenue Agent McConnell’s Examination
On December 10, 2001, respondent sent a statutory notice ofdeficiency to petitioner and Mr. Ohrman for 1999. In the noticeof deficiency, respondent determined that petitioner andMr. Ohrman are liable for a deficiency in income tax of $31,515and a section 6662(a) accuracy-related penalty in the amount of$6,303. On March 10, 2002, petitioner timely filed her Petitionfor Determination of Relief from Joint and Several Liability on aJoint Return under section 6015(b), (c), and (f) in response tothe statutory notice of deficiency.
· 13 -
In August 2002, Revenue Agent Joan McConnell (McConnell) wasassigned to examine petitioner’s qualification for relief fromjoint and several liability under section 6015. McConnellinterviewed petitioner on September 11, 2002. During thisinterview, petitioner told McConnell that monthly statements forthe Dean Witter account came to the Birdshill residence during1999, but she did not open them because they were not addressedto her. Additionally, petitioner explained to McConnell that sheobtained the legal separation from Mr. Ohrman in order to protectherself financially. Petitioner also provided to McConnell awritten response to respondent’s Innocent Spouse Questionnaire atthis interview and signed it under penalties of perjury.McConnell interviewed Mr. Ohrman on October 31, 2002. Whenquestioned during this interview about the transfer of assets topetitioner, Mr. Ohrman told McConnell that the legal separationand transfer of assets were his ideas and that he did not feelthat petitioner should have to pay for his mistakes.
McConnell referred to Rev. Proc. 2000-15, 2000-1 C.B. 447, to determine whether petitioner should be granted equitable relief under section 6015(f) for the 1999 tax deficiency. Based upon her analysis of the facts and circumstances of petitioner’s case, McConnell determined that petitioner did not qualify for equitable relief under section 6015(f). McConnell concluded that petitioner received a transfer of disqualified assets from Mr. Ohrman. In addition, McConnell concluded that petitioner hadreason to know of at least some of the distributions from theDean Witter account.
Generally, married taxpayers may elect to file a jointFederal income tax return. Sec. 6013(a). After making theelection, each spouse is jointly and severally liable for theentire tax due for that taxable year. Sec. 6013(d)(3). A spouse(requesting spouse) may, however, seek relief from joint andseveral liability by following procedures established insection 6015. Sec. 6015(a). A requesting spouse may requestrelief from liability under section 6015(b) or, if eligible, mayallocate liability according to provisions under section 6015.Sec. 6015(a). If relief is not available under section 6015(b)
or , an individual may seek equitable relief under section
Section 6015(b) Analysis
Section 6015(b) provides, in pertinent part, as follows:
SEC. 6015(b). Procedures For Relief From
Liability Applicable to All Joint Filers.
(1)In general.Under procedures prescribed
(A)a joint return has been made for ataxable year;
(B)on such return there is an understatement of tax attributable to erroneous items of 1 individual filing the joint return;
(C)the other individual filing the joint return establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement;
(D)taking into account all the factsand circumstances, it is inequitable to holdthe other individual liable for thedeficiency in tax for such taxable yearattributable to such understatement; and
(E)the other individual elects (in suchform as the Secretary may prescribe) thebenefits of this subsection not later thanthe date which is 2 years after the date theSecretary has begun collection activitieswith respect to the individual making theelection,then the other individual shall be relieved ofliability for tax (including interest, penalties,and other amounts) for such taxable year to theextent such liability is attributable to suchunderstatement.
The requirements of section 6015(b)(1) are stated in the
conjunctive. Accordingly, a failure to meet any one of them
prevents a requesting spouse from qualifying for relief offered
therein. Alt v. Commissioner, 119 T.C. 306, 313 (2002).
There is no dispute that petitioner satisfies subparagraphs
(A)and (B) of section 6015(b)(1). Moreover, respondent does notargue that petitioner’s election was untimely under section6015(b)(1)(E). Respondent contends, however, that petitionerfailed to meet the requirements of subparagraphs and (D) ofsection 6015(b)(1). Petitioner argues that she has met all of
· 16 -
the requirements for equitable relief set forth in section6015(b)(1) and is entitled to relief from joint and severalliability for the joint 1999 return.
Section 6015(b)(1)(C) requires that the requesting spouseestablish that in signing the return she did not know, and had noreason to know, that there was an understatement. The partieshave stipulated that petitioner did not have actual knowledge ofthe understatement at the time she signed the joint 1999 return.In deciding whether petitioner has carried her burden of proof inestablishing that she had no reason to know of the understatementin the joint 1999 return, witness credibility is an importantconsideration. See Penfield v. Commissioner, T.C. Memo. 2002-254; Ishizaki v. Commissioner, T.C. Memo. 2001-318. In thiscase, as discussed below, various inconsistencies in theassertions of petitioner and Mr. Ohrman undermine the reliabilityof their generalized assertions that petitioner had no reason toknow of the withdrawals from the Dean Witter account. Therefore,we are not required to accept them. See Geiger v. Commissioner,440 F.2d 688 (9th Cir. 1971), affg. T.C. Memo. 1969-159.
Petitioner believed that there was approximately $700,000 in the Dean Witter account at one point in 1998. In an effort to protect this amount, she solicited promises from Mr. Ohrman before and during 1999 that he would not use any of the funds in the Dean Witter account for gambling. Petitioner was aware of how much money was in the Dean Witter account in 1998 and 1999because she was present with Mr. Ohrman when the account wasestablished and had maintained a file for the account’s monthlystatements.
While Mr. Ohrman may have been deceitful in hiding theactual withdrawals from the Dean Witter account from petitioner,the account statements showing these withdrawals were sent to theBirdshill residence for the months of March, April, May, June,July, and August 1999. These statements show that withdrawalstotaling $44,000 were taken from the Dean Witter account duringthese months. Mr. Ohrman changed the address on the Dean Witteraccount to his work address in September 1999.
It is not clear from the testimony or the evidence before uswhat happened to the Dean Witter account statements for themonths of March, April, May, June, July, and August 1999.Petitioner does not account for these six monthly accountstatements in her written response to respondent’s InnocentSpouse Questionnaire. Specifically, in petitioner’s response toquestion No. 22 of the Innocent Spouse Questionnaire, sheprovided information only as to Mr. Ohrman’s changing the addresson the Dean Witter account statements for the months ofSeptember, October, November, and December 1999 and hisevasiveness about the account statements for those months.
· 18 -
When McConnell interviewed petitioner on September 11, 2002,she inquired as to the Dean Witter account statements for the6 months of March through August 1999. Petitioner told McConnellthat monthly statements for the Dean Witter account came to theBirdshill residence during 1999, but she did not open thembecause they were not addressed to her. When questioned attrial, however, petitioner was not so forthcoming with anexplanation as to what happened to the Dean Witter accountstatements for the 6 months of March through August 1999.Petitioner testified that she could not remember getting anystatements during 1999 for the Dean Witter account at theBirdshill residence. Therefore, when examined in their totality,petitioner’s response on the Innocent Spouse Questionnaire, herresponse to McConnell during their interview of September 11,2002, regarding the delivery of the Dean Witter accountstatements to the Birdshill residence during 1999, and herresponse at trial about these statements are vague, inconsistent,and evasive.
Mr. Ohrman also provided testimony as to what happened tothe Dean Witter account statements for the 6 months of Marchthrough August 1999. Mr. Ohrman testified that he would leavework and “chase the mailtruck” in order to prevent the DeanWitter account statements from reaching the Birdshill residence.
He also testified that, when petitioner asked about the Dean
· 19 -
Witter account statements, he would show her statements that hehad “doctored up” in order to hide his withdrawals from the DeanWitter account. When asked about the whereabouts of these“doctored up” statements on cross-examination, however,Mr. Ohrman acknowledged that neither he nor petitioner hadprovided them and that “they were thrown away” by him orpetitioner.
The Dean Witter account statements were not the only sourceof information indicating that Mr. Ohrman had taken the earlywithdrawals during 1999. Two Forms 1099-R for 1999 were alsosent to the Birdshill residenceone indicating a grossdistribution and taxable amount of $71,000 from the Dean Witteraccount and the other indicating a gross distribution and taxableamount of $8,000 from the Dean Witter account. On the InnocentSpouse Questionnaire, petitioner stated that the two Forms 1099-Rwere sent to Mr. Ohrman’s work address. This statement isinconsistent with the address clearly shown on both Forms 1099-R.Petitioner is a fairly well-educated individual who hadgained experience with financial matters as a result of her10 years of employment as a lending officer with two large banks.
Petitioner took complete control of her family’s finances in 1999 as a result of Mr. Ohrman’s gambling addiction, was aware of the existence and magnitude of the Dean Witter account, and prepared the joint 1999 return by herself. A reasonable person in petitioner’s position would have been put on notice byMr. Ohrman’s evasion and deception with respect to the DeanWitter account statements. Petitioner was well aware of theextent of Mr. Ohrman’s past gambling and that he needed access tomoney in order to continue gambling. Even though petitioner hadknowledge of these facts, she did not keep close watch over theDean Witter account. Although petitioner also suffered difficultpersonal circumstances during 1999, she was able to retaincontrol of other aspects of the family finances. Therefore, whenwe consider the entire record of this case, we conclude thatpetitioner has not established that she had no reason to know ofthe understatement when she signed the joint 1999 return.
