I am looking
at a bench opinion.
The tax
issue is relatively straightforward, so the case is about substantiation. To
say that it went off the rails is an understatement.
Let us
introduce Jacob Bright. Jacob is in his mid-thirties, works in storm restoration
and spends way too much time and money gambling. The court notes that he
“recognizes and regrets the negative effect that gambling has had on his life.”
He has three
casinos he likes to visit: two are in Minnesota and one in Iowa. He does most
of his sports betting in Iowa and plays slots and table games in Minnesota.
He reliably uses a player’s card, so the casinos do much of the accounting for him.
Got it. When
he provides his paperwork to his tax preparer, I expect two things:
(1) Forms W-2G for his winnings
(2) His player’s card annual accountings
The tax
preparer adds up the W-2Gs and shows the sum as gross gambling receipts. Then
he/she will cross-check that gambling losses exceed winnings, enter losses as a
miscellaneous itemized deduction and move on. It is so rare to see net winnings
(at least meaningful winnings) that we won’t even talk about it.
COMMENT: Whereas the tax law changed in 2018 to do away with most miscellaneous itemized deductions, gambling losses survived. One will have to itemize, of course, to claim gambling losses.
Here starts
the downward cascade:
Mr. Bright hired a return preparer who was recommended to him, but he did not get what or whom he expected. Rather than the recommended preparer, the return preparer’s daughter actually prepared his return.”
OK. How did
this go south, though?
The return preparer reported that Mr. Bright was a professional gambler ….”
Nope. Mind
you, there are a few who will qualify as professionals, but we are talking the
unicorns. Being a professional means that you can deduct losses in excess of
winnings, thereby possibly creating a net operating loss (NOL). An NOL can
offset other income (up to a point), income such as one’s W-2. The IRS is very,
very reluctant to allow someone to claim professional gambler status, and the
case history is decades long. Jacob’s preparer should have known this. It is
not a professional secret.
Jacob did
not review the return before signing. For some reason the preparer showed over
$240 grand of gross gambling receipts. I added up the information available in
the opinion and arrived at little more than $110 grand. I have no idea what she
did, and Jacob did not even realize what she did. Perhaps she did not worry
about it as she intended the math to zero-out.
She should
not have done this.
The IRS
adjusted the initial tax filing to disallow professional gambler status.
No surprise.
Jacob then
filed an amended return to show his gambling losses as miscellaneous itemized
deductions. He did not, however, correct his gross gambling winnings to the
$110 grand.
The IRS did
not allow the gambling losses on the amended return.
Off to Tax Court
they went.
There are
several things happening:
(1) The IRS was arguing that Jacob did not
have adequate documentation for his losses. Mind you, there is some truth to
this. Casino reports showed gambling activity for months with no W-2Gs (I would
presume that he had no winnings, but that is a presumption and not a fact). Slot
winnings below $1,200 do not have to be reported, and he gambled on games other
than slots. Still, the casino reports do provide some documentation. I would
argue that they provide substantiation of his minimum losses.
(2) Let’s say that the IRS behaved civilly and allowed
all the losses on the casino reports. That is swell, but the tax return showed
gambling receipts of $240 grand. Unless the casino reports showed losses of (at
least) $240 grand, Jacob still had issues.
(3) The Court disagreed with the IRS
disallowing all gambling deductions. It looked at the casino reports, noting
that each was prepared differently. Still, it did not require advanced degrees
in mathematics to calculate the losses embedded in each report. The Court
calculated total losses of slightly over $191 grand. That relieved a lot – but not
all – of the pressure on Jacob.
(4) Jacob did the obvious: he told the Court that
the $240 grand of receipts was a bogus number. He did not even know where it
came from.
(5) The IRS immediately responded that it
was being whipsawed. Jacob reported the $240 grand number, not the IRS. Now he
wanted to change it. Fine, said the IRS: prove the new number. And don’t come
back with just numbers reported on W-2Gs. What about smaller winnings? What
about winnings from sports betting? If he wanted to change the number, he was also
responsible for proving it.
The IRS had
a point. It was being unfair and unreasonable but also technically correct.
Bottom line:
the IRS was not going to permit Jacob to reduce his gross receipts number
without some documentation. Since all he had was the casino reports, the result
was that Jacob could not change the number.
Where does
this leave us? I see $240 – $191 = $49 grand of bogus income.
My takeaway
is that we have just discussed a case of tax malpractice. That is what lawyers
are for, Jacob.
Our case
this time was Jacob Bright v Commissioner, Docket No. 0794-22.
