John Allen and Glenna A. Lyle  6/7/1999

Joseph F. and Dorothy M. German  3/31/1999

John David Zielonka 2/18/1997

Timothy C. Sadlier 1/27/1997

Edward B. Rood 5/29/1996

James K. Roberts 5/16/1996

Robert Libutti  3/7/1996

John J. Burke and Vivian Burke  12/26/1995

Philip H. and Anna Friedman 12/4/1995

Gregory Alberico  11/16/1995

Stanley B. and Rose M. Whitten  10/25/1995

Connecticut Cases:
http://www.jud.ct.gov/external/super/Tax/recent.htm

136 T.C. No. 4
UNITED STATES TAX COURT
RONALD ANDREW MAYO and LESLIE ARCHER MAYO, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15527-03. Filed January 25, 2011.

Summary of the decision: Gambling losses are deductible only to the extent of winnings.  But in agreement with the position taken by ProfesssionalGamblerStatus.com, the operating expenses of the business, such as meals, lodging and transportation are not treated as wagering losses.  Rather these costs are used to offset self-employment tax in other trades or businesses and current year federal and state income taxes, and further, they can create a net operating loss (NOL) and be carried back to offset prior year's federal and state income.

Offutt v. Commissioner, 16 T.C. 1214 (1951) interpreted that "Losses from wagering transactions" covers both the cost of wagers placed as well as the more general expenses incurrent in the conduct of a gambling business.  This intrepretation has generally been followed by this Court in the 60 years since that case was decided, but no Court of Appeals (other than that for the 1st Circuit in Estate of Todisco) has had occasion to directly address it.  This Court now has concluded that interpretation should no longer be followed.

T.C. Summary Opinion 2007-194
UNITED STATES TAX COURT
LINDA M. MYERS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 23664-05S. Filed November 19, 2007. Kathryn J. Sedo and Christine Rittberg, for petitioner.
Lisa R. Woods, for respondent.

KROUPA, Judge: This case was heard pursuant to the provisions of section 7463⁽¹⁾ of the Internal Revenue Code in effect at the time the petition was filed. Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case.

Respondent concedes that petitioner is not liable for the accuracy-related penalty under sec. 6662(a). Respondent determined a $5,266 deficiency in petitioner’s Federal income tax for 2003 and determined that petitioner was liable for a $1,055 accuracy-related penalty under section 6662(a). After concessions,⁽²⁾ the sole issue for decision is whether petitioner was in the trade or business of gambling in 2003. We hold that she was.

Background

Some of the facts have been stipulated and are so found. The stipulation of facts and the accompanying exhibits are incorporated by this reference. Petitioner resided in South Saint Paul, Minnesota, at the time she filed the petition.

Petitioner’s Activities

Petitioner spent nearly all of her time during 2003 pursuing two activities, a trucking business that she owned and operated, and her gambling activity. She spent 25 to 35 hours per week working at the trucking business and about 40 hours per week on the gambling activity.

Petitioner oversaw the management and operations functions of her trucking business, which employed eleven drivers for eight trucks in 2003. She worked diligently to maintain the documentation required to run a successful trucking business, such as licenses, maintenance logs, and insurance matters. Petitioner retained an accountant to assist her with financial recordkeeping. Petitioner received a $28,000 salary and $36,000 nonemployee compensation from the trucking business in 2003. Petitioner’s gambling activity consumed the rest of her time. In fact, a typical day for petitioner involved working at the trucking business until 1 or 2 p.m., followed by a trip to the casino that typically lasted until 2 a.m. to 6 a.m. Petitioner would then return home and sleep for a little while before arising the next day to follow the same routine. Petitioner’s children, who had lost their father in an automobile accident, were extremely worried about petitioner’s early morning drives home from the casino, particularly in the wintertime. Nevertheless, petitioner gambled and made these late night trips home nearly every day.

Petitioner originally began gambling in 1992 after her husband’s death, focusing on the $1 slot machines. When she first began gambling, petitioner would occasionally talk with other gamblers. Petitioner became increasingly serious about her gambling pursuits as time progressed and as she became accustomed to the casinos and learned more about their operations. She considered herself a professional gambler by 2000. Petitioner viewed herself as a gambling expert but found no pleasure in gambling. Instead, she considered gambling stressful, tiring, and time consuming. She did not go to the casino with friends or companions and was focused on doing everything she could to win while she was there.