We also conclude that petitioner has not satisfied the requirements of subparagraph (D) of section 6015(b)(1). Taking into account all the facts and circumstances of petitioner’s case, it is not inequitable to hold her liable for the 1999 tax deficiency because the tax-avoidance purpose of the separation agreement is apparent from the evidence. First, a proposed tax liability of nearly $43,000 prompted petitioner to meet with Rackner for advice in early June 2001. Second, petitioner told Rackner about the proposed tax deficiency during this meeting, and Rackner informed her that relief from joint and several liability might be available. Third, with the knowledge that relief from joint and several liability might be available to her, petitioner instructed Rackner to draft the separationagreement whereby she would be financially separated fromMr. Ohrman. Fourth, pursuant to this separation agreement,petitioner received approximately $782,000 in assets that hadpreviously been held in Mr. Ohrman’s name along with spousalsupport amounting to at least $4,000 per month for a minimumperiod of 78 months, leaving Mr. Ohrman stripped of nearly all ofhis assets and monthly income. Finally, petitioner andMr. Ohrman have continued their marital relationship since theirlegal separation was finalized in July 2001 and have continued touse Mr. Ohrman’s income to pay the family’s ongoing livingexpenses.
In Doyle v. Commissioner, T.C. Memo. 2003-96, we denied ataxpayer relief from joint and several liability under section6015(b)(1)(D) because she and her family had engaged in asystematic plan to put their assets beyond the reach ofrespondent’s legitimate collection activities. Similarly, inPierce v. Commissioner, T.C. Memo. 2003-188, we denied a taxpayerrelief under section 6015(b)(1)(D) when the object of a series oftransactions entered into by the taxpayer was to shield assetsfrom creditors, which ultimately included respondent. In bothcases, we concluded that granting relief to taxpayers in suchcircumstances would wrongfully permit them to shield themselvesfrom Federal tax liabilities by using section 6015.
· 22 -
In this case, petitioner has presented no credible nontaxreason for the transfer of assets pursuant to the separationagreement. Mr. Ohrman’s gambling addiction, long known to her,did not cause a legal separation. Petitioner reacted to thatsituation by taking practical control of the family finances.
These circumstances lead us to the ultimate conclusion that
petitioner obtained a legal separation in order to shield as many
assets and as much of the family’s income as possible from the
1999 tax deficiency.
Furthermore, it is not inequitable to hold petitioner liable
for the 1999 tax deficiency because she would not suffer a majorfinancial hardship as a result. Petitioner holds assets that shecould use to pay the 1999 tax deficiency. In addition, herfamily’s living expenses are all paid from Mr. Ohrman’s earnings.
Therefore, although her circumstances may be unfortunate, they do
not compel relief from joint and several tax liability under
Section 6015 Analysis
Because petitioner cannot avoid liability for the deficiency
arising from the joint 1999 return under section 6015(b), we now
turn our attention to her claim for relief from joint and several
liability under section 6015. Section 6015 allows a
taxpayer, who is eligible and so elects, to limit his or her
liability to the portion of a deficiency that is properly
· 23 -
allocable to the taxpayer as provided in section 6015(d). Sec.6015(1). Under section 6015(d)(3)(A), generally, any itemsthat give rise to a deficiency on a joint return, e.g., theunreported early distributions from the Dean Witter account,shall be allocated to the individual filing the return in thesame manner as it would have been allocated if the individual hadfiled a separate return for the taxable year.
A taxpayer is eligible to elect the application of section6015 if, at the time the election is filed, the taxpayer islegally separated from the individual with whom the taxpayerfiled the joint return to which the election relates. Sec.6015(3)(A)(i)(I). Furthermore, the election under section6015 must not be made later than 2 years after the date onwhich respondent has begun collection activities with respect tothe taxpayer making the election. Sec. 6015(3)(B).
Respondent does not contend that petitioner’s election undersection 6015 was untimely. Therefore, petitioner is eligibleto elect the application of section 6015 to limit herliability for the 1999 tax deficiency.
The issue with which we are faced in this case, however,
deals with the application of section 6015(4) to the transfer
of assets from Mr. Ohrman to petitioner pursuant to the
separation agreement. Specifically, we must decide whether the
amount of the 1999 tax deficiency for which petitioner can be
· 24 -
held liable under section 6015(1) may be increased as a resultof a transfer of disqualified assets under section 6015(4).Under section 6015(4)(A), the portion of the deficiencyfor which the taxpayer electing the application of section6015 is liable (without regard to section 6015(4)(A)) isincreased by the value of any disqualified asset transferred tothe taxpayer. The term “disqualified asset” means any propertyor right to property transferred to the taxpayer making theelection under section 6015 (i.e., petitioner) by the otherindividual filing such joint return (i.e., Mr. Ohrman) if theprincipal purpose of the transfer was the avoidance of tax orpayment of tax. Sec. 6015(4)(B)(i).
Under section 6015(4)(B)(ii), there is a presumption thatany asset transfer that occurs after the date that is 1 yearbefore the first letter of proposed deficiency is sent byrespondent has as its principal purpose the avoidance of tax orpayment of tax. (The letter of proposed deficiency allows thetaxpayer an opportunity for administrative review in the InternalRevenue Service Office of Appeals. Sec. 6015(4)(B)(ii)(I).)This presumption, however, does not apply to any transfer madepursuant to a decree of divorce or separate maintenance or awritten instrument incident to such a decree. Sec.
6015(4)(B)(ii)(II); see also sec. 71(b)(2)(B) (explaining that
the term “divorce or separation instrument” means a written
separation agreement). Consequently, this presumption is notapplicable in this case because the transfer of assets fromMr. Ohrman to petitioner took place pursuant to a writtenseparation agreement.
Respondent argues that the burden of proof under section6015(4) is on petitioner because of the language of section6015(2) and caselaw interpreting section 6015. Conversely,petitioner contends that respondent has the burden of proofbecause of the language of section 1.6015-3(3)(iii), IncomeTax Regs., and the legislative history of section 6015. Weneed not resolve this dispute, however, because the preponderanceof the evidence establishes that the principal purpose of thetransfer was the avoidance of tax.
Respondent contends that the facts of this case show thatpetitioner and Mr. Ohrman intentionally and purposely obtained alegal separation and transferred assets in an attempt to shieldthese assets from respondent’s effort to collect the 1999 taxdeficiency. Petitioner primarily argues that, because thetransfer of assets from Mr. Ohrman to petitioner took placepursuant to the equitable distribution rules of Oregon familylaw, the transfer did not have as its principal purpose theavoidance of tax or payment of tax. For the reasons set forthbelow, respondent’s argument is persuasive on this matter.
· 26 -
Petitioner’s use of State family law as a vehicle to lend
legitimacy to Mr. Ohrman’s transfer of assets and income to her
is the type of abuse that Congress expressly intended to stop by
adding paragraph (4) to section 6015. While the State of
Oregon’s equitable distribution rules provided the mechanism for
the transfer of Mr. Ohrman’s assets and income to petitioner,
they do not negate the principal purpose for which the transfer
occurred, the avoidance of tax. As discussed in detail above,
the separation agreement was a way for petitioner to enjoy the
benefits of the family assets and income without satisfying the
1999 tax deficiency. Accordingly, we hold that petitioner
received a transfer of disqualified assets under section
The next step in the section 6015 analysis is to decidethe amount by which petitioner’s liability for the 1999 taxdeficiency should be increased because of the transfer ofdisqualified assets. Under section 6015(4)(A), the portion ofthe deficiency for which petitioner is liable is increased by thevalue of the disqualified assets that were transferred to her.
In this case, petitioner’s portion of the 1999 tax deficiency
would have been zero absent the transfer of disqualified assets
because of her eligibility to make an election to limit her
liability under section 6015(3). The value of the
disqualified assets petitioner received, however, far exceeds
· 27 -
petitioner’s liability for the 1999 tax deficiency.
Consequently, her election under section 6015 does not allowher to avoid liability for those taxes.
Section 6015(f) Analysis
Section 6015(f) provides an additional opportunity forrelief to those taxpayers who do not otherwise meet therequirements of subsection (b) or (c) of section 6015.
Specifically, section 6015(f) gives respondent the discretion togrant equitable relief from joint and several liability if“taking into account all the facts and circumstances, it isinequitable to hold the individual liable for any unpaid tax”.We have jurisdiction to review respondent’s denial ofpetitioner’s request for equitable relief under section 6015(f).Jonson v. Commissioner, 118 T.C. 106, 125 (2002); Butler v.Commissioner, 114 T.C. 276, 292 (2000). We review such denial ofrelief to decide whether respondent abused his discretion byacting arbitrarily, capriciously, or without sound basis in fact.Jonson v. Commissioner, supra at 125; Butler v. Commissioner,supra at 292. The review of respondent’s denial of petitioner’srequest for relief under section 6015(f) is a question of fact.Cheshire v. Commissioner, 115 T.C. 183, 198 (2000), affd. 282F.3d 326 (5th Cir. 2002). Petitioner bears the burden of provingthat respondent abused his discretion. Washington v.
