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Pourquoi Story of Goo

February 7th, 2012 2 comments

I think it’s fair to assume most folks other than tax professionals find U.S. Tax Court opinions plainly boring. Perhaps the same is true for most tax professionals. Sometimes, however, a judge will go extra lengths to add entertaining touches in an opinion that we can all find amusing. Today’s tax court case of Commissioner v. Esrig is a perfect example.

Here’s how the opinion begins:

Steven and Lori Esrig didn’t timely file their tax returns for any year from 1998 through 2003. For some years they were so late that the Commissioner prepared substitute returns for them, and for all those years he sent them notices of deficiency. But the Esrigs claim the Commissioner got it all wrong, that they don’t owe any taxes, additions to tax, or penalties because they were involved in a number of businesses for which, in total, they have more losses and deductions than income. The case is all about substantiation, and we therefore must decide whether the Esrigs have substantiated their claimed losses and deductions, and then figure out how much they owe in taxes, additions to tax, and penalties, if any.

The introduction’s tone makes it easy to see where this opinion is going. Well, not entirely.

In 2002, Steven Esrig started a company named Stelor Productions, Inc. At trial, he explained where the idea for this business came from:

Apparently, [Steven's] then-five-year-old child asked to look at the Power Rangers website. Steven logged on but inadvertently mistyped a character in the web address. Instead of getting the Power Rangers website, up popped a seriously pornographic one. This, he told us, was the reason he started Stelor, a company he claims invented a technology that protects children from predators and pornography and “shuts down identity theft.”

Didn’t see that coming. Judge Holmes labeled this testimony as “nothing more than a pourquoi story.” Thanks judge, I learned a new phrase today. A pourquoi story is a fictional narrative that explains why something is the way it is. I wonder, what was the mistype? Shower Rangers?

There are more goodies. Mr. Esrig claimed the company failed because it endured several years of litigation after buying the domain name “googles.com.” In 1997, the prior owner of “googles.com,” Steven A. Silvers, a convicted narcotics trafficker and money launderer, published a children’s book about four-eyed creatures called “Googles” who live on planet Goo. After purchasing the rights to sell Googles products from Silvers in 2002, Esrig sued Google, among other companies, for trademark infringement. If you want a good laugh, check out this 2004 story for more background.

I can’t make this stuff up.

Back to the present case. Esrig claimed large net operating losses and losses from Stelor and other business activity during the years in question. The only proof he offered to the court was his testimony. Well, he actually offered the filed tax returns and IRS worksheets to substantiate the NOLs. No, a tax return is not substantiation. And the IRS worksheets were used to help the taxpayers compute their NOLs. Mr. Esrig failed to understand that he must prove the basis for the losses.

After agreeing with the Commissioner’s tax deficiencies, the court evaluated the proposed penalties. A taxpayer may dispute some types of penalties based upon reasonable cause. Mr. Esrig attributed the failure to timely file his tax returns on his preparer:

[Mr. Esrig] said that he’d asked his accountant to request extensions for all the years at issue, but his accountant missed all the deadlines because she had to serve a very long prison sentence for murdering her husband, and the person in her office who took over their account made a slew of mistakes.

Mr. Esrig offered no evidence of the alleged murder.

In the end, the court found for the IRS on each and every issue in dispute. For the years in question, the Esrigs now owe the IRS $705,911 in tax and $234,297 in penalties. Plus interest. These liabilities, my friends, is no pourquoi story.

Case: Commissioner v. Esrig, T.C. Memo. 2012-38 (Feb. 7, 2012).

Categories: Tax Court Tags:

Receive Less Up Front, Pay More Later

November 1st, 2011 No comments

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).

Sovereignty Over a Jail Cell

October 27th, 2011 No comments

“Sovereign citizens” genuinely believe that there are two types of citizens: (1) “Fourteenth Amendment citizens” who are subject to federal, state, and local statutes and proceedings; and (2) “Sovereign citizens” who are subject only to the “common law.” Sovereign citizens claim the common law means a citizen possesses absolute power over all her property. A corollary to this power is that sovereign citizens are free from taxation. Individuals holding this position are also known as “tax protesters.”

“Tax protesters” refuse to pay federal or state tax. After the IRS or state tax agency comes calling for its share, sometimes the tax protester will go to court in dispute. Such was the case for Brian Steven Richmond in U.S. Tax Court, and the court’s decision was filed today.