Petitioner developed certain strategies she felt would maximize her odds of winning. Petitioner’s primary strategy was essentially to locate and play those slot machines that were due to make a payout. Petitioner strategized that the more money put into a machine without a payout increased the odds of a payout. Petitioner would speak with the casino attendants upon arriving at the casino to determine which slot machines to play. The attendants would describe what had happened so far that day, which slot machines were played most heavily but had made no payouts, and which slot machines had made payouts. The attendants knew this information because they made the payouts by hand to gamblers who won over a certain amount. Petitioner also sometimes watched other gamblers playing slot machines to learn the slot machines’ patterns. After learning this information, petitioner identified those slot machines petitioner considered “ripe” for a payout and played them.

Petitioner gambled about $500 in each of five slot machines that she felt were good candidates to make payouts on a typical day at the casino. Petitioner would carefully watch the results of each machine once she began using it. If the slot machine began giving her free plays, doubles, or triples, she viewed that as a very good sign and an indication that the slot machine was about to make a large payout. These results validated petitioner’s choice of slot machine and convinced petitioner to continue playing that machine. Petitioner also strategized from her experience that a slot machine would stay “hot” for a few weeks once it started paying.

Documentation of the Gambling Activity

The casinos gave petitioner Forms W-2G, Certain Gambling Winnings, when she won $1,200 or more on the slot machines. The casinos also provided petitioner a player card that she could insert into the slot machines to track her activities. The player card, when inserted into the machine, would record the amounts petitioner gambled and the amounts she won. Each year, the casinos would process the player card information to generate an annual profit and loss statement for petitioner. While petitioner used her player card most of the time, she did not use it every single time. The profit and loss statements were thus not a complete reflection of petitioner’s gambling activities because they lacked any gambling petitioner did without the player card.

Petitioner was not interested in the non-recordkeeping benefits the player card offered, such as free lodging and meals. She only wanted it to track her profits. In fact, petitioner was disappointed when the casino offered her a free trip to Las Vegas because she thought she must have been losing too much money at her gambling activity for the casino to offer her such a trip and an opportunity to lose more.

Petitioner did not find it necessary to keep her own written set of separate gambling records. She knew in her head how much she had won or lost each day. In addition, the casinos documented her activities through the player card system. Petitioner did retain bank statements, canceled checks, credit card statements, the Forms W-2G, and the profit and loss statement, which documented the gambling activities. Petitioner did not make a budget for the gambling activity but generally knew how much she entered the casino with each time.

Success of Petitioner’s Gambling Activity

Petitioner did not report an overall profit from her gambling activities in the 3 years before and the year after the year at issue. She has won large jackpots several times, however, including $50,000 twice. She won jackpots of $1,200 or more over 300 times during 2003. Petitioner also has taken home as much as $45,000 profit from 1 day’s gambling. Despite the occasional large jackpots, petitioner was concerned that she continued to lose money. She changed her strategy accordingly. Petitioner tried to focus on winning a little bit at a time rather than try to earn back large losses in one night. For example, if petitioner won money early in the afternoon, petitioner would go home rather than stay at the casino and play more to try to recoup old losses.

Petitioner’s Returns

Petitioner has treated herself as a professional gambler on her income tax returns since at least 2000. Petitioner used the same accountant that helped with the trucking business to assist her with matters related to the gambling activity and to prepare her individual returns.

While sec. 165(a) generally permits the deduction of losses from gross income, there is a special rule limiting the deduction of gambling losses. Losses from wagering transactions may only be deducted to the extent of gains from wagering transactions. Sec. 165(d).

Petitioner filed her return for 2003 reporting that she was in the trade or business of gambling. She deducted her gambling losses as an expense to the extent of her gambling winnings, totaling $1,408,740 in 2003. Respondent examined petitioner’s return for 2003 and issued a deficiency notice. Petitioner timely filed a petition.

