The IRS often contests claims for gambling losses and, more often than not, prevails in the courts. Frequently, the reason is that the losses aren’t properly substantiated. However, in a new case, Coleman, TC Memo 2020-146, 10/22/20, the Tax Court approved as deduction for a compulsive gambler who didn’t furnish documentation.
First, here’s some background information. The tax law allows you to deduct your gambling losses for the year, but only up to the amount of your winnings. For instance, if you win $5,000 playing blackjack at a casino and then you lose $4,000 betting on horseracing, you can offset the winnings so that you’re taxed on only $1,000 of income. This applies to all gambling activities—even playing the lottery or bingo at a house of worship.
What’s more, unlike most other miscellaneous expenses—such as unreimbursed employee business expenses or investment advisory fees—you can still deduct these gambling losses against gambling income. The Tax Cuts and Jobs Act (TCJA) suspends the deduction for miscellaneous expenses from 2018 through 2025, but this TCJA crackdown doesn’t apply to gambling losses.
Nevertheless, you can’t simply enter estimated losses on your return. The IRS requires you to keep adequate records to substantiate losses and this is a frequent audit item. Practically speaking, you should keep a log of their activities stating the date of the activity, the location, names of any people who were there with you, the amounts wagered, the type of gambling and your winnings and losses. Supplement this log with receipts, tickets, statements and other records.
Due to unusual circumstances in the case at hand, the Tax Court allowed an annual loss of about $350,000 without the taxpayer submitting documentation into evidence.
Facts of the case: The taxpayer, a resident of Maryland, was a self-employed insurance consultant. By all accounts, his gambling compulsion had caused him many financial and personal setbacks. He often ignored other aspects of his life and didn’t even file a tax return for 2014, the tax year in question.
During this year, the taxpayer gambled at four different casinos for a total of close to 200 days. He concentrated on slot machines and the IRS calculated that he won about $350,000. On the other hand, the IRS concedes that the taxpayer made bank account withdrawals of more than $240,000 that were used exclusively for gambling in addition to other funds used to support his addiction, including a $150,000 personal injury claim.
When the IRS assessed the deficiency for 2014, the taxpayer took a calculated risk that he could show under the “Cohan rule” that his gambling losses for the year exceeded his winnings. The Cohan rule, based on a landmark case, has previously enabled some taxpayers to deduct expenses without the requisite records.
Tax payoff: The Tax Court sided with the taxpayer. First, it relied heavily on the testimony of an expert casino gaming witness who convinced the court that a compulsive gambler like the taxpayer would have squandered all of his funds. Second, the taxpayer demonstrated from his style of living and increased debt levels that he didn’t use his funds for other purposes. This included extreme financial distress resulting from his gambling activities.
To cement this winning hand, the Tax Court judge used an annual netting method, rather than reliance on regular sessions, to determine that the taxpayer incurred losses of at least $350,000 during the year.
Can your clients use the same theory to deduct gambling losses that are not properly substantiated? Don’t press your luck. This is a long shot that you can’t take to the bank.