Commissioner, 120 T.C. 137, 146 (2003); see also Alt v.
· 28 -
Commissioner, 119 T.C. 306, 311 (2002) (“Except as otherwiseprovided in section 6015, petitioner bears the burden ofproof.”); Jonson v. Commissioner, supra at 113 (same).As directed by section 6015(f), respondent has prescribedprocedures to use in determining whether a relief-seeking spousequalifies for relief under section 6015(f). At the time thatpetitioner filed her Petition for Determination of Relief fromJoint and Several Liability on a Joint Return, March 10, 2002,those procedures were found in Rev. Proc. 2000-15, 2000-1 C.B.447. Section 4.01 of Rev. Proc. 2000-15, 2000-1 C.B. at 448,lists seven threshold conditions that must be satisfied beforerespondent will consider a request for relief under section6015(f). The threshold conditions are as follows:
(1) The requesting spouse filed a joint return for
the taxable year for which relief is sought;
(2) Relief is not available to the requesting
spouse under [section] 6015(b) or 6015(c);
(3) The requesting spouse applies for relief no
later than two years after the date of the Service’s
first collection activity after July 22, 1998, with
respect to the requesting spouse;
(4) * * * the liability remains unpaid. * * *
(5) No assets were transferred between the spouses
filing the joint return as part of a fraudulent scheme
by such spouses;
(6) There were no disqualified assets transferred
to the requesting spouse by the nonrequesting spouse.
If there were disqualified assets transferred to the
requesting spouse by the nonrequesting spouse, relief
will be available only to the extent that the liability
· 29 -exceeds the value of such disqualified assets. Forthis purpose, the term “disqualified asset” has such
meaning given such term by section 6015(4)(B); and(7) The requesting spouse did not file the returnwith fraudulent intent.
Id. A requesting spouse must satisfy all seven thresholdconditions before respondent will consider his or her request forequitable relief under section 6015(f). Id. We have upheld theuse of these procedures in reviewing a negative determination.See Washington v. Commissioner, supra at 147; Jonson v.
Commissioner, supra at 125.
Respondent denied petitioner’s request for equitable relief
under section 6015(f) because she did not meet all seven of the
threshold conditions listed above. Specifically, respondent
concluded that petitioner received a transfer of disqualified
assets from Mr. Ohrman in violation of the sixth condition of
Rev. Proc. 2000-15, sec. 4.01. Respondent reached this
conclusion by considering the time line of events beginning with
petitioner’s receipt of the May 29, 2001, letter of proposed
changes to petitioner’s and Mr. Ohrman’s reported tax liability
for 1999, the transfer of assets from Mr. Ohrman to petitioner
pursuant to the separation agreement, and statements made by
petitioner and Mr. Ohrman during their separate interviews with
respondent. Petitioner maintains that she did not receive a
transfer of disqualified assets; thus, petitioner argues that she
· 30 -
has satisfied the threshold requirements of Rev. Proc. 2000-15,sec. 4.01.
Because we decided that petitioner received a transfer ofdisqualified assets from Mr. Ohrman, we conclude that petitionerdoes not meet all seven of the threshold conditions of Rev. Proc.2000-15, sec. 4.01. Accordingly, we conclude that respondent didnot abuse his discretion by acting arbitrarily, capriciously, orwithout sound basis in fact in denying petitioner’s request forequitable relief under section 6015(f).
We hold that respondent did not err in denying petitioner
relief from joint and several liability under section 6015 with
respect to the joint return filed with Mr. Ohrman for 1999. We
have considered the arguments of the parties not specifically
addressed in this opinion. Those arguments are either without
merit or irrelevant to our decision.
To reflect the foregoing,
Decision will be entered
UNITED STATES TAX COURT
LEROY VERNON AND ANNE J. SATRANG, Petitioners v.COMMISSIONER OF INTERNAL REVENUE, RespondentDocket No. 1459-00S. Filed September 10, 2001.Leroy V. Satrang, pro se.
J. Anthony Hoefer, for respondent.
LARO, Judge: This case was heard pursuant to the provisionsof section 7463 in effect when the petition was filed. Thedecision to be entered is not reviewable by any other court, andthis opinion should not be cited as authority.
Respondent determined a $7,066 deficiency in petitioners’1996 Federal income tax and a related $1,413 accuracy-relatedpenalty for negligence under section 6662(a). Following theparties’ concessions, and our dismissal of the case as to Anne J.
· 2 -
Satrang for lack of prosecution, we must decide whether LeroyVernon Satrang (petitioner) may deduct his alleged gamblinglosses. We hold he may not. We also must decide whetherpetitioner is liable for the accuracy-related penalty determinedby respondent. We hold he is. Unless otherwise indicated,section references are to the Internal Revenue Code as applicableto the subject year, Rule references are to the Tax Court Rulesof Practice and Procedure, and dollar amounts are rounded to thenearest dollar.
Some facts have been stipulated and are so found. Thestipulated facts and the exhibits submitted therewith areincorporated herein by this reference. Petitioners are husbandand wife, and they resided in Sioux City, Iowa, when theirpetition was filed.
Petitioner, a civil engineer by profession, is a
recreational gambler who bets primarily on horse races. During
the subject year, he won at least 29 of his gambling bets and
received a total of at least $32,050 in gambling winnings. He
reported none of those winnings on his 1996 Federal income tax
return even though he received Forms W2-G, Gambling Winnings,
listing those winnings. He asserts that none of the winnings are
taxable to him because his gambling losses during that year
totaled more than $70,000. His employer paid $51,600 to
· 3 -
1 For example, petitioner testified that during 1996 he had
“taken home” approximately $75,000 of his salary from hisemployer and that he gambled away most of that amount and some ofhis savings. The record, however, reveals clearly thatpetitioner’s gross salary was only $51,600 and that, of thatamount, he took home at the most $37,265.petitioner during 1996 and withheld $14,335 of that amount forFederal and State taxes.
Respondent determined that petitioner’s gross incomeincludes the $32,050 in gambling winnings shown on the Forms W2-G. Petitioner admits that he received those winnings and that hedid not report any of them on his 1996 Federal income tax return.Petitioner contends that he also had gambling losses for thatyear which exceeded his winnings.
Petitioner’s gambling winnings are includable in his grossincome. Sec. 61(a); Commissioner v. Glenshaw Glass Co., 348 U.S.426 (1955). As to his alleged gambling losses, petitioner bearsthe burden of proving that he sustained gambling losses and, ifso, the amount of those losses. Stein v. Commissioner, 322 F.2d78 (5th Cir. 1963), affg. T.C. Memo. 1962-19. Section 165(d)provides that “Losses from wagering transactions shall be allowedonly to the extent of the gains from such transactions.”
Petitioner relies primarily on his testimony to prove his
allegation. We find his testimony to be incredible and decline
to rely on it.1 Although we acknowledge that petitioner most
likely had some gambling losses during the year, we are unable to
· 4 -
determine (either with specificity or by estimation) the amountof those losses on the basis of the record at hand. Given thefact that petitioner bears the burden of proof on this issue, wesustain respondent’s determination with respect to it. See Mayerv. Commissioner, T.C. Memo. 2000-295; Zielonka v. Commissioner,T.C. Memo. 1997-81; see also Finesod v. Commissioner, T.C. Memo.1994-66.
As to the accuracy-related penalty for negligence, section6662(a) and (b)(1) imposes a 20-percent accuracy-related penaltyon the portion of an underpayment that is due to negligence orintentional disregard of rules or regulations. Negligenceincludes a failure to attempt reasonably to comply with the Code.Sec. 6662. Disregard includes a careless, reckless, orintentional disregard. Id. An underpayment is not attributableto negligence or disregard to the extent that the taxpayer showsthat the underpayment is due to the taxpayer’s reasonable causeand good faith. Secs. 1.6662-3(a), 1.6664-4(a), Income Tax Regs.Reasonable cause requires that the taxpayer exercise ordinarybusiness care and prudence as to the disputed item. UnitedStates v. Boyle, 469 U.S. 241 (1985); see also Estate of Young v.Commissioner, 110 T.C. 297, 317 (1998).
On the basis of the record, we sustain respondent’sdetermination of the accuracy-related penalty. Petitioner hasfailed to prove respondent’s determination wrong.
· 5 -
To reflect respondent’s concession,
Decision will be entered
under Rule 155.
UNITED STATES TAX COURT
PAUL S. LEBLANC, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, RespondentDocket No. 13599-99S. Filed June 22, 2001.Paul S. LeBlanc, pro se.
Linda A. Neal, for respondent.
DINAN, Special Trial Judge: This case was heard pursuant tothe provisions of section 7463 of the Internal Revenue Code ineffect at the time the petition was filed. The decision to beentered is not reviewable by any other court, and this opinionshould not be cited as authority. Unless otherwise indicated,subsequent section references are to the Internal Revenue Code ineffect for the year in issue.