Discussion

The sole issue for decision is whether petitioner was in the trade or business of gambling in 2003. If petitioner was in the trade or business of gambling, she may deduct her wagering losses to the extent allowable in computing adjusted gross income.⁽³⁾ See sec. 62. If petitioner was not in the trade or business of gambling, on the other hand, she may only deduct the wagering losses to the extent allowable as an itemized deduction to compute taxable income. See Calvao v. Commissioner, T.C. Memo. 2007-57.

All ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business are generally deductible. Sec. 162(a). 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. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). Whether the taxpayer is carrying on a trade or business depends on the facts and circumstances.⁽⁴⁾ Id. at 36.

Respondent has conceded that petitioner’s gambling activity was conducted with the required continuity and regularity during 2003. The parties dispute, however, whether petitioner’s primary purpose for engaging in the activity was to earn a profit. See id.; Miller v. Commissioner, T.C. Memo. 1998-463, affd. without published opinion 208 F.3d 214 (6th Cir. 2000). We examine whether the taxpayer engaged in the activity with the actual and honest objective of making a profit. See Evans v. Commissioner, 908 F.2d 369, 373 (8th Cir. 1990), revg. T.C. Memo. 1988-468; Keanini v. Commissioner, 94 T.C. 41, 46 (1990); Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income Tax Regs. While a taxpayer’s expectation of profit need not be reasonable, there must be a good faith objective of making a profit. Allen v. Commissioner, 72 T.C. 28, 33 (1979); sec. 1.183-2(a), Income Tax Regs. We give greater weight to objective facts than to a taxpayer’s statements of intent. Dreicer v. Commissioner, supra at 645; sec. 1.183-2(a), Income Tax Regs.

We structure our analysis around nine nonexclusive factors. Sec. 1.183-2(b), Income Tax Regs. The nine factors are:

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. Id.

No factor or set of factors is controlling, nor is the existence of a majority of factors favoring or disfavoring a profit objective necessarily controlling. Hendricks v. Commissioner, 32 F.3d 94, 98 (4th Cir. 1994), affg. T.C. Memo.

1993-396; Brannen v. Commissioner, 722 F.2d 695, 704 (11th Cir. 1984), affg. 78 T.C. 471 (1982); sec. 1.183-2(b), Income Tax Regs. The individual facts and circumstances of each case are the primary test. Keanini v. Commissioner, supra at 46; Allen v. Commissioner, supra at 34; sec. 1.183-2(b), Income Tax Regs.

We now examine each of the nine nonexclusive factors. Manner in Which the Taxpayer Carried On the Activity We begin by examining the manner in which petitioner carried on her gambling activity. The fact that a taxpayer carries on the activity in a businesslike manner may indicate a profit objective. Sec. 1.183-2(b)(1), Income Tax Regs. In determining whether a taxpayer conducted an activity in a businesslike manner, we consider whether the taxpayer maintained complete and accurate books and records, whether the taxpayer conducted the activity in a manner substantially similar to those of comparable businesses that are profitable, and whether the taxpayer attempted changes in an effort to earn a profit. Engdahl v. Commissioner, 72 T.C. 659, 666-667 (1979); sec. 1.183-2(b)(1), Income Tax Regs.

The casinos maintained profit and loss tallies for petitioner through the player card system. Petitioner thus did not find it necessary to keep separate books and records to track this information. She used her player card most of the time to enable the casino to perform this tracking function. Petitioner also did not keep a separate bank account for her gambling activities but kept a tally of the amount she had with her when she went to the casino. See Canale v. Commissioner, T.C. Memo. 1989-619; cf. Calvao v. Commissioner, T.C. Memo. 2007-57 (taxpayer claimed he kept daily records of gambling activity but failed to offer any records into evidence). Petitioner also had no written budget or business plan, although she had a strategy she felt would enable her to win. She explained her strategy in detail to the Court. Petitioner’s strategy was to identify and play slot machines that were due for a payout. She implemented the strategy by carefully gathering information about the playing history of the slot machines in the casino and studying their patterns to determine which slot machines were likely to pay out. Moreover, petitioner testified that after some initial losses she changed her strategy to help her win. She decided to try to win just a little at a time rather than to try to recoup old losses all at once. See Engdahl v. Commissioner, supra at 669. If petitioner won some money early in the day, she would take the winnings and return home, rather than continue to gamble with the money she had just won and risk losing it. We find that this factor favors petitioner. Expertise of Taxpayer or His or Her Advisers We next consider petitioner’s expertise (or the expertise of her advisers) in the gambling activity. Preparing for the activity by extensive study of its accepted business, economic, and scientific practices, and consulting with experts in these matters may indicate that a taxpayer has a profit objective when the taxpayer follows that advice. Sec. 1.183-2(b)(2), Income Tax Regs.

