Taxes and Gambling
Several days ago, the Tax Court overruled one of its existing decisions, and in Mayo v. Comr., 136 T.C. No. 4 (Jan. 25, 2011), held that the limitation in section 165(d) on gambling losses does not apply to a gambler’s expenses that are not wagering losses and that otherwise qualify as trade or business deductions under section 162. The taxpayer drew attention to himself by deducting from gambling gross receipts not only section 162 deductions but also his gambling losses, generating a $22,265 Schedule C loss and deducting it against other income. The IRS, relying on Offutt v. Comr., 16 T.C. 1214 (1951), and on section 165(d), disallowed all of the taxpayer’s deductions.
Though the IRS initially took the position that the taxpayer was not in the trade or business of gambling, it later conceded the point. Considering that the taxpayer wagered almost $131,760 and won $120,463, it would have been difficult to persuade the court, in light of Comr. v. Groetzinger, 480 U.S. 23 (1987), that the taxpayer was not in a trade or business. The taxpayer also incurred $10,968 of business expenses, including travel, meals, telephone, internet, entry fees, subscriptions, and my favorite, ATM fees.
The IRS, however, also took the position that the taxpayer was permitted to deduct only $120, 463 of combined wagers and other expenses. The taxpayer argued that section 165(d) does not apply to professional gamblers. The taxpayer rested the argument on the premise that because section 165(d) does not apply to trades or businesses generally, it ought not apply to the gambling losses of gamblers who are in a trade or business and should be limited to the gambling losses of people who gamble without being in a trade or business. The taxpayer, in effect, was viewing section 165(d) as analogous in this respect to section 183.
The Tax Court noted that it had on several prior occasions rejected the proposition that the Groetzinger decision absolved professional gamblers from the restrictions of section 165(d). The court repeated what it had explained in a prior case, Valenti v. Comr., T.C. Memo 1994-483, namely, that section 165(d), the more specific provision, trumps section 162(a), which is more general. Thus, the taxpayer’s attempt to deduct more than $120,463 of his wagers of $131,760 was stymied.
However, when the Tax Court turned to the question of the other expenses, the taxpayer fared much better. The court decided that the term “losses from wagering transactions,” which is what section 165(d) limits, does not include the other expenses. The court noted that it had to work through the analysis without a benefit of the phrase in the statute, the regulations, or the legislative history. In fact, its own precedent on the point, the Offutt case, “offered no reasoning to support the conclusion that ‘Losses from wagering transactions’ should be interpreted to cover both the cost of losing wagers as well as the more general expenses incurred in the conduct of a gambling business.”
In reconsidering its position, the Tax Court relied on several strands of analysis. Each relied on analyses in prior case law.
First, it determined that because “gains from such [wagering] transactions” was limited to “proceeds from a wager by the taxpayer where the taxpayer stands to gain or lose on the basis of chance” and does not include a taxpayer’s other income, even income based on shares of a casino’s house fees, the term “losses from wagering transactions” should be limited to amounts lost on a wager. In other words, because income that is in connection with, but not a consequence of, placing a wager is excluded from the section 165(d) limitation, expenses that are in connection with, but not a consequence of, placing a wager should not be subject to the limitation.
Second, the court noted that in Comr. v. Sullivan, 356 U.S. 27 (1958), the Supreme Court cast doubt on the appropriateness of treating a professional gambler’s expenses other than wager costs as a loss subject to section 165(d). The Supreme Court treated a gambler’s wage and rent expenses were ordinary and necessary business deductions allowable under section 162(a). Because the taxpayer in Sullivan had gains from wagering transactions that exceeded the total of his wagering losses combined with the other expenses, the Supreme Court did not reach the section 165(d) issue, but its dictum suggests that it would have held that the limitation did not apply.
Third, the court noted that the Court of Appeals for the Ninth Circuit, in Boyd v. U.S., 762 F.2d 1369 (9th Cir. 1985), had distinguished, in dictum, between wagering losses and “expenses incidental to gambling,” characterizing the latter as not subject to section 165(d). The Ninth Circuit’s observations did not constitute a holding because the issue was precluded by the taxpayer’s failure to raise the matter in the refund claim the denial of which had led to the litigation.
Fourth, the court identified a series of cases in which the IRS itself had conceded that section 165(d) did not apply to expenses that were not wagering losses, or had failed to raise the section 165(d) limitation in the notice of deficiency. In fact, in Chief Counsel Memo AM 2008-013 (Dec. 19, 2008), the IRS announced that it would no longer follow the Offutt decision.
Aside from the obvious lesson to be learned from the case, namely, that the Tax Court takes the position that section 165(d) does not apply to expenses otherwise deductible under section 162(a) that are not wagering losses, there are other lessons to be learned. For example, though many people who are not tax practitioners might think otherwise, the Tax Court is no different from other courts in overruling its earlier decisions if and when careful analysis determines that it is appropriate to do so. Another lesson is the need to look carefully not only at what appears to be a rule extracted from a case, but at administrative issuances and the procedural history of other cases. Knowing that the IRS had conceded the issue and failed to raise the issue in some cases, while litigating the point in other cases, suggests that its original position was not as airtight as might otherwise appear.