Mr. Richmond’s income in 2008 was $38,915. He submitted his 2008 tax return, as required. Problem was, it was a “zero” income tax return. He listed no income, and claimed a refund of $3,447. Under established law, a “zero” income tax return is treated as if the return was not actually filed.

The IRS prepared a substitute for return for Mr. Richmond, and then sent a notice of deficiency for the amount owed. Mr. Richmond filed a petition to challenge the deficiency in court.

What were Mr. Richmond’s arguments? He claimed that he is a citizen of the “Sovereign State of Kansas” and not a citizen of the United States. As a result, he argued, federal income taxes are optional. Of course, the court rejected this argument. In ruling in favor of the IRS, the court also sustained penalties for the taxpayer’s failure to timely file a tax return. In addition, Mr. Richmond may very well face criminal charges for his acts.

Another self-proclaimed “sovereign citizen,” Samuel Davis, already has. As reported by the Las Vegas Review-Journal, Mr. Davis was sentenced to 54 months in prison earlier today for money laundering. Authorities described Davis as a national leader of the “sovereign citizen” movement, traveling around the country to preach his drivel philosophies. Davis won’t be spreading his words anytime soon.

Stories involving tax protesters never end well. Not that we expect them to. I just don’t follow the logic of these folks. Then again, there is no logic to follow.

Case: Richmond v. Commissioner, T.C. Memo 2011-251.

Categories: Tax Court, Tax Fraud Tags:

Professional v. Recreational Gambler Status in Tax Court

July 18th, 2011 7 comments

From a tax perspective, one of the benefits to filing as a “professional” gambler instead of as a “recreational” gambler is that only the former may deduct gambling-related business expenses that exceed the taxpayer’s “net” gambling winnings. This proposition is supported by a recent U.S. Tax Court decision from January. Earlier today, the U.S. Tax Court disallowed a taxpayer’s business loss from gambling in 2006 because the court held that the taxpayer was not a professional gambler in 2006.

In 2006, Randy Moore of North Carolina worked approximately 40 hours per week as a traveling x-ray technician, earning $63,619. During his downtime, he liked to gamble, primarily playing slot machines. He was issued twelve Form W-2Gs from two casinos for the year, totaling $25,534.

To his 2006 tax return, Moore attached a Schedule C and filed as a “pro gambler,” claiming zero “net” gambling winnings (Moore reported $25,534 of wagering losses), and $15,455 of assorted business expenses, reflecting an overall business loss of $15,455. The IRS challenged Moore’s professional gambler status, taking the position that he could not claim the business loss, and that he must itemize his wagering losses of $25,534 on Schedule A.

What’s noteworthy here is how the case likely began. The IRS first raised the professional gambler status issue in its answer to the taxpayer’s petition. The notice of deficiency claimed that the taxpayer failed to report $25,534 in gambling winnings. The IRS later conceded that he did report such, but likely only after an explanation that the winnings were offset by gambling losses. It’s this explanation that probably resulted in the IRS taking notice of the taxpayer’s business loss from gambling.

Because the IRS first raised the professional gambler status issue in its answer, the burden of proof was on the IRS to prove that Moore was not a professional gambler. Accordingly, the IRS was required to demonstrate that Moore did not gamble with the intent to profit. Here are the factors the court considered to make its analysis:

  • Manner in which the taxpayer carries on the activity;
  • The expertise of the taxpayer or his advisors;
  • The time and effort expended by the taxpayer in carrying on the activity;
  • Expectation that assets used in activity may appreciate in value;
  • The success of the taxpayer in carrying on other similar or dissimilar activities;
  • The taxpayer’s history of income or losses with respect to the activity;
  • The amount of occasional profits, if any, which are earned;
  • The financial status of the taxpayer; and
  • Elements of personal pleasure or recreation.

From the evidence presented, the decision was easy for the court to make. He didn’t keep records of his gambling activity. Big mistake. Also, he had never profited from gambling, and did not seek possible ways to improve upon his performance.

As an aside, I find it rather interesting that the IRS conceded the deductibility of the taxpayer’s $25,534 in wagering losses, despite the taxpayer failing to maintain any records of his gambling activity. We can’t glean the entire history of the audit from this tax opinion alone. It’s possible the concession from the IRS was a product of audit negotiations. I wouldn’t expect the IRS to concede gambling losses without substantiation in most audits, however, particularly with reported gambling losses of six figures or greater.

This case is informative for a taxpayer who asks the question: Can I file as a professional gambler? Remember, a taxpayer doesn’t have a choice. It’s a matter of whether he/she can show that the above factors as applied to particular facts and circumstances demonstrate one engaged in gambling for profit. If not, winnings and losses are reported in separate places on the tax return.