Petitioner considers herself a gambling expert and has gambled for over 10 years. The continuity and regularity of her gambling activity strongly suggest that she is an expert at slot machines. Petitioner also consulted regularly with casino employees to further her gambling strategy and watched other gamblers to understand what she believed to be slot machine payout patterns. We find that this factor favors petitioner.

Time and Effort Expended by the Taxpayer in Carrying On the Activity We next consider the time and effort petitioner expended in carrying on the gambling activity. A taxpayer’s devotion of much time and effort to conducting an activity, particularly if the activity does not have substantial personal or recreational aspects, may indicate an intention to derive a profit. Sec. 1.183-2(b)(3), Income Tax Regs.

Petitioner spent at least 40 hours per week gambling at the casinos. Petitioner would often gamble for 12 to 15 hours at a time, often as late as 2 a.m. to 6 a.m. We acknowledge that gambling activities are often viewed as recreational, enjoyable pursuits upon which many people enjoy spending significant time. See, e.g., Calvao v. Commissioner, T.C. Memo. 2007-57. Petitioner testified credibly, however, that she did not view gambling as a mere recreational pursuit. She credibly testified that she found no pleasure in gambling. Moreover, petitioner did not go to the casino with others and while there, was focused on winning as much money as possible. We find that this factor favors petitioner.

Expectation That the Assets Used in the Activity May Appreciate in Value Another factor to be considered is the expectation that the assets used in the activity may appreciate in value. Sec. 1.183-2(b)(4), Income Tax Regs. The parties agree that this factor does not apply.

Success of the Taxpayer in Carrying On Other Similar or Dissimilar Activities We next examine petitioner’s success in carrying on other similar or dissimilar activities. If a taxpayer has previously engaged in similar activities and made them profitable, this success may show that the taxpayer has a profit objective, even though the current activity is presently unprofitable. Sec. 1.183-2(b)(5), Income Tax Regs. A taxpayer’s success in other, unrelated activities also may indicate a profit objective. Daugherty v. Commissioner, T.C. Memo. 1983-188. A taxpayer’s success in a different business enterprise may be evidence of a profit objective where the taxpayer relied on diligence, initiative, foresight, and other qualities that generally lead to success in business activities. Id.

Petitioner has shown that she was capable of running a successful business through her ownership and operation of the trucking business. Petitioner’s success with the trucking business indicates that she had the skills to operate a business successfully. She relied on the same accountant for her gambling activities and relied on her player card to track her winnings. We find this factor favors petitioner.

Taxpayer’s History of Income or Loss With Respect to the Activity We next examine petitioner’s history of income or loss with respect to the gambling activity. A history of substantial losses may indicate that the taxpayer did not conduct the activity for profit. Golanty v. Commissioner, 72 T.C. 411, 427 (1979), affd. without published opinion 647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(b)(6), Income Tax Regs. Losses during the initial or startup stage of an activity do not necessarily indicate, however, that the taxpayer did not conduct the activity for profit, but losses that continue to be sustained beyond the period that is customarily necessary to bring the operation to profitable status may indicate the taxpayer did not engage in the activity for profit. Engdahl v. Commissioner, 72 T.C. at 668; sec. 1.183-2(b)(6), Income Tax Regs. Abandoning an activity after indications that the activity will be unprofitable signifies that the taxpayer engaged in the activity for profit. Canale v. Commissioner, T.C. Memo. 1989-619. Petitioner has not shown a profit from her gambling activity for the 3 years before and the year after the year at issue. Petitioner persisted in the activity despite the ongoing pattern of losses, although she did change her strategy to some extent. This factor favors respondent.

