Did taxpayer engage in gambling activities with the intention of making a profit?
Taxpayer Says: Losses were incurred as a gambling professional engaged in the business of playing slot machines and are deductible in full against winnings.
Internal Revenue Service Says: Gambling losses were not incurred in the course of a trade or business, and are deductible only as an itemized deduction.
From IRC Section 162(a): Ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business are generally deductible.
From IRC Section 165(d): Losses from wagering transactions may only be deducted to the extent of gains from wagering transactions.
From Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987): An activity must be conducted with continuity, regularity, and the primary purpose of earning a profit to be considered a trade or business under section 162.
From Federal Tax Regulation 1.183-2(b): Relevant factors to be taken into account in determining whether an activity is engaged in for profit include:
(1) The manner in which the taxpayer carried on the activity;
(2) The expertise of the taxpayer or his or her advisers;
(3) The time and effort expended by the taxpayer in carrying on the activity;
(4) The expectation that the assets used in the activity may appreciate in value;
(5) The success of the taxpayer in carrying on other similar or dissimilar activities;
(6) The taxpayer’s history of income or loss with respect to the activity;
(7) The amount of occasional profits, if any, which are earned;
(8) The financial status of the taxpayer; and
(9) Whether elements of personal pleasure or recreation are involved.
THE CAUSE OF THE DISPUTE
Gambling winnings are fully taxable whether gambling is a hobby or a business.
However, gambling losses incurred by non-business (hobby) gamblers do not directly reduce gambling income. Instead, losses are generally deductible (to the extent of winnings) only as an itemized deduction. This treatment may decrease or eliminate the deduction.
Professional gamblers can directly reduce gambling winnings by the amount of gambling losses and other expenses (but only to the extent of winnings).
WHAT WOULD YOU DECIDE?
Note: In applying the nine factors from Federal Tax Regulation 1.183-2 to this case, the court determined:
(1) Manner in which the taxpayer carried on the activity – No separate books or records kept; no written business budget or plan.
(2) Expertise of the taxpayer or advisers – Taxpayer gambled for more than ten years and consulted regularly with casino staff.
(3) Time and effort expended in carrying on the activity – At least 40 hours per week spent gambling at casinos, often 12-15 hours at a time.
(4) Expectation that the assets used in the activity may appreciate in value – Not relevant.
(5) Success in carrying on other similar or dissimilar activities – Taxpayer owned and operated a successful trucking business.
(6) Taxpayer’s history of income or loss with respect to the activity – No profit from gambling activity for the three years before and the year after the year at issue.
(7) Amount of occasional profits, if any, which are earned – Frequent wins; occasional big wins.
(8) Financial status – Taxpayer had another source of income that could not be offset by gambling losses.
(9) Whether elements of personal pleasure or recreation are involved – Taxpayer testified credibly that gambling was stressful, tiring, and time consuming work.
Make your selection, then see “The Court’s Decision” below for a full explanation
THE COURT’S DECISION
HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.
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