Case: Moore v. Commissioner, T.C. Memo 2011-173.

Chequered Flag for the IRS

July 15th, 2011 No comments

When it comes to tax time, we like to see losses. Losses may reduce or completely wipe out taxable income. The prospect of paying no taxes sometimes puts on display a taxpayer’s over-creativity to generate losses. Tuesday’s U.S. Tax Court case of Ronald J. Zenzen illustrates why a taxpayer can’t just claim one ran a business in order to create business losses that would otherwise be nondeductible personal expenditures.

Zenzen enjoys drag racing. He’s been involved with the sport in some capacity since 1970. In 1998 he bought a car, and together with his two sons, a racing team was born. Over the years, Zenzen purchased and improved cars to participate in various drag racing activities, and incurred various expenses along the way.

To each of his 2005, 2006, and 2007 tax returns, Zenzen attached a Schedule C claiming income and expenses relating to drag racing business activity. Among the three years, the Schedule C expenses totaled at least 29 times Schedule C income and at most 171 times Schedule C income. Of course, with no more than $950 of drag race income from each year, such disparities are not surprising. Zenzen claimed for each year a net business loss of $24,194, $33,752, and $59,714, respectively.

In order to offset other ordinary income with a Schedule C business loss on a tax return, a taxpayer must actually run a business in the first place. Therein lied Zenzen’s problem. The auditor disallowed each of the Schedule C losses on the basis that Zenzen was not engaged in the drag racing activity with the intent to make a profit. If not engaged in for profit, Zenzen could deduct his expenses only up to the extent of gross income from the activity. Big difference in this case.

The Treasury regulations provide a list of factors to consider in determining whether an activity is engaged in for profit. The burden of proof on this issue is on the taxpayer. In this case, the court considered the following factors:

  • Expertise of the taxpayer or his advisors;
  • Time and effort expended in carrying on the activity;
  • Expectation that assets may appreciate in value;
  • Success of taxpayer in other activities;
  • Taxpayer’s history of income or losses;
  • Amount of occasional profits, if any;
  • Financial status of the taxpayer; and
  • Elements of personal pleasure

Zenzen came up short for several reasons. He didn’t maintain books or records or have a business plan. Although Zenzen had “extensive expertise” with drag racing, he failed to show he had “requisite expertise regarding the business aspects of drag racing.”

It was clear Zenzen put a lot of time into drag racing, but it was more akin to a hobby. For each year in issue, Zenzen and his wife earned over $115,000 combined in wages from sources unrelated to drag racing. The court emphasized that the presence of such income, particularly if losses from the activity in question generate significant tax benefits, may indicate that the activity is not engaged in for profit.

For taxpayers considering filing a Schedule C, this case is helpful in evaluating whether the activity in question is engaged in for profit. Just because a Schedule C produces favorable tax breaks doesn’t necessarily mean the decision to attach one to a tax return will be upheld in court. In this case, the IRS took home the trophy.

Case:  Zenzen v. Commissioner, T.C. Memo. 2011-167.

Categories: IRS, Sports, Tax Court Tags: ,

No Mulligan in Tax Court for Goosen

June 10th, 2011 No comments

In April, I examined the U.S. tax consequences on the winnings earned by South African Charl Schwartzel resulting from capturing the Green Jacket in the 2011 Masters Tournament.  Today we turn to a far more well-known South African native golfer: Retief Goosen.

You will find Retief Goosen’s name listed in the top ten of the Official World Golf Rankings for over 250 out of a total 364 weeks between 2001 and 2007.  He has two U.S. Open titles to his name (2001 and 2004), and is known on the PGA Tour as “The Iceman” because of his strikingly calm demeanor on the golf course.  His popularity has landed him several endorsement deals over the years, including those with sponsors TaylorMade (as pictured to the right) and Electronic Arts, among several others (Izod; Acushnet; Rolex; Upper Deck).  Yesterday, the U.S. Tax Court issued a decision that re-characterized and reallocated substantial portions of his income earned from these endorsement deals in 2002 and 2003, ultimately resulting in a hefty U.S. tax bill.

The opinion is rather confusing to follow.  It’s not because it is poorly written.  It’s because Goosen is a U.K. resident and had several endorsement deals, each with its own terms, during the years in question.  This required the court to closely examine each agreement’s terms and determine whether Goosen properly reported the income therefrom on his U.S. tax returns under IRS examination.