· 2 -
Respondent determined a deficiency in petitioner’s Federalincome tax of $504 for the taxable year 1996.The issue for decision is whether requiring petitioner toinclude unreported gambling winnings in income violates theconstitutional right to equal protection.Some of the facts have been stipulated and are so found.The stipulations of fact and the attached exhibits areincorporated herein by this reference. Petitioner resided inGretna, Louisiana, on the date the petition was filed in thiscase.
Petitioner filed a joint Federal income tax return for 1996with his now deceased wife, Jacquelyn S. LeBlanc. Petitioner’swife received a Form W-2G, Statement for Recipient of CertainGambling Winnings, reflecting 1996 slot machine winnings of$1,773.61. However, no income from gambling was reported ontheir return. In the statutory notice of deficiency, respondentdetermined that petitioner had unreported gambling income of$1,773.
Gross income generally includes income from whatever sourcederived, including gambling winnings. See sec. 61(a); Umstead v.
Commissioner, T.C. Memo. 1982-573. Gambling losses generally are
allowed to the extent of the gambling winnings for the taxable
year. See sec. 165(a), (d). A nonprofessional gambler may claim
· 3 -
such losses as itemized deductions if he elects to forgo thestandard deduction. See sec. 63.
Petitioner admits that his wife received slot machinewinnings in the amount of $1,773 in 1996, that this amount wasnot reported on their tax return, and that this amount is incomesubject to the Federal income tax. Petitioner argues that thetaxation of the gambling winnings in his case is “unequaltreatment under the law,” in violation of the “equal protectionas well as equal treatment” afforded by the United StatesConstitution. Petitioner argues that certain taxpayers escapetaxation on their gambling winnings because casinos do not issueinformational returns for all taxpayers who receive suchwinnings.Although the Equal Protection Clause in the FourteenthAmendment limits the powers of the States, there is no comparableclause explicitly applicable to Federal legislation. However,the Due Process Clause of the Fifth Amendment has been construedas imposing an equal protection requirement in respect ofclassification to the extent that “discrimination [resulting fromsuch classification] may be so unjustifiable as to be violativeof due process.” Bolling v. Sharpe, 347 U.S. 497, 499 (1954)(fn. ref. omitted).
In evaluating whether a statutory classification violatesequal protection, we generally apply a rational basis standard.
· 4 -
See Regan v. Taxation With Representation, 461 U.S. 540, 547(1983). We apply a higher standard of review only if it is foundthat the statute (1) impermissibly interferes with the exerciseof a fundamental right, such as freedom of speech, or (2) employsa suspect classification, such as race. See, e.g., id.; Harrisv. McRae, 448 U.S. 297, 322 (1980). Neither of these exceptionsapplies in this case. Under the rational basis standard, achallenged classification is valid if rationally related to alegitimate governmental interest. See City of Cleburne v.
Cleburne Living Ctr., Inc., 473 U.S. 432, 440 (1985); City of New
Orleans v. Dukes, 427 U.S. 297, 303 (1976). Legislatures have
especially broad latitude in creating classification anddistinctions in tax statutes. See Regan v. Taxation WithRepresentation, supra at 547.The informational return which petitioner’s wife received inthis case was required by section 6041 and the accompanyingregulations. As a general rule, a person engaged in a trade orbusiness who makes a payment to an individual in excess of $600must provide an informational return to the Secretary of theTreasury (or his delegate) and to the individual. See sec.
6041(a), (d). A person engaged in a trade or business who pays
winnings to an individual of $1,200 or more from a bingo game or
slot machine play, or of $1,500 or more from a keno game, must
provide such an informational return. See sec. 7.6041-1(a),
· 5 -
Temporary Income Tax Regs., 42 Fed. Reg. 1471 (Jan. 7, 1977).This latter return must be made on a Form W-2G. See sec. 7.6041-1, Temporary Income Tax Regs., supra; see also sec.31.3402(q)-1(f), Employment Tax Regs. (Form W-2G payer reportingrequirements for purposes of withholding). In determining theamount won from such games, the amount wagered is deducted fromthe winnings in a keno game, but is not deducted in a bingo gameor slot machine play. See sec. 7.6041-1(b)(1), (2), TemporaryIncome Tax Regs., supra. Winnings from more than one game arenot aggregated. See sec. 7.6041-1(b)(5), Temporary Income TaxRegs.
Legislation enacted in 1917 added informational reporting
requirements to the Internal Revenue Code similar to the current
provisions under section 6041. See Act of October 3, 1917, ch.63, tit. XII, sec. 1211, 40 Stat. 300. The Senate reportaccompanying this legislation stated:
That the provisions of the law requiring withholding atthe source of the tax due on profits or incomes ofresident taxable persons be repealed and instead therebe substituted “information at the source,” where theamount of income received in any taxable year and paidover to the taxable person exceeds $800 for any taxableyear. * * * The proposed amendment is conducive to amore effective administration of the law in that itwill enable the Government to locate more effectivelyall individuals subject to the income tax and todetermine more accurately their tax liability. This isof prime importance from a viewpoint of collections.
In addition to this very important consideration, the
changes will result in the saving of annoyance and
expense to taxpayers and withholding agents in
lessening of expense to the Government, and in
· 6 -
simplifying administration, and in increasedeffectiveness * * *It is the Treasury Department’s judgment, basedupon close observation and study of the practicalworkings of the withholding feature of the income-taxlaw as well as of the general requirements ofadministration, that information at the source is afoundation upon which the administrative structure mustbe built if the income-tax law is to be rendered mosteffective and if due regard is to be paid to economyand simplicity of administration and to the impositionof no greater burden and expense upon taxpayers than isnecessary for effective administration. [S. Rept. 103,65th Cong., 1st Sess. (1917), 1939-1 C.B. (Part 2) 56,67-68.]We find petitioner’s argument to be without merit. There isno provision in the Internal Revenue Code which relieves ataxpayer from liability for the income tax on gambling winningsif the winnings are not reported by the payer. Thus, petitioneressentially is arguing that he has not been afforded equalprotection because those taxpayers whose winnings were notreported on informational returns have an easier time evading theFederal tax laws. The statutory requirements for informationalreturns classifies individuals according to the amount ofgambling winnings they pay to others. These classificationrequirements are rationally related to the legitimategovernmental interest of balancing the need for reportingrequirements to ensure compliance with the tax laws and the needto avoid imposing excessive burdens on covered individuals.Requiring a casino to report every dollar won from every slotmachine would undoubtedly be such a burden.
· 7 -
An aspect of petitioner’s argument apparently is that thecasino was not complying with the law by not issuinginformational returns when required. Petitioner has provided noevidence supporting this assertion, and even if he had it isunclear how such noncompliance by the casino would bear on anequal protection claim by petitioner.
We hold that requiring petitioner to include unreportedgambling winnings in income does not violate the constitutionalright to equal protection.
Reviewed and adopted as the report of the Small Tax CaseDivision.
To reflect the foregoing,
Decision will be entered
UNITED STATES TAX COURT
ELDRON U. ERBS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, RespondentDocket No. 1890-00S. Filed June 13, 2001.Eldron U. Erbs, pro se.
James M. Klein and Mark J. Miller, for respondent.
DINAN, Special Trial Judge: The proceedings in this case
were conducted pursuant to the provisions of section 7463 of the
Internal Revenue Code in effect at the time the petition was
filed. The decision to be entered is not reviewable by any other
court, and this opinion should not be cited as authority. Unless
otherwise indicated, subsequent section references are to the
Internal Revenue Code in effect for the year in issue, and all
· 2 -
Rule references are to the Tax Court Rules of Practice andProcedure.
Respondent determined a deficiency in petitioner’s Federalincome tax of $2,532 for the taxable year 1996.The issue for decision is whether petitioner was engaged inthe trade or business of gambling in 1996.
This case was submitted fully stipulated pursuant to Rule
122. All of the facts stipulated are so found. The stipulations
of fact and the attached exhibits are incorporated herein by this
reference. Petitioner resided in Oakdale, Wisconsin, on the date
the petition was filed in this case. Petitioner’s auditcommenced on July 2, 1998.Petitioner is semiretired. During the year in issue, he wasengaged in a business in which he purchased and sold antiques.
He incurred a loss of $3,415 in this business. Also during 1996,
petitioner visited the Ho-Chunk Casino in Baraboo, Wisconsin, on
at least 89 occasions. Ho-Chunk Casino produced a Player Coin
Report which indicates petitioner had “coin-in” and “coin-out”
amounts during the year of $368,166.95 and $341,530.20,
respectively. Petitioner made bank withdrawals from automated
teller machines in connection with his Ho-Chunk gambling activity
on 88 separate dates. The following summarizes on a monthlybasis the number of days he made withdrawals:
Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.
3 11 3 3 11 6 9 13 10 17 2 0
· 3 -
We treat these numbers as the approximate number of timespetitioner visited the casino in each month. He would normallyvisit the casino during late evening and early morning hours,averaging 9 hours per visit.