Amount of Occasional Profits, If Any, Which Are Earned We next consider the amounts of occasional profits, if any, that petitioner earned. Occasional profits the taxpayer earned from the activity, in relation to the amount of losses incurred, the amount of the taxpayer’s investment, and the value of the assets used in the activity provide useful criteria in determining the taxpayer’s intent. Sec. 1.183-2(b)(7), Income Tax Regs. A practical possibility that a taxpayer could earn enough money in a year to exceed expenses also can indicate a profit objective. Bolt v. Commissioner, 50 T.C. 1007, 1014-1015 (1968).

Petitioner has occasionally won jackpots as large as $50,000 from her gambling activity. Petitioner won sums of $1,200 or more over 300 times in 2003. Her frequent wins and occasional big wins indicate the possibility that petitioner could have earned enough to cover her expenses in a year. This factor favors petitioner.

Financial Status of the Taxpayer

We next examine petitioner’s financial status. If a taxpayer does not have substantial income or capital from sources other than the activity in question, it may indicate that the taxpayer engages in the activity for profit. Sec. 1.183-2(b)(8), Income Tax Regs. Conversely, substantial income from sources other than the activity, especially if the losses generate large tax benefits, may indicate that the taxpayer is not conducting the activity for profit. Id. Those with substantial income from other sources have a much greater tax incentive to incur large expenditures in a hobby type of business. Jackson v. Commissioner, 59 T.C. 312, 317 (1972). Petitioner earned $64,000 from the trucking business in 2003. Merely because petitioner had another source of income in 2003 is not dispositive, however. See Calvao v. Commissioner, supra. None of petitioner’s income from the trucking business could be offset by gambling losses due to the limitation on deducting gambling losses only to the extent of winnings. See sec. 165(d). Petitioner thus had no tax incentive to engage in the gambling activity to shield income from other endeavors. We conclude that this factor is neutral.

Whether Elements of Personal Pleasure or Recreation Are Involved We next examine whether elements of personal pleasure or recreation were involved in the gambling activity. The presence of recreational or pleasurable motives in conducting an activity may indicate that the taxpayer is not conducting the activity for profit. Sec. 1.183-2(b)(9), Income Tax Regs.; see Calvao v. Commissioner, T.C. Memo. 2007-57 (taxpayer’s gambling strategy and desire to win found consistent with gambling for entertainment or recreational purposes). That the taxpayer derives personal pleasure from engaging in the activity is insufficient to cause the activity to be classified as not engaged in for profit if other factors show that the activity is conducted for profit. Jackson v. Commissioner, supra; sec. 1.183-2(b)(9), Income Tax Regs.

We acknowledge that gambling at a casino is an activity commonly understood to be a pleasant amusement. Petitioner testified credibly, however, that she found no pleasure in gambling. It was work. Petitioner testified that she found gambling to be stressful, tiring, and time consuming. She further testified that she always went to the casino alone and that no friends or family members accompanied her to add any entertainment element to her activities. We find her testimony thoughtful and credible. On balance, we find this factor favors petitioner.

Conclusion

Taking into account the above factors and considering the facts and circumstances relating to petitioner’s gambling activity, we conclude that petitioner engaged in the gambling activity with the actual and honest objective of making a profit in 2003. As the parties have agreed that petitioner conducted the gambling activity with continuity and regularity, we conclude that petitioner was in the trade or business of gambling during 2003. Accordingly, petitioner may deduct her gambling expenses under section 162(a) to the extent allowable under section 165(d).

To reflect the foregoing, Decision will be entered for petitioner.


Footnotes:

(1) All section references are to the Internal Revenue Code in effect for the year at issue, unless otherwise indicated.

(2) Respondent concedes that petitioner is not liable for the accuracy-related penalty under sec. 6662(a)

(3) While sec. 165(a) generally permits the deduction of losses from gross income, there is a special rule limiting the deduction of gambling losses. Losses from wagering transactions may only be deducted to the extent of gains from wagering transactions. Sec. 165(d).