One major reason why international taxation at first glance may seem a daunting subject is because there are two fundamental and critical concepts one must always keep in mind with respect to the income in question: (1) source and (2) character.  Regarding source, the country in which income is earned—also known as the “source” country—has the primary right to tax the income.  International tax issues arise when the source country is not the taxpayer’s country of residence.  The “character” of income (e.g. personal services, royalty, dividend, etc.) is important in order to determine the applicable tax rate, whether or not there is an international tax issue.  When considering (1) and (2) together, one must be very careful and thorough while analyzing U.S. tax consequences.

With that framework in mind, let’s proceed to the heart of Goosen’s case.  Each of his agreements was considered one of the following:

  • A.  On-Course Agreements: These required Goosen to wear or use the sponsor’s products during golf tournaments; and
  • B.  Off-Course Agreements: These did not have the on-course requirement.

For purposes of relative brevity, let’s look at how the court treated Goosen’s income earned from two endorsement agreements: (i) The TaylorMade on-course agreement, and (ii) The Electronic Arts off-course agreement.

The TaylorMade On-Course Endorsement Agreement

TaylorMade agreed to pay a $400,000 annual endorsement fee so long as Goosen completed certain golf tournament playing requirements, wore required clothing, and made certain appearances.  In addition, TaylorMade agreed to pay a tournament bonus if he won a specified tournament, and pay a ranking bonus if he achieved a specified ranking on the World Golf Rankings.

On his nonresident U.S. tax returns, Goosen characterized the annual fee and bonuses as 50 percent royalty income and 50 percent personal services income.  For the “source” component, Goosen attributed the royalty income as 3.4 percent U.S. source; for the personal services, he sourced endorsement fees and tournament bonuses based upon the number of days he played golf inside the U.S. over the total days he played golf for the year, and sourced ranking bonuses based on a ratio of his U.S. prize winnings to his worldwide winnings.

After taking five pages to analyze the issue, the court held Goosen’s characterization as accurate.  Payments for the right to use a person’s name and likeness has been repeatedly held as royalties because the person has an ownership interest in that right.  Goosen asserted that TaylorMade paid him, in part, to co-market and co-brand the company’s products with his name and likeness.  So, on the one hand, the court observed TaylorMade’s desire to be associated with Goosen’s “cool and professional persona,” which cast in public view internationally.  On the other hand, the court highlighted the value of Goosen’s participation at tournaments to promote TaylorMade products; in fact, the full endorsement fee was conditioned upon Goosen’s participation in a specified number of golf tournaments.

For sourcing, Goosen and the IRS agreed to his approach for sourcing the personal services income, but disagreed as to what portion of the royalty income was U.S. source.  Generally, royalty income paid for the right to use intangible property is sourced where the property is used or to given the privilege to use.  To make this determination, the court considered where Goosen’s name and likeness were used, and held that 50 percent of the royalty income as U.S. source.  This represents an increase of over forty percentage points for U.S. source from how Goosen sourced the royalty income.

Finally, the court had to determine whether the U.S. source income was effectively connected to a trade or business.  That’s because in the case of U.S. source income effectively connected to a trade or business, a nonresident alien is essentially treated like a U.S. resident for tax purposes with respect to that income: graduated rates apply. If not effectively connected and the income consists of rents, royalties, or other similar types of income, the nonresident instead is subject to a thirty percent withholding tax.

In this case, the parties agreed that the income from personal services was effectively connected, but disagreed to the royalty income.  The court held that the royalty income was effectively connected, because Goosen’s participation in golf tournaments was material to receiving income for the use of his likeness.

The Electronic Arts Off-Course Endorsement Agreement

Electronic Arts develops video games, including Tiger Woods PGA Tour.  Pursuant to the agreement, EA obtained the right to use Goosen’s name and likeness in the game, and EA agreed to pay $45,000.  Goosen characterized his endorsement fees as 100 percent royalty income, and attributed the income as 6.8 percent U.S. source.

The parties in the case agreed with the 100 percent royalty characterization, but disagreed as to source.  After evaluating where EA’s video games were sold and marketed and the extent to which Goosen’s name and likeness was tied to those sales, the court held that this income as 70 percent U.S. source.  That’s an increase of over 60 percentage points from how Goosen sourced the income in the U.S., ultimately subjecting far more of his EA royalty income to U.S. taxation.  For the effectively connected analysis, the court held that the royalty income from the EA agreement was not, because the income therefrom did not depend on whether Goosen participated in any golf tournaments.