Petitioner received six Forms 1099 in 1996 for gambling
winnings. On his 1996 Federal income tax return, he reported the
amounts indicated on the Forms 1099 as his only winnings from
gambling. He reported this income of $10,538 on Schedule C,
Profit or Loss From Business, claiming no cost of goods sold or
expenses other than gambling losses of $10,538, resulting in zero
net profit. Petitioner reported $27,865 in adjusted grossincome, consisting of the following:
IRA distributions $26,600
Social Security benefits 3,052
Business loss (antique sales) (3,415)
Adjusted gross income 27,865
In addition, petitioner received $9,530 in nontaxable net SocialSecurity benefits. The occupation stated on his return was“retailer”.Respondent determined that petitioner’s gambling activitywas not an activity entered into for profit. Accordingly,respondent recharacterized petitioner’s gambling income anddetermined that petitioner’s gambling losses were deductible asan itemized deduction rather than as a trade or business expense.
Respondent also determined that petitioner was entitled to
· 4 -
itemized deductions in lieu of the claimed standard deduction andallowed petitioner an additional itemized deduction for thepayment of taxes. Finally, a computational adjustment was madeto the amount of taxable Social Security benefits. Petitionerdisputes respondent’s determination that he was not engaged inthe trade or business of gambling.
Ordinary and necessary expenses paid in carrying on a tradeor business generally are deductible under section 162(a). Ataxpayer who is engaged in the trade or business of gambling maydeduct gambling losses and expenses, if otherwise permitted, onlyto the extent of the taxpayer’s gambling winnings. See secs.162(a) and 165(d); Valenti v. Commissioner, T.C. Memo. 1994-483.
A taxpayer who is not engaged in the trade or business of
gambling also may deduct such losses and expenses to the extent
of their winnings, but must do so under section 165(a). Adeduction under section 165(a) reduces a taxpayer’s taxableincome only if the taxpayer elects to forgo the standarddeduction. See sec. 63.Resolving the question whether a taxpayer is engaged in atrade or business “requires an examination of the facts in eachcase.” Commissioner v. Groetzinger, 480 U.S. 23, 36 (1987)
(quoting Higgins v. Commissioner, 312 U.S. 212, 217 (1941)). The
Supreme Court in Commissioner v. Groetzinger, supra, addressing
· 5 -
1That the taxpayer in Groetzinger gambled “with a view to
earning a living from such activity” was not disputed by the
Commissioner. See Groetzinger v. Commissioner, supra at 24 n.2
(quoting Groetzinger v. Commissioner, 82 T.C. 793, 795 (1984)).
the question whether a full-time gambler who gambled solely for
his own account was engaged in a trade or business, stated:
to be engaged in a trade or business, the taxpayer must be
involved in the activity with continuity and regularity and
* * * the taxpayer’s primary purpose for engaging in the
activity must be for income or profit. A sporadic activity,
a hobby, or an amusement diversion does not qualify. * * *
we conclude that if one’s gambling activity is pursued full
time, in good faith, and with regularity, to the production
of income for a livelihood, and is not a mere hobby, it is a
trade or business within the meaning of the statutes withwhich we are here concerned. Respondent Groetzingersatisfied that test in 1978. Constant and large-scaleeffort on his part was made. Skill was required and wasapplied. He did what he did for a livelihood, though with aless-than-successful result. This was not a hobby or apassing fancy or an occasional bet for amusement. Id. at35-36.
After his employer terminated his position in February 1978, the
taxpayer in Groetzinger devoted the remainder of the year to
parimutuel wagering, primarily on greyhound races. During this
time, he spent 6 days a week for 48 weeks at the track and spent
a substantial amount of time studying racing forms, programs, and
other materials. In all, he devoted 60 to 80 hours each week to
gambling-related activities. After February, he had no
employment or profession other than gambling. He received $6,498
in non-gambling income from interest, dividends, capital gains,
and salary earned prior to termination.1
· 6 -
2Respondent has not challenged petitioner’s deduction of the
loss from the antiques business, so we need not address theaccuracy of petitioner’s treatment of the activity as a business.In this case, petitioner’s visits to the casino were notcontinuous or regular. Petitioner points to the total number ofhours he spent at the casino over the course of the year, andargues that he averaged 20 hours per week gambling. However, hisvisits to the casino throughout the year were very sporadic. Thenumber of monthly visits rose as high as 17 in October, but inDecember he made no visits and in several other months he madeonly 2 or 3. Petitioner also argues that the amount of time hespent in his antique sales business is similar to the amount oftime he spent in the gambling activity.2 The aggregate amount oftime spent in the activity is not as determinative as the factthat petitioner had little continuity or regularity to hisvisits. Finally, petitioner argues that the sporadic nature ofhis gambling was dictated by his knowledge of “how the machineswere cycling or if the machines were being adjusted to reduceplayers odds.” We do not accept this argument, both because itis not supported by any evidence and because we do not find itplausible that petitioner had knowledge of when the video pokermachines were producing higher payoffs which was sufficientlyaccurate or specific to dictate when he should visit the casino.
The primary purpose of petitioner’s gambling activity was
for amusement, not for profit: His activity, although
substantial, was more consistent with a hobby than a trade or
business. He argues that he spent a significant amount of time
studying “cycles” of video poker machines, reading publications
relating to video poker, and practicing on his own video pokermachine in order to “achieve greater success while gambling.”These efforts would be consistent with a desire to win money.However, the desire to win money is consistent with gamblingpurely for its entertainment or recreational aspects, and we findthat petitioner gambled primarily for this reason rather thanprimarily for profit.
Finally, we note that petitioner is semiretired and in 1996received a substantial amount of income: Excluding his businessloss of $3,415, he received over $40,000 in interest, individualretirement account distributions, and Social Security benefits.This income and petitioner’s semiretired status indicate that hewas not relying upon gambling for his livelihood.
In his trial briefs, petitioner discusses the material
participation requirements of section 469 and the regulations
thereunder. First, petitioner points to the references in these
provisions to 500 hours of participation in an activity, arguing
that he was in the trade or business of gambling because he
devoted nearly twice that amount of time. See, e.g., sec. 1.469-
5T(a)(1), Temporary Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25,
1988). These provisions govern whether a trade or business is
· 8 -
passive and do not address the more fundamental question of
whether an activity constitutes a trade or business. Second,
petitioner argues that instructions for the Schedule C provide
that there are no “limitations on losses” for nonpassive
activities (i.e., activities which meet the material
participation requirements). It is true that section 469 imposes
no additional limitations on such losses, but the losses are
still subject to the more general limitations discussed above.We hold that petitioner was not engaged in the trade orbusiness of gambling in 1996.
Reviewed and adopted as the report of the Small Tax CaseDivision.
To reflect the foregoing,
Decision will be entered
T.C. Memo. 2001-36
UNITED STATES TAX COURT
JUAN RODRIGUEZ, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, RespondentDocket No. 4624-97. Filed February 14, 2001.Juan Rodriguez, pro se.
George D. Curran, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WHALEN, Judge: Respondent determined the followingdeficiencies in, additions to, and penalty with respect topetitioners Federal income tax for 1990, 1991, and 1993:
· 2 -
Penalty and Addition to Tax
Year Deficiency Sec. 6651(a) Sec. 6554 Sec. 6662(a)
1990 $2,284 $571 $150 -0-
1991 2,374 -0- –0- $475
1993 24,654 6,164 1,035 –0-
After concessions, the issues for decision are: (1)Whether petitioner is entitled to deduct wagering lossesin the amount of $19,690 for the taxable year 1991; (2)whether petitioner must include in gross income a paymentin the amount of $100,000 that he received during 1993from the Federal Bureau of Investigation (FBI) and, if so,whether he is entitled to deduct a portion of such amountas relocation expenses; (3) whether petitioner is liablefor the accuracy-related penalty under section 6662(a) forthe taxable year 1991; (4) whether petitioner is liablefor the addition to tax under section 6651(a)(1) forfailure to file a timely return for 1993; and (5) whetherpetitioner is liable for the addition to tax under section6654 for failure to pay estimated income tax for thetaxable year 1993. Unless stated otherwise, all sectionreferences in this opinion are to the Internal RevenueCode as in effect during the years in issue.
FINDINGS OF FACT
Some of the facts have been stipulated and are sofound. The stipulation of facts and the attached exhibits- 3 -are incorporated herein by this reference. Petitionerresided in Philadelphia, Pennsylvania, when he filed hispetition in this case.
