Gambling Losses in Tax Court
I’m interrupting the weekly flow to my blog in order to highlight a U.S. Tax Court case filed on November 10, 2010, that emphasizes a point I’ve made several times:
You cannot deduct gambling losses if you do not have any gambling winnings in a given tax year.
The Aus, a California couple, lost money from gambling in 2006 and claimed this loss as a miscellaneous itemized deduction on their federal tax return. The IRS audited their return and discovered that they did not claim any gambling winnings. The IRS made the according adjustments to their return (i.e. disallowed the deduction, which was $40,000) and sent letters to the Aus demanding payment for additional tax due, plus interest and penalties.
The Aus apparently failed to respond to the IRS or consult a tax professional about their case until the case went to trial. While I won’t go into detail, there are plenty of opportunities for taxpayers to discuss their tax matter with the IRS before it gets even close to trial. The IRS will listen to what you have to say, and quite often reasonable settlements are reached.
To prepare their 2006 federal tax return, the Aus used TaxCut, which is tax return software created by H&R Block. At trial, the Aus purported they simply followed TaxCut’s instructions, which were “approved by the IRS,” in order to complete their return. The court noted the Aus failed to indicate what aspect of the instructions led them to believe the gambling loss deduction was proper, and that the court “doubt[ed] that the instructions, if correctly followed, permitted a result contrary to the express language of the [Internal Revenue] Code.” In other words, this defense doesn’t fly.
Ultimately, not only do the Aus have to pay Uncle Sam the additional tax incurred as a result of the disallowed gambling loss deductions, but also interest on the additional tax due as of the filing due date of their return, which was April 15, 2007, plus penalties. Penalties for underreporting are far from insignificant.
Don’t let this happen to you.