Tax Preparer Gives Gambler A Losing Hand

 

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.

Ohio Residency: Bright-Line and Common-Law Tests

How does one become an Ohio resident?

It’s not hard, I suppose. One could just buy a house in Ohio and live there.

How does one stop being an Ohio resident?

That one is a bit trickier. I would probably start by selling that same house and moving. It is a simple solution, but not one tailored to the needs of the snowbirds. I would not mind being a snowbird. Call me crazy, but I could separate myself from Cincinnati winters and spend that time in better weather.

Let’s say that you live in Cincinnati. You have a second home in Ft. Myers, Florida and a great deal of discretion as to how much time you spend in each state. You would like to move your “residency” to Florida, as Florida does not have an income tax. You still have friends and family in Cincinnati, however, so you intend to keep your house here. Can you do so and still be considered a Florida resident?

Of course you can.

Ohio is not one of those states that will chase you down to the ends of the earth to tax you years after you have left.

But that doesn’t mean there aren’t rules to follow.

And someone recently thought that those rules did not apply to them. The case is Cunningham v Testa. Let’s talk about it.

We have talked before about the idea of “domicile” in state taxation. Domicile is easy for the vast majority of us. We have one house, and we live there with our family. We have one house, one abode, one domicile. A house gives one an “abode,” and if one is fortunate one can afford more than one abode. Domicile rises above that. Domicile wants to know which abode is one’s true home: the one with the pencil markings measuring the kids’ height over the years, the squeaky floorboard at the top of the steps, the cold corner in the living room that never really warms up no matter how one sets the thermostat.

Domicile wants to know which abode is that house. You know - your home. The concept borders on the mystical.

Ohio is one the states that looks at domicile when determining whether one is a resident or nonresident. Ohio doesn’t care about that house in Florida. That is just an abode until one raises it to the level of domicile.

Remember that Ohio has a tremendous number of snowbirds. In years past the state expended a not-insignificant amount of resources reading tea lives and consulting Tarot cards to figure-out whether or not someone was an Ohio resident. Ohio needed something less employee-intensive.

Ohio decided to use a “bright-line” test and would henceforth look at “contact periods.” If one had enough contact periods it would consider one a resident. If not, it would consider one a nonresident … unless there were other factors indicating that one was a resident.  

For the most part it was now an arithmetic exercise. The “… unless” part was there to prevent one from gaming the count.

COMMENT: A contact period occurs if (1) one is away from his/her domicile (2) overnight and (3) is in Ohio for all or part of two consecutive days.  It is not the same as sleeping overnight in Ohio, as the test is not where one sleeps. One could book a hotel in Covington, Kentucky for example, and cross the bridge into Ohio in the morning. If one crossed the bridge for two consecutive days, there would be a contact period.

Ohio added up the contact periods. If there were at least 183, then Ohio considered one a resident.

            NOTE: Starting in 2015 that count has been raised to 213.

Back to the Cunninghams.

He filed an “Affidavit of Non-Ohio Domicile” for tax year 2008, using his name, social security number and Cincinnati address. She did not file anything.

COMMENT: Mrs. Cunningham is immediately out-of-the-game.

He declared he was a resident of Tennessee, although he did not give an address.   

            COMMENT: That did not help.

Nonetheless, filing the Affidavit shifted the burden to Ohio.

And Ohio responded by issuing a notice and then an assessment.

The Cunninghams appealed.

Time to show your cards, Ohio.

(1)   Cunningham and his wife were raised in Ohio and raised their children there.

COMMENT: Fail. What else do you have, Ohio?

(2)   He listed his Ohio address on his tax return.

COMMENT: Dumb but not fatal.

(3)   He had his Tennessee utility bills forwarded to Cincinnati for payment.

COMMENT: Same as (2), although I am wondering who was in Cincinnati to pay the bills if they were in Tennessee.

(4)   He maintained an Ohio driver’s license.

COMMENT: That guy, he is such a procrastinator …

(5)   He voted in Ohio during the year.

COMMENT: Did no one advise this guy?

(6)   He did not present a calendar of contact periods.

COMMENT: He’s got this ADD thing with paperwork …

(7)   He filled-out paperwork to obtain homestead exemption on his Cincinnati residence.

COMMENT: Really?! I mean it, REALLY???

Let’s just say that the Tax Commissioner persuaded the Ohio Supreme Court that any affidavit Cunningham filed was bunkum. Cunningham was an Ohio resident under common-law tests. The bright lines rules – while invaluable – are not an absolute defense against the common-law tests for residency.

There has been some hyperventilation in the wake of this decision. Here is an example from the Ohio Society of CPAs:

This ruling will encourage even more litigation whenever the commissioner decides to challenge an affidavit as ‘false,’ and will render almost meaningless the recent increase in allowable contact periods from 182 to 212.”  

No, no it doesn’t, and I greatly doubt that Ohio wants to get into repetitive shootouts with taxpayers on this issue. That is why Ohio moved to a bright-line standard in the first place.

Just have some common sense out there, folks.