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Receive Less Up Front, Pay More Later

In 2005, Gerald and Monica Ware had luck on their side playing the slot machines at the Imperial Palace Casino in Biloxi, Mississippi. Six years later, the luck is on the side of the Internal Revenue Service.

International Game Technology (IGT) was responsible for paying slot machine winnings to casino patrons of the Imperial Palace. In 2005, IGT issued to Mr. and Mrs. Ware a Form W-2G reflecting gambling winnings of $604,093. Mr. and Mrs. Ware, however, believed they had won $993,728, and that the $389,635 difference constituted federal and state income tax withholding. Accordingly, their 2005 Form 1040 reflected $993,728 gambling winnings and $370,022 federal income tax withheld. Because their reported total tax liability for the year was $239,896, the taxpayers received a refund for the difference, or $130,126.

The W-2G filed by IGT with the IRS reflected no income tax withheld. Unsurprisingly, the IRS system picked up the discrepancy and sent a notice, dated March 22, 2010, to Mr. and Mrs. Ware. The notice stated that the IRS had assessed the $370,022 amount claimed as withheld because in fact no tax was paid on the winnings. The IRS also charged interest and penalties. Less than two months later, the taxpayers filed a petition with the U.S. Tax Court, challenging the assessment.

Unfortunately for the taxpayers, the U.S. Tax Court could not entertain the taxpayer’s petition. The court’s jurisdiction to redetermine a deficiency requires the issuance of a valid notice of deficiency. The notice must advise the taxpayer that the IRS intends to assess the taxpayer of a deficiency.

In this case, the March 22 notice was not a notice of deficiency. Instead, the March 22 notice reflected an assessment correcting overstated federal income tax withholding. In other words, because the taxpayers admitted on their 2005 Form 1040 a tax liability arising from the gambling winnings, the IRS did not have to issue a notice to assert new deficiency.

Since the taxpayers were not able to take the IRS to court to be heard, what can they do? The taxpayers can file a Request for a Collection Due Process or Equivalent Hearing (CDP hearing) after the IRS issues a levy or lien notice with respect to the liability. According to the court’s opinion, the taxpayers had a CDP hearing in IRS Appeals, but no determination has been made yet. If IRS Appeals sustains the assessment, then the taxpayer can appeal that decision by filing a petition with the U.S. Tax Court.

Ultimately, it seems clear the taxpayers owe tax on the $604,093 of winnings, plus interest and penalties. Apparently, the taxpayers agreed to receive a lump-sum payment from the casino of $604,093, in lieu of receiving the $993,728 in installments. As a result, the W-2G issued by IGT accurately reported $604,093 in gambling winnings and no tax withheld.

After scoring on the slot machines several years ago, the taxpayers are now required to pay to the IRS more than just tax on the winnings.

Case: Ware v. Commissioner, T.C. Memo 2011-254 (Oct. 31, 2011).

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