Possible Treaty Relief

When the source country is not the taxpayer’s country of residence, the resident country only has residual taxing rights on the income.  Sometimes, the source country relaxes its primary taxing rights on the income by law or treaty.

Retief Goosen is a resident of the U.K., so the court considered whether Goosen would receive any benefits offered by the U.S.-U.K Tax treaty.  The court held that he did not, because payments from Goosen’s sponsors were made to entities controlled by the company he hired to manage his career and finances; Goosen couldn’t prove the payments he received from these entities constituted endorsement income or another type of income.  To me, losing on that point sounds like the result of poor tax planning and/or record keeping.

(Hat tip: TaxProf Blog)

Substantiating Gambling Losses in Tax Court

April 14th, 2011 No comments

Many taxpayers who report gambling winnings and losses don’t maintain satisfactory records of their gambling activity.  Page 12 of this IRS publication states:

You must keep an accurate diary or similar record of your losses and winnings.  Your diary should contain at least the following information:

  • The date and type of your specific wager or wagering activity.
  • The name and address or location of the gambling establishment.
  • The names of other persons present with you at the gambling establishment.
  • The amount(s) you won or lost.

The publication goes on to provide types of sufficient documentation specific to the type of wagering activity.

As I’ve said before, the amount of detail asked from the IRS in this regard is excessive.  If you merely present that excuse to the IRS, however, you will likely lose every time.  Alternatively, taxpayers conjure up various methods to prove the amount of gambling losses reported on their tax return is accurate.

The method employed by William Jones in his recent U.S. Tax Court case came up very short.

Mr. Jones regularly played slots in Chicagoland area casinos during 2006.  Jones didn’t file a tax return that year.  Instead, the IRS prepared a substitute return for him, and assessed a tax deficiency.  Although not entirely clear from the court’s opinion, let’s presume this deficiency was based upon $7,000 in gambling winnings reported to the IRS on multiple Form W-2Gs.

Jones contended that he also had gambling losses from the tax year of approximately $7,000.  A predictable response from the IRS: OK, prove to us your gambling losses.

Instead of showing any sort of contemporaneous diary of his gambling activity, Jones presented his bank account statements, which showed a balance of $7,531 on December 31, 2005, and a balance of $947 on December 31, 2006.  Jones testified that most of his withdrawals from the account was spent on gambling.  The taxpayer’s theory was “that his losses must have approximately equaled the difference between his beginning-of-year and end-of-year bank account balances.”

Nice try, but that ain’t gonna fly.  Decision in favor of the IRS.

In some instances, however, the court may estimate the amount of a deduction that the taxpayer is entitled to.  To make this estimation, the court requires a basis upon which to make it.  This doctrine is known as the Cohan rule.  One example exhibiting application of the Cohan rule to gambling losses was in the case Doffin v. Commissioner, T.C. Memo. 1991-114.

Mr. Doffin compulsively engaged in pulltab gambling.  Unsurprisingly, Doffin mightily struggled with his finances, so his parents arranged for his paychecks to be deposited with a credit counseling service.  Mr. Doffin pretty much gambled away whatever allowance he received.  Because the court was presented with a very detailed description of the taxpayer’s lifestyle and financial position, the court was able to approximate the taxpayer’s gambling losses.

Had Mr. Jones read the Doffin decision, perhaps his Tax Court case would have turned out differently.

Categories: Gambling, Gambling Tax Basics, IRS, Tax Court Tags:

Currency Transaction Reports Burn the “Cook”

February 17th, 2011 No comments

That didn’t take long.  Within hours of my posting about how the IRS can detect a taxpayer’s gambling winnings from Currency Transaction Reports this past Monday, the U.S. Tax Court issued a decision sustaining a tax deficiency based in large part on, you guessed it, Currency Transaction Reports.  Credit fellow tax practitioner Russ Fox of Irvine, CA for breaking the story in the tax blogosphere.

On their joint 2004 and 2005 tax returns, the petitioner and his wife reported gross income amounts of $16,450 and $18,230, respectively.  The petitioner stated “cook” as his occupation for both years.

The petitioner did not just spend his time perfecting the culinary arts.  A New York resident, he traveled frequently to the Foxwoods Resort Casino in Connecticut.  And gambled, of course.

During the two years in question, Foxwoods issued currency transaction reports showing that the taxpayer purchased more than $800,000 in casino chips.  Foxwoods filed these CTRs with the IRS as required.  Seeing a large discrepancy between reported income and cash transacted by the taxpayer, the IRS selected the returns for audit.