(4) At trial, we denied petitioner’s motion to shift the burden of proof under sec. 7491 because the outcome of this case is determined on the preponderance of the evidence, making it unnecessary to determine who has the burden of proof. See Topping v. Commissioner, T.C. Memo. 2007-92. The Court invited the parties to address this issue on brief. We have carefully reviewed the parties’ arguments on brief and stand by our ruling denying petitioner’s motion to shift the burden of proof to respondent. Instead, we shall determine the outcome of this case on the preponderance of the evidence. See id.

 

T.C. Memo. 2007-57
UNITED STATES TAX COURT
JOSE CALVAO, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7287-05. Filed March 8, 2007.
Timothy J. Burke, for petitioner.
Luanne S. Di Mauro, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HAINES, Judge: Respondent determined a deficiency in petitioner’s 2002 Federal income tax of $17,096 and an accuracy related penalty under section 6662(a) of $3,419.⁽¹⁾ The issues for decision are whether petitioner was in the trade or business of gambling during 2002, and whether petitioner is liable for an accuracy-related penalty under section 6662(a).

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time he filed his petition, petitioner resided in Tiverton, Rhode Island.

Prior to 1993, petitioner was an operations manager for a textile firm called Prim/Dritz Corporation. In 1993, petitioner started Caltex Corporation (Caltex), an S corporation. Caltex is a textile firm which sells embroidered T-shirts, caps, and other similar products. Sometime before 1999, Caltex hired petitioner’s brother with the goal that, once petitioner’s brother learned about the textile business, petitioner could reduce his involvement in Caltex. In 1999, petitioner’s brother took over the day-to-day operations of Caltex. During 2002, petitioner was the president and 100-percent owner of Caltex and worked at Caltex 20 to 25 hours per week providing “consulting services”. In 2002, petitioner received a salary of $42,000 and a distribution of income of $99,790 from Caltex.

During 2002, petitioner played the slot machines at several casinos throughout the United States.⁽²⁾ Petitioner spent most of his time at Foxwoods Resort and Casino in Connecticut, which was approximately 100 miles from his home. The casinos issued petitioner Forms W-2G, Certain Gambling Winnings, for 2002, reflecting gross winnings of $132,800. Prior to filing his 2002 Federal income tax return, petitioner prepared a summary of his gambling activity (the gambling summary). The gambling summary reflected that petitioner gambled on 24 separate occasions, won a total of $132,800, and lost a total of $180,300. Petitioner timely filed his 2002 Federal income tax return.⁽³⁾ Petitioner reported the following sources of income: (1) Wage income from Caltex of $42,000; (2) taxable interest of $7,676; (3) ordinary dividends of $3,176; (4) taxable State income tax refund of $3,224; and (5) income from rental real estate, S corporations, and trusts of $109,403.⁽⁴⁾ On an attached Schedule C, Profit or Loss From Business, petitioner reported that his principal business or profession was professional gambling. Petitioner reported gross receipts of $132,800, cost of goods sold of $180,300, and deducted $3,150 in travel expenses, for a net Schedule C loss of $50,650. After deducting the Schedule C loss and a net operating loss carryover of $1,106, petitioner reported total income of $113,723. Petitioner claimed itemized deductions of $14,077 and a personal exemption of $3,000, resulting in taxable income of $96,646 and total tax of $23,303. On March 21, 2005, respondent issued petitioner a notice of deficiency. Respondent determined petitioner was not engaged in the trade or business of gambling during 2002 and therefore could not deduct his gambling losses on Schedule C. Instead, respondent determined petitioner could deduct the gambling losses as an itemized deduction, but only to the extent of his gambling winnings.⁽⁵⁾ Based on the above, respondent determined the amount of tax required to be shown on petitioner’s 2002 return was $40,399, resulting in a deficiency of $17,096. Respondent also determined petitioner was liable for an accuracy-related penalty under section 6662(a) of $3,419.

In response to the notice of deficiency, petitioner filed his petition with this Court on April 18, 2005.

