Taxable Talk

The Tax Court today looked at the case of a couple who gambled in their local casino, won, but didn’t include the income on their tax return. That they had taxable income is a given, but there’s a very interesting and useful aspect of the decision.

During 2005 the taxpayers gambled on the slots at their local casino in Charles Town, West Virginia. For the most part they lost. However, on one lucky day they withdrew $500 from the bank, went to the casino and hit a $2000 slot jackpot, and walked out of the casino with $1600. The IRS sent the taxpayers a Notice of Deficiency for $2000.

The taxpayers argued that they should be able to net their losses from their other trips to the casino. That argument fell flat with the Tax Court.

Because petitioners were not engaged in the trade or business of gambling, their gambling losses are allowable only as itemized deductions. But because petitioners have elected the standard deduction, they are not entitled to itemize their deductions.3 Sec. 63(b), (e); see Johnston v. Commissioner, supra; Heidelberg v. Commissioner, supra. We reject as without merit petitioners’ contention that this statutory arrangement is unconstitutional. [citations omitted]

But there’s a huge amount of good news for other gamblers in the decision today. I’ll let the Court note the relevant point:

Respondent asserts that for purposes of applying section 165(d) to casual gamblers like petitioners, the correct analysis and methodology is set forth in Chief Counsel Advice 2008-011 (Dec. 5, 2008) (the Chief Counsel Advice), which states in part:

A key question in interpreting §165(d) is thesignificance of the term “transactions.” The statute refers to gains and losses in terms of wagering transactions. Some would contend that transaction means every single play in a game of chance or every wager made. Under that reading, a taxpayer would have to calculate the gain or loss on every transaction separately and treat every play or wager as a taxable event. The gambler would also have to trace and recompute the basis through all transactions to calculate the result of each play or wager. Courts considering that reading have found it unduly burdensome and unreasonable. See Green v. Commissioner, 66 T.C. 538 (1976); Szkirscak [sic] v. Commissioner, T.C. Memo. 1980-129. Moreover, the statute uses the plural term “transactions” implying that gain or loss may be calculated over a series of separate plays or wagers.

The better view is that a casual gambler, such as the taxpayer who plays the slot machines, recognizes a wagering gain or loss at the time she redeems her tokens. We think that the fluctuating wins and losses left in play are not accessions to wealth until the taxpayer redeems her tokens and can definitively calculate the amount above or below basis (the wager) realized. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955). For example, a casual gambler who enters a casino with $100 and redeems his or her tokens for $300 after playing the slot machines has a wagering gain of $200 ($300-$100). This is true even though the taxpayer may have had $1,000 in winning spins and $700 in losing spins during the course of play. Likewise, a casual gambler who enters a casino with $100 and loses the entire amount after playing the slot machines has a wagering loss of $100, even though the casual gambler may have had winning spins of $1,000 and losing spins of $1,100 during the course of play. [Fn. ref. omitted.]

Because of this the taxpayer only had $1100 of unreported gambling income ($1600 in cash less $500 withdrawn from the bank), not $2000. More importantly, this is a major victory for casual gamblers. I’ve been arguing this point during audits for years with varying amounts of success. For the IRS’ counsel to agree with this in a precedential decision of the Tax Court should make this far easier during future audits.

There is a major caveat to this decision: You need good records. By far, the lack of backup documentation is what trips us most gamblers in audits. For those gamblers who do keep good records, the Tax Court has given you a very nice belated Christmas present.

Case: Shollenberger v. Commissioner, T.C. Memo 2009-306