At one time, petitioner operated an illegal bookmakingbusiness that was frequented by a number of drug dealers.In 1987, he was arrested by the FBI while acting as amiddleman in a transaction involving the purchase and saleof two kilograms of cocaine. The criminal drug chargesstemming from his arrest carried a maximum prison sentenceof 80 years and fines of $2 million. In order to avoidincarceration on such charges, petitioner pleaded guiltyto a narcotics charge and agreed to work as an undercoverinformant for the Philadelphia office of the FBI. Inreturn, the FBI agreed to bring petitioners cooperationto the attention of the judge at the time of sentencing.In March 1988, petitioner and the FBI initiated anundercover investigation of money laundering and drugtrafficking in the Philadelphia area. The investigationwas assigned the code name Metroliner. The investigationtook place at petitioners off-track betting parlor wherepetitioner also conducted his illegal bookmaking operation.Petitioner played a central role in the investigation.He introduced five undercover FBI agents to drugtraffickers, money launderers, and gamblers. He made over- 4 -150 tape recordings, both audio and video, documenting 72transactions consisting of 23 drug purchases and 49 moneylaundering transactions. While under surveillance,subjects of the investigation purchased 31 kilograms ofcocaine and laundered $5 million in drug proceeds fromseven different drug organizations operating in and aroundPhiladelphia. As a result of the Metroliner investigation,91 persons were indicted and $2.5 million was seized.Petitioner testified in five trials, the last of whichended in July 1993. Ultimately, because of his cooperation,petitioner was sentenced to 5 years probation onthe drug charges mentioned above.
During 1991 or 1992, operation Metroliner was
terminated upon short notice. Due to the circumstances
surrounding the termination of the undercover investigation,
petitioner lost certain personal property, includinga safe containing some of his personal records. After theinvestigation was terminated, petitioner declined to enterthe witness protection program.
The FBI paid petitioner subsistence and other expenseswhile the FBIs investigation continued. Generally, thisconsisted of monthly payments, that began at $1,500 in1991, and increased to $2,000 in 1992, and furtherincreased to $3,000 in the middle part of 1992 when the- 5 -indictments were unsealed and petitioner became a witnessfor the Government. These payments ended in the summerof 1993 at the conclusion of the last trial.Mr. Paul D. Allen, Jr., Supervisory Special Agent ofthe FBI, wrote a letter to the United States AttorneysOffice, dated July 7, 1993, stating that between October1987 and the present Mr. Rodriguez has been paid by theFBI a total of $84,424.77 all of which has been forexpenses. Mr. Allens letter further states:
These expenses were for items such as rent,utilities, food/subsistence, transportation(automobile, gas, oil, tolls, maintenance,insurance), clothing, child support,medical/dental and other miscellaneousliving expenses.
In a letter to the Internal Revenue Service, datedMarch 27, 1995, Mr. Allen stated: Mr. Rodriguez waspaid a total of $75,400.00, all of which was consideredto be reimbursement for expenses he incurred during theinvestigation.
Petitioner executed receipts for expense reimbursementsin the aggregate amount of $81,732.30. Three of thereceipts, totaling $4,500, are dated after July 7, 1993,the date of Mr. Allens letter to the United StatesAttorneys Office mentioned above.
· 6 -
Based upon petitioners cooperation in the Metrolinerinvestigation and his testimony during the criminal trials,the FBI made a lump-sum payment to petitioner of $100,000.A telex from the Philadelphia office of the FBI requestingthe Director of the FBI to authorize the payment states asfollows:
REQUEST OF THE BUREAU: BUREAU AUTHORITYIS REQUESTED TO EFFECT A LUMP SUM PAYMENT OF$100,000 TO CAPTIONED COOPERATING WITNESS (CW)FOR HIS COOPERATION IN PHFILE 245B-PH-224ENTITLED METROLINER. THIS LUMP SUM PAYMENTREPRESENTS A SHARE OF THE VALUE OF UNITED STATESCURRENCY, CERTIFICATES OF DEPOSIT, VEHICLES,RESIDENCES, FARMS, AND BUSINESS LOCATIONS SEIZEDAS A DIRECT RESULT OF THE COOPERATION FURNISHEDBY THE [COOPERATING WITNESS].
Mr. Allens letter of March 27, 1995, to the InternalRevenue Service describes this payment as follows:
At the conclusion of the case, Mr. Rodriguezwas paid a lump sum of $100,000. These fundswere to offset relocation expenses and compensateMr. Rodriguez for his efforts during theinvestigation.
Mr. John R. Thomas, Special Agent of the FBI, statedin a letter dated May 16, 1995, to a revenue agent of theInternal Revenue Service, that the lump-sum payment givento petitioner at the conclusion of the case was for anyand all claims he may have had, to include: servicesrendered, relocation, reimbursement for reasonable and- 7 -necessary authorized expenditures, and the like. Ourfiles do not disclose an allocation of these funds.Petitioner executed a receipt on or aboutSeptember 30, 1993, which states as follows: On thisdate I, Tony Rodriguez, received $100,000 from the FBIas witnessed by the two Special Agents of the FBI whosesignatures appear below mine. At that time, petitioneractually received a cash payment of $90,000 and thecancellation of an advance of $10,000 that had previouslybeen made on August 6, 1993, in anticipation of the lumpsumpayment. The receipt for the advance payment thatwas executed by petitioner states that it was paid forservices.
Petitioner expected to receive more than the $100,000from the FBI. His understanding was that the FBI couldpay him a maximum of $250,000. He expected the FBI to payhim the maximum amount because the operation had been sosuccessful. He later sued the FBI and six agents of theFBI in the United States District Court for the EasternDistrict of Pennsylvania attempting to obtain more money.His suit was transferred by the District Court to theUnited States Court of Federal Claims. See Rodriguezv. FBI, 876 F. Supp. 706 (E.D. Pa. 1995). His suit wasunsuccessful.
· 8 -
While the undercover investigation was ongoing,petitioner was permitted to continue his illegal bookmakingbusiness and to retain the net proceeds from that business.
Petitioner also continued his gambling activities, including
betting at various racetracks and casinos. During thattime, petitioner received sizeable winnings and incurredsizeable losses from his gambling activities. SpecialAgents of the FBI were aware of petitioners gambling atracetracks and casinos.
Petitioner attached to his 1991 Federal income tax
return 10 Statements for Certain Gambling Winnings on Form
W-2G that report the following gross winnings, Federal and
State tax withholding, and net winnings from three racetracks:
Gross Fed. Tax St. Tax Net
Date Winnings Wheld. Wheld. Winnings
N.J. State Sports & Exposition Auth. 01/08/91 $8,140.00 $1,626 $244 $6,270.00
N.J. State Sports & Exposition Auth. 01/12/91 5,527.50 1,105 166 4,256.50
N.J. State Sports & Exposition Auth. 03/09/91 626.20 -0- -0- 626.20
N.J. State Sports & Exposition Auth. 03/09/91 626.20 -0- -0- 626.20
Garden State Race Track, Inc. 05/16/91 652.80 -0- -0- 652.80
N.J. State Sports & Exposition Auth. 05/30/91 685.00 -0- -0- 685.00
Philadelphia Park - GRI 06/28/91 2,241.50 447 -0- 1,794.50
Philadelphia Park - GRI 07/30/91 1,801.20 359 -0- 1,442.20
N.J. State Sports & Exposition Auth. 08/01/91 918.60 -0- -0- 918.60
Philadelphia Park - GRI 11/11/91 812.60 -0- -0- 812.60
22,031.60 3,537 410 18,084.60
Petitioner also attached a handwritten schedule to his 1991return that lists 9 of the 10 payments reported on theForms W-2G. The handwritten schedule does not list the- 9 -payment from Garden State Race Track, Inc., shown above,in the amount of $652.80.
On line 22 of his 1991 return, petitioner reportedother income from Race Track in the amount of $21,379.This amount is $652.60 less than the aggregate winningsreported on the Forms W-2G attached to his return. Therecord does not explain why petitioner reported only$21,379 of the $22,031.60 shown on the Forms W-2G thatare attached to petitioners return. Petitioner reportedno income from his gambling at casinos or from his othergambling activities.
For taxable year 1991, petitioner claimed a deductionfor gambling losses in the amount of $19,690.Petitioners return does not give any details concerningthis deduction, such as the identity of the payees, thedates, or the amounts paid. This amount is claimed asmiscellaneous itemized deduction. Thus, petitioners 1991return does not claim that petitioner is in the trade orbusiness of gambling. Petitioner also claimed a credit of$3,537, the aggregate amount of Federal tax withheld fromthe winnings reported on the Forms W-2G attached to hisreturn.
· 10 -
Petitioner never filed a Federal income tax return for1993. Respondent prepared a return for that year, whichdetermined that petitioner owed tax on the $100,000 lumpsumpayment.
In the subject notice of deficiency, respondent madeadjustments to petitioners income for 1990, 1991, and1993. The adjustments for 1990 were resolved by theparties and are no longer at issue in this proceeding.Respondent made the following adjustments to petitionerstaxable income for 1991 and 1993:
Exemptions -0- ($2,350)
Compensation (FBI) -0- 100,000
standard deduction $16,290 (3,700)
Total adjustments 16,290 93,950
The notice describes the adjustment disallowing thegambling losses claimed in 1991 as follows:
For the taxable year ending December 31, 1991,you have failed to substantiate the claimedgambling losses of $19,690. Since this was theonly claimed itemized deduction, you are nowentitled to the standard deduction of $3,400.Accordingly, your taxable income is increased$16,290.
The notice describes the adjustment increasing petitionerscompensation from the FBI in 1993, as follows:
· 11 -
Compensation you received from the FederalBureau of Investigation for services renderedin [sic] includible in income. Accordingly,your taxable income for 1993 is increased$100,000.
