The Tax Code is anything but fair towards gamblers. This is especially true for professional gamblers; they’re in one of the few professions where you can’t lose. Section 165(d) states that losses from wagering (gambling) transactions are only allowable up to the amount of wins.
So let’s look at John Doe, a normally winning professional gambler. He has a bad year, and his $100,000 of wins are offset by $150,000 of losses. To top that off, he has $30,000 of expenses. He just lost $80,000, right?
Well, maybe not. A new IRS position paper notes that the business expenses may be eligible for a net operating loss (NOL) carryforward/carryback in a year that a gambler loses.
As the paper notes, it’s a case of language. Section 165(d) states, “losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” [emphasis added] Those two words are the key: Does the statute mean the transactions or the activity?
The paper notes that Whitten v. Commissioner (T.C. Memo 1995-508) agrees with this line of reasoning and allows expenses to be deducted. On the other hand, there is a string of cases holding the contrary point of view. These go back to 1951 (Offutt v. Commissioner, 16 T.C. 1214; Estate of Todisco v. Commissioner, 757 F 2d 1 (1st Cir. 1985) affg T.C. Memo 1983-247); one of these cases is Kochevar v. Commissioner (T.C. Memo 1995-607).
So what does this mean for the gambler who has a bad year? First, you can’t deduct losses in excess of wins. However, you may be able to claim expenses, and carry them forward or backward as a NOL carryforward/carryback. The “may” is very necessary. The Estate of Todisco case may bind those gamblers who are in the 1st Circuit (Maine, Massachusetts, New Hampshire, Rhode Island, and Puerto Rico) and they may not be able to try this strategy.
Additionally, a position paper in no way binds the IRS to this view. It’s one attorney’s opinion. The staff at the IRS hasn’t been favorable towards gamblers in the past, and nothing prevents them from taking a contrary view. However, for those gamblers who wish to be aggressive having some expenses carried forward can mollify (to some degree) a bad year.
Anyone taking this position should absolutely discuss this with their own personal tax professional. Taking this position will definitely increase the risk of audit of the gambler’s return; you could win this part of your argument only to have other items on your return thrown in your face. Additionally, this position paper doesn’t bind the IRS or the Tax Court.