Though the IRS initially took the position that the taxpayer was not in the trade or business of gambling, it later conceded the point. Considering that the taxpayer wagered almost $131,760 and won $120,463, it would have been difficult to persuade the court, in light of Comr. v. Groetzinger, 480 U.S. 23 (1987), that the taxpayer was not in a trade or business. The taxpayer also incurred $10,968 of business expenses, including travel, meals, telephone, internet, entry fees, subscriptions, and my favorite, ATM fees.
The IRS, however, also took the position that the taxpayer was permitted to deduct only $120, 463 of combined wagers and other expenses. The taxpayer argued that section 165(d) does not apply to professional gamblers. The taxpayer rested the argument on the premise that because section 165(d) does not apply to trades or businesses generally, it ought not apply to the gambling losses of gamblers who are in a trade or business and should be limited to the gambling losses of people who gamble without being in a trade or business. The taxpayer, in effect, was viewing section 165(d) as analogous in this respect to section 183.
The Tax Court noted that it had on several prior occasions rejected the proposition that the Groetzinger decision absolved professional gamblers from the restrictions of section 165(d). The court repeated what it had explained in a prior case, Valenti v. Comr., T.C. Memo 1994-483, namely, that section 165(d), the more specific provision, trumps section 162(a), which is more general. Thus, the taxpayer’s attempt to deduct more than $120,463 of his wagers of $131,760 was stymied.
However, when the Tax Court turned to the question of the other expenses, the taxpayer fared much better. The court decided that the term “losses from wagering transactions,” which is what section 165(d) limits, does not include the other expenses. The court noted that it had to work through the analysis without a benefit of the phrase in the statute, the regulations, or the legislative history. In fact, its own precedent on the point, the Offutt case, “offered no reasoning to support the conclusion that ‘Losses from wagering transactions’ should be interpreted to cover both the cost of losing wagers as well as the more general expenses incurred in the conduct of a gambling business.”
In reconsidering its position, the Tax Court relied on several strands of analysis. Each relied on analyses in prior case law.
First, it determined that because “gains from such [wagering] transactions” was limited to “proceeds from a wager by the taxpayer where the taxpayer stands to gain or lose on the basis of chance” and does not include a taxpayer’s other income, even income based on shares of a casino’s house fees, the term “losses from wagering transactions” should be limited to amounts lost on a wager. In other words, because income that is in connection with, but not a consequence of, placing a wager is excluded from the section 165(d) limitation, expenses that are in connection with, but not a consequence of, placing a wager should not be subject to the limitation.
Second, the court noted that in Comr. v. Sullivan, 356 U.S. 27 (1958), the Supreme Court cast doubt on the appropriateness of treating a professional gambler’s expenses other than wager costs as a loss subject to section 165(d). The Supreme Court treated a gambler’s wage and rent expenses were ordinary and necessary business deductions allowable under section 162(a). Because the taxpayer in Sullivan had gains from wagering transactions that exceeded the total of his wagering losses combined with the other expenses, the Supreme Court did not reach the section 165(d) issue, but its dictum suggests that it would have held that the limitation did not apply.
Third, the court noted that the Court of Appeals for the Ninth Circuit, in Boyd v. U.S., 762 F.2d 1369 (9th Cir. 1985), had distinguished, in dictum, between wagering losses and “expenses incidental to gambling,” characterizing the latter as not subject to section 165(d). The Ninth Circuit’s observations did not constitute a holding because the issue was precluded by the taxpayer’s failure to raise the matter in the refund claim the denial of which had led to the litigation.
Fourth, the court identified a series of cases in which the IRS itself had conceded that section 165(d) did not apply to expenses that were not wagering losses, or had failed to raise the section 165(d) limitation in the notice of deficiency. In fact, in Chief Counsel Memo AM 2008-013 (Dec. 19, 2008), the IRS announced that it would no longer follow the Offutt decision.
Aside from the obvious lesson to be learned from the case, namely, that the Tax Court takes the position that section 165(d) does not apply to expenses otherwise deductible under section 162(a) that are not wagering losses, there are other lessons to be learned. For example, though many people who are not tax practitioners might think otherwise, the Tax Court is no different from other courts in overruling its earlier decisions if and when careful analysis determines that it is appropriate to do so. Another lesson is the need to look carefully not only at what appears to be a rule extracted from a case, but at administrative issuances and the procedural history of other cases. Knowing that the IRS had conceded the issue and failed to raise the issue in some cases, while litigating the point in other cases, suggests that its original position was not as airtight as might otherwise appear.
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