Petitioner asks the Court to redetermine two of theadjustments made in the subject notice of deficiency, thedisallowance of gambling losses in 1991 in the amount of$19,690, and the inclusion in gross income of the lump-sumpayment of $100,000 from the FBI in 1993. Petitioner alsoseeks redetermination of the accuracy-related penalty undersection 6662(a) for tax year 1991 in the amount of $475,and of the addition to tax under section 6651(a)(1) in theamount of $6,164 for failure to timely file his return fortax year 1993.
At trial, petitioner presented no evidence regarding
the addition to tax under section 6654 for failure to pay
estimated tax with respect to his 1993 tax, and he made no
reference to it in his posttrial brief. Therefore, we
consider this issue waived or abandoned. See Bradley v.Commissioner, 100 T.C. 367, 370 (1993) (Petitioner has notpursued this line of objection on brief, and we consider itabandoned.). We hereby sustain respondents determinationwith respect to the addition to tax under section 6654 for1993.
· 12 -
Wagering Loss Deduction
The first issue for decision is whether petitioner isentitled to deduct wagering losses in the amount of $19,690for the taxable year 1991. As noted above, respondentdisallowed all of the wagering losses claimed by petitionerbecause petitioner had failed to substantiate thededuction. In his posttrial brief, petitioner acknowledgesthat he did not substantiate this deduction, but he arguesthat some amount should be allowed as a deduction. Hisbrief states as follows: Although it is true thepetitioner did not produce complete and accurate recordsof gambling losses after seven years time, some allowanceshould have been made for the losses sustained.Respondent argues that petitioner did not prove the amountof his gambling losses or that his gambling losses exceededthe amount of his unreported gambling winnings.Section 165(d) allows taxpayers to deduct losses fromwagering transactions to the extent of the gains from suchtransactions. In order to establish entitlement to adeduction for wagering losses in this Court, the taxpayermust prove that he sustained such losses during the taxableyear. See Mack v. Commissioner, 429 F.2d 182 (6th Cir.1970), affg. T.C. Memo. 1969-26; Stein v. Commissioner, 322F.2d 78 (5th Cir. 1963), affg. T.C. Memo. 1962-19. He must- 13 -also prove that the amount of such wagering losses claimedas a deduction does not exceed the amount of the taxpayersgains from wagering transactions. See sec. 165(d).Implicitly, this requires the taxpayer to prove both theamount of his losses and the amount of his winnings. SeeSchooler v. Commissioner, 68 T.C. 867, 869 (1977); Donovanv. Commissioner, T.C. Memo. 1965-247, affd. per curiam 359F.2d 64 (1st Cir. 1966). Otherwise, there can be no way ofknowing whether the sum of the losses claimed on the returnis greater or less than the taxpayers winnings. SeeSchooler v. Commissioner, supra at 869. For example, ifthe taxpayer, in addition to the winnings reported on hisor her return, received other winnings that were notreported, then the taxpayer must prove that the lossesclaimed in his or her return exceeded the unreportedwinnings in order to be entitled to deduct any such losses.
See id.; Donovan v. Commissioner, supra. The amount
deductible in this situation is the amount of the claimed
losses which exceeds the unreported winnings, as long as
such excess is less than the winnings reported on the
taxpayers return. See sec. 165(d); Schooler v. Commissioner;
supra; Donovan v. Commissioner, supra.In this case, the racetrack winnings reported onpetitioners 1991 return, $21,379, exceed the gambling- 14 -losses deducted on that return, $19,690. Petitionertestified at trial that at one time he had recordsconsisting of a shoe box full of losing tickets from theracetrack that would have substantiated the loss deductionbut that those records were lost when the undercoverinvestigation was terminated. Petitioner testified asfollows:
THE WITNESS: *** Now, as one of the lettersindicates from the FBI, that things were leftbehind. One of the things that was left behindin the safe was a shoebox of losing [racetrack]tickets that would have served [sic] the $19,000.Even if we were to accept petitioners explanation forhis failure to verify the gambling losses claimed on his1991 return, we could not agree that he has met his burdenof proof regarding the gambling losses. Petitioner did notprove the amount of his gambling winnings, both reportedand unreported, and, thus, he failed to prove that theamount of the wagering losses claimed on his 1991 return,$19,690, is greater than his unreported gains from wageringtransactions.
Petitioner acknowledged during his testimony at trialthat he had additional winnings that were not reported onhis return. On cross-examination, petitioner testified asfollows:
· 15 -
Q Now, these winnings are only based upon on [sic]the forms you received from the Government?A Right.
Q You received other gambling winnings in thatyear, correct?
A Yes. I also had a lot of losses.
Q But with respect to the gambling winnings, youwon other money at the racetrack, correct?A Oh, yes.
Thus, petitioner admitted that he had earned gamblingwinnings at the racetrack in addition to the winnings hereported on his return for 1991.
There is also evidence that petitioner had winningsother than from betting at racetracks. For example, theFBI agents with whom petitioner cooperated during theundercover investigation were aware that he had sizeablelosses and sizeable winnings at racetracks and casinos.Furthermore, petitioner testified that in 1991 he engagedin other gambling activities. He testified as follows:
Q Did you bet any other activities during 1991?A I bet summer baseball and I play casinos,the dice, poker, everything.
Q At the casinos?
A Im a gambler.
Q And you bet
· 16 -
A Ill bet anything.
Qanything and lose, correct?
A Anything you could bet.
When asked whether he reported income from thoseactivities, he gave the following vague testimony:
Q Okay. But you dont have any of that incomelisted on your 1991 tax return; is thatcorrect?
A Well, there wasnt any at that time. I waswith the FBI at all times. Being with theFBI, they were with me. I didnt listanything because we would be at the casinos.We would take drug dealers to the casinos.And I was always with two agents and I wasalways risking my life every time I wentout because the FBI was a mile away from me.Q Thank you. But you had other gambling winsthat you did not report?
A I dont think so. I lost that year, becauseI was winning, too.
There is no evidence in the record that gives us abasis for determining or even guessing the amount ofunreported gambling winnings earned by petitioner during1991. Accordingly, we find that petitioner has failed toprove that the losses from wagering transactions claimed asa deduction on his 1991 return do not exceed the gains fromsuch transactions, as required by section 165(d), and we- 17 -sustain respondents disallowance of the wagering lossesclaimed on petitioners 1991 return.
Lump-Sum Payment From FBI
The next issue is whether petitioner is entitled to
exclude from gross income or deduct any or all of the lumpsum
payment received from the FBI in the amount of
$100,000. Petitioner acknowledges that he received the
lump-sum payment, and he testified candidly: I know I owe
taxes on it. He testified that the lump-sum payment was
paid in part as his share of the property seized by the
Government during the investigation, in part as consideration
for refusing to join the witness protection program,and in part as reimbursement for the expenses of relocatinghis family. In his posttrial brief, petitioner focuses onthe last of the above three reasons for the lump-sumpayment, relocation expenses. He argues that he incurredsubstantial expenses and cost associated with moving hisfamily and that an allowance for relocation expensesshould be taken into account in computing the taxableamount of this lump-sum payment. Petitioners briefstates:
· 18 -
While acknowledging that the burden of proofrests upon the petitioner for this issue, commonsense would dictate the consideration of somecosts associated with moving the petitioner andhis family.
Petitioner claims that the Internal Revenue Service hadpreviously agreed to allocate twenty percent (20%) ofthis payment toward relocation expenses.Respondent argues that petitioner is required toinclude in gross income the entire lump-sum payment of$100,000 received from the FBI. Respondent argues that,except for his self-serving testimony: Petitioner hasnot offered any evidence to prove he incurred the expensesclaimed or that the alleged expenses were deductible.We agree with respondent. There is no basis in therecord of this case upon which we can find that some orall of the lump-sum payment should be excluded frompetitioners gross income. According to the record, theFBI intended the payment to award petitioner a share ofthe seized property, to compensate petitioner for hiscooperation, and to defray any relocation expenses he hadincurred. The original telex requesting authorization tomake the payment states that it represents a share of thevalue of United States currency, certificates of deposit,vehicles, residences, farms, and business locations seizedas a direct result of the cooperation furnished. Rewards- 19 -of this kind are includable in gross income. See sec.1.61-2(a)(1), Income Tax Regs. Similarly, Mr. Allensletter of March 27, 1995, states that the payment was tooffset relocation expenses and to compensate petitioner.The receipt for the advance on the lump-sum paymentallocates the entire amount to services. Compensationpayments are includable in the recipients gross income.See sec. 1.61-2(a), Income Tax Regs.Petitioner cites no authority under which the lump-sumpayment would be excluded from gross income. We understandthat payments to a Government witness are sometimesconsidered by the Commissioner as welfare payments to therecipient that are not includable in the recipientsincome. See G.C.M. 37,028 (Mar. 3, 1977) and G.C.M. 37,564(June 9, 1978). For example, assistance payments made bythe Department of Justice under the witness protectiveprogram of the Organized Crime Control Act of 1970, Pub. L.91-452, tit. V, 84 Stat. 922, 933-934, are treatedas welfare payments and are excluded from gross income.See G.C.M. 37,028 (Mar. 3, 1977).