During the audit, the IRS requested on numerous occasions an explanation of the taxpayer’s source for the cash used to purchase the casino chips.  For example, the taxpayer could have used borrowed money (nontaxable source).

Taxpayer presented two explanations:

  • He lent his “Dream Card” (a card issued by Foxwoods for patrons to use for gambling and to accumulate rewards points) to his friends.  The taxpayer ultimately demonstrated that approximately $211,860 in chips were purchased while he was out of the country; and
  • He obtained a loan from “Fukkianese company” and would testify to such at the trial.

Problem was, the taxpayer didn’t show for trial.  He was represented by counsel, who argued that because the IRS conceded that some of the CTRs were erroneously attributed to the taxpayer, that the remainder are unreliable.

It doesn’t take a leap of faith to accurately predict the taxpayer lost on this point.  The IRS used the CTRs to determine unreported taxable income, and ultimately, additional tax, interest, and penalties.

In a footnote, the decision notes that Foxwoods provided to the IRS a log detailing the taxpayer’s gambling activity at the casino.  The log reflected chip purchases exceeding those reported in the CTRs; this is no surprise since CTRs are issued only if total cash ins or cash outs in a gaming day exceed $10,000.  The IRS probably could have assessed even more tax from unreported income, but chose not to.

As a final note, the taxpayer’s total assessed liabilities regarding the two tax years in question will almost certainly not end with this entree of a decision.  It’s dessert time.  There was a reason for mentioning the taxpayer’s New York residency status:

Under NY Tax Law, taxpayers are *required* to report any change in their federal return that has the effect of changing NY tax liability.

NYS applies income tax on all income earned by its residents, regardless of the source.  NYS will assess tax on the taxpayer’s additional income, plus interest, plus penalties.  Perhaps a very minor “victory” for the taxpayer is that Connecticut does not impose income tax on gambling winnings of nonresidents, other than state lottery winnings.

In the end, the “cook” gets burned in more ways than one.

Victory in U.S. Tax Court for Professional Gamblers

January 27th, 2011 No comments

Sometimes, just sometimes, persuasive authority that seems to favor your side of the law becomes binding authority.

Last week I noted the confusion of this IRS memorandum from 2008.  The memorandum’s position is only wagering losses, and not business expenses, are limited in deduction to the extent of wagering gains.  For the professional gambler, this may result in a lower tax burden.  I also expressed caution with relying on this memorandum, as it was merely advisory, and not binding on taxpayers.

Earlier this week, the United States Tax Court issued a decision examining the position of this memorandum.

The basic facts of the case are straightforward.  The petitioner was a professional gambler.  He liked to bet on horse races.  A lot.  For the 2001 year, the petitioner reported $120,463 in gambling winnings, $131,760 in gambling losses, and $10,968 in “ordinary and necessary” expenses incurred with the taxpayer’s business of gambling.  The petitioner attached a Schedule C to his 2010 tax return, reported a $22,265 business loss, and applied it against other income from the year.

The court upheld the rule that gambling losses can be applied against gambling winnings to the extent of gambling winnings.  The holding reaffirms the fundamental principle we have discussed all along.

How about the more interesting position of the IRS memorandum; whether “ordinary and necessary” expenses incurred with the taxpayer’s business of gambling are deductible beyond the extent of gambling winnings.  The court said this is proper.

The United States Tax Court is a federal court of record.  The court’s decisions are binding on both the IRS and taxpayers, unless reversed on appeal.  In this case, it seems unlikely the IRS will appeal the decision, considering the previous position taken in the memorandum.

The holding’s significance:  Although professional gamblers may still only deduct gambling losses to the extent of gambling winnings, the taxpayer may further deduct the “ordinary and necessary” expenses incurred with the taxpayer’s business of gambling.  This may cause a professional gambler to have business loss, which may be applied against other income.

Back to the facts for clarification.  The taxpayer was allowed to deduct $120,463 of gambling losses (the additional $11,297 in gambling losses lands in a black hole), as well as the $10,968 of business expenses.  The result:  The taxpayer may report a business loss of $10,968.

Important takeaway:  If reporting a business loss from professional gambling, be sure to maintain proper records to substantiate these losses.  The burden is on the taxpayer to prove these losses.  If unable to, the result could be a large tax deficiency, plus interest and penalties.

Categories: Gambling, Gambling Tax Basics, IRS, Tax Court Tags:
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