The lump-sum payment made to petitioner in this casewas not made under the witness protection program, nor wasit made in consideration of petitioners declining to enterthe witness protection program. Petitioner has shown no- 20 -basis for excluding all or any part of the lump-sum paymentin this case.
Petitioner argues that the lump-sum payment was madeto reimburse him for relocation expenses, and petitionerclaims to have incurred relocation expenses greatlyexceeding the lump-sum payment. However, petitionerpresented no proof that he incurred any such relocationexpenses. Indeed, in his posttrial brief, petitioner neveridentifies the payees of such expenses, nor does he givethe amounts, dates, and purposes of any such payments.
At trial, he suggested, at one point, that his relocation
expenses consisted of cash payments made to his sons and
his former wife (I gave each son $5,000, I gave her 10,
and $18,000 to move). At another point, petitioner made
reference to receipts from the moving company that were
left in the abandoned safe when the undercover investigation
terminated. Petitioner never substantiated any suchpayments, such as by obtaining duplicate receipts fromthe moving company. Thus, even if the lump-sum paymentwere excludable from gross income to the extent used todefray relocation expenses, petitioner has notsubstantiated that he paid any such relocation expenses.To the extent that petitioner claims to be entitledto deduct some part of the payment as relocation expenses,- 21 -we also agree with respondent that petitioner has not methis burden of proving entitlement to the deduction. SeeRule 142(a), Tax Court Rules of Practice and Procedure.Petitioner does not cite the section of the InternalRevenue Code under which he claims to be entitled to thededuction. See generally secs. 217, 132(a)(6), (g), 82.Moreover, as described above, he refers to relocationexpenses, but he never explains the nature of the expensesthat he incurred, or identifies the payees, amounts, ordates of any such payments, nor has he introduced proofthat he paid any such expenses.
Accuracy-Related Penalty for 1991
The next issue for decision is whether petitioner isliable for the accuracy-related penalty under section6662(a), as determined by respondent in the amount of $475.According to the schedules attached to the notice ofdeficiency, respondent determined that the entire amountof the underpayment was due to negligence. Under section6662, a penalty is added to a taxpayers tax liability ifany portion of an underpayment is attributable tonegligence or disregard of rules or regulations. See sec.6662(b)(1). For this purpose, the term negligenceincludes any failure to make a reasonable attempt to complywith the provisions of the Internal Revenue Code. Sec.
· 22 -
6662. The amount of the penalty is 20 percent of theportion of the underpayment to which section 6662 applies.See sec. 6662(a).
An exception to imposition of the negligence penaltyis provided by section 6664. Under that exception, Nopenalty shall be imposed * * * with respect to any portionof an underpayment if it is shown there was a reasonablecause for that portion of the underpayment and thetaxpayer acted in good faith. Petitioner bears the burdenof proving that he is not liable for the penalty undersection 6662(a). See Vaira v. Commissioner, 444 F.2d 770(3d Cir. 1971), revg. on another issue 52 T.C. 986 (1969);
Bixby v. Commissioner, 58 T.C. 757, 791 (1972).
Petitioner argues as follows:
Accurate records of gambling losses and winningsare difficult to maintain. The very nature ofthe business makes this task daunting, if notimpossible. The very fact that petitionerreported his gambling winnings and losses in his1991 income tax return, produced records of thisfact seven years later, attests to the degree ofeffort taken by the petitioner to accuratelyreport his gambling winnings and losses. Beforethe accuracy-related penalty is imposed, I.R.C.§6662(b)(1) requires taxpayer negligence ordisregard for the rules. In the instant case,the respondent has shown neither exists.Respondent argues that petitioner has not met his burdenof proof under section 6662(a). According to respondent,- 23 -petitioner has not shown that there was a reasonable causefor the underpayment or that he acted in good faithregarding the underpayment.
We agree with respondent. Petitioners contention,that maintaining accurate records of gambling losses andwinnings is difficult, is legally insufficient to overcomerespondents determination. The fact is that all taxpayersare required to substantiate deductions under section165(d), and petitioner is being held to the same standardthat is imposed on all taxpayers seeking a deduction undersection 165(d). See, e.g., Wolkomir v. Commissioner, T.C.Memo. 1980-344; Salem v. Commissioner, T.C. Memo. 1978-142;
Myers v. Commissioner, T.C. Memo. 1976-191; Taormina v.
Commissioner, T.C. Memo. 1976-94.
We find that petitioner did not prove that the underpaymentwith respect to his 1991 return was due to reasonablecause or that he acted in good faith. Accordingly, wesustain respondents imposition of an accuracy-relatedpenalty under section 6662(a).
Additions to Tax for 1993
The final issue is whether petitioner is liable forthe addition to tax under section 6651(a)(1) for failure tofile a timely return for 1993, as determined by respondentin the amount of $6,164. An addition to tax is imposed- 24 -under section 6651(a)(1) for failure to file a returnunless such failure is due to a reasonable cause and notwillful neglect. See sec. 6651(a)(1). The amount of theaddition to tax is 5 percent of the tax required to beshown on the return, if the return is filed within a monthof the due date, with an additional 5 percent for eachadditional month or fraction thereof during which thefailure continues, not exceeding 25 percent in theaggregate. See id. Petitioner bears the burden of provingthat he is not liable for the addition. See Rule 142(a).
Petitioner argues as follows:
* * * Of the $100,000.00 the petitionerreceived from the FBI, ninety percent (90%), or$90,000.00 was received after petitioner hadworked undercover for the FBI. It was agreedthat this payment of $100,000.00 would be usedto pay for the enormous cost of relocating thepetitioner and his family to Puerto Rico.Although it is true the FBI did not have theauthority to determine the taxability of thispayment, it is certainly reasonable forpetitioner to rely on the FBIs position andstatements regarding this payment. Respondentcorrectly states that is the burden of thepetitioner to establish this fact. However,due to the highly sensitive nature of theundercover operation (which is ongoing), it canhardly be expected for the petitioner to produceas witnesses the FBI agents responsible forleading the petitioner to believe this paymentwould not be considered taxable income. It isthe position of the petitioner that this$100,000.00 payment is not fully taxable. Ifplausible disagreement as to the taxability ofthis income exists to this day, it can surely besaid the petitioner had a reasonable expectation- 25 -this payment would not be taxable income; hencereasonable cause and not willful neglect. Forthese reasons, the respondents determinationshould not be sustained.
Thus, petitioner argues that his failure to file his1993 return is due to reasonable cause and not willfulneglect. Sec. 6651(a)(1). Respondent argues thatpetitioner failed to timely file an income tax return forthe taxable year 1993 and presented no evidence disputingthe assertion of the addition to tax. We find thatpetitioners argument lacks merit.
Petitioner admitted at trial that he received thelump-sum payment of $100,000 from the FBI and he owed taxon the payment. He testified as follows:
THE COURT: * * * Do you admit that $100,000 is
income? * * *
THE WITNESS: I admit that was income. * * *
* * * * * * *
THE WITNESS: I know I owe taxes on it. But I figurea reasonable amount should be used forrelocation of me.
Thus, petitioner admittedly earned substantial taxableincome during 1993, and he was required to file a returnfor that year. See sec. 6012(a).
Petitioners posttrial brief implies that he relied onthe statements of unnamed FBI agents that the subject lump-26 -sum payment would not be considered taxable income.There is no factual basis for such argument in the recordof this case. Neither petitioner nor the FBI agent who wascalled as a witness testified that an FBI agent gavepetitioner any such advice. Indeed, petitioner did noteven ask the FBI agent about any such statements.Petitioner does not identify the agent or employee of theFBI who allegedly gave him such advice, nor did he subpoenasuch person to testify. We do not accept petitionersattempt to explain his failure to call the agent to testifyon the ground that the undercover operation was ongoing atthe time of trial or that it would have been compromised bythe agents testimony. There is nothing in the record tosuggest that the operation was ongoing at the time oftrial, but, even if it were, there is no reason to believethat the agents testimony concerning statements about thetaxability of petitioners lump-sum payment would havecompromised the operation. Indeed, petitioner exhibitedno such reluctance in 1994 when he filed suit against theFBI and six of its special agents seeking a greater shareof the money and property that had been seized during theundercover operation. We find that petitioner failed toshow that his failure to file a return for 1993 was due toreasonable cause and not willful neglect, and we sustain- 27 -respondents determination of the addition to tax undersection 6651(a)(1) in the amount of $6,164.
To reflect the foregoing and concessions by the
Decision will be entered
under Rule 155.
January 22, 2012
ProfessionalGamblerStatus™, and ProfessionalGamblerStatus.com™
are trademarks and service marks of Colin M. Cody, CPA and ProfessionalGamblerStatus.com, LLC, Trumbull Connecticut
Copyright© 2005 to 2011 Colin M. Cody, CPA and ProfessionalGamblerStatus.com, LLC, All Rights Reserved