OPINION

I. Petitioner’s Gambling Activity

Respondent determined petitioner was not in the trade or business of gambling during 2002 and thus could not claim his gambling losses as a Schedule C deduction. Petitioner argues he was in the trade or business of gambling because he pursued the activity full time, in good faith, with regularity, and for the production of income.⁽⁶⁾ Section 162(a) allows deductions for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. If a taxpayer were engaged in the trade or business of gambling, losses would be deductible from gross income in arriving at the adjusted gross income. See sec. 62. However, if the taxpayer were not in the trade or business of gambling, his losses would be deductible as an itemized deduction in arriving at taxable income. See sec. 63(a). Regardless of whether the gambling activity constituted a trade or business, section 165(d) provides: “Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” See also sec. 1.165-10, Income Tax Regs. Although petitioner deducted gambling losses exceeding his gambling winnings by $50,650, petitioner does not dispute that section 165(d) limits his gambling loss deduction to the amount of his gambling winnings.

To be engaged in a trade or business within the meaning of section 162(a), an individual taxpayer must be involved in the activity with continuity, regularity, and with the primary purpose of deriving income and profit. Commissioner v.Groetzinger, 480 U.S. 23, 35 (1987). Whether the taxpayer is carrying on a trade or business requires an examination of all the facts in each case. Id. at 36; Higgins v. Commissioner, 312 U.S. 212, 217 (1941).

In Groetzinger, the Supreme Court addressed the issue of whether a taxpayer’s gambling activity was a trade or business within the meaning of section 162(a). The taxpayer devoted 60 to 80 hours each week for 48 weeks to parimutuel wagering, primarily on greyhound races. Commissioner v. Groetzinger, supra at 24. The taxpayer gambled at racetracks 6 days a week and spent a substantial amount of time studying racing forms, programs, and other materials. Id. While the taxpayer received $6,498 in income from other sources during the year, the taxpayer had no other profession or type of employment during the 48 weeks he devoted to gambling. Id. at 24-25. The Supreme Court stated:

to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and * * * the taxpayer’s primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement diversion does not qualify. * * *

 * * * * * * *

we conclude that if one’s gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business within the meaning of the statutes with which we are here concerned. * * *

Id. at 35-36. The Supreme Court affirmed the judgment of the Court of Appeals for the Seventh Circuit, finding the taxpayer was engaged in the trade or business of gambling. Id. at 36.

Petitioner argues the facts of Groetzinger are similar to the facts of this case, and, like the Supreme Court in Groetzinger, we should find petitioner was engaged in the trade or business of gambling. After carefully considering the facts in this case, we disagree.

Petitioner argues, like the taxpayer in Groetzinger, he spent a substantial amount of time preparing for his trips to the casino and developed a strategy for his gambling:

In 2002, the petitioner went to the casino with a plan.The petitioner would first talk to the casino hosts to find out which areas of the casino were heavily played and what slot machines were/were not hitting. Based upon the information, the petitioner then determined what slot machines he was going to play and how much money he would need.

In 2002, the petitioner set a limit for his losses each day that he went to the casino. The petitioner also set a limit on his games/winnings such that he left the casino once he made a twenty (20%) percent return on his money.

Petitioner also argues that he bought a slot machine, spent a significant amount of time studying how the “chips” and cycles of slot machines worked, subscribed to a gambling magazine, and read “probably about 20” books on playing the slot machines. Petitioner’s efforts and strategy are consistent with the desire to win money playing the slot machines. However, we find petitioner’s desire to win money and his strategy for doing so is also consistent with gambling purely for its entertainment or recreational aspects. The time petitioner spent and the strategy he developed, by themselves, do not establish petitioner was engaged in the trade or business of gambling. Petitioner testified he maintained daily records of his gambling activity and argues on brief his record keeping is indicative of a trade or business. Petitioner did not provide respondent with these records, nor did he introduce the records into evidence. Given the lack of evidence, we do not find that petitioner maintained daily records of his gambling activity.

Petitioner argues that he spent “approximately 2,206.5 hours” gambling at various casinos, “where he focused primarily on slot machines such as the ‘Double Diamond’”, and that the amount of time devoted to his gambling activity is indicative of a trade or business. Petitioner relies on a schedule of gambling wins and losses to establish the hours spent gambling. The schedule of gambling wins and losses reflects petitioner’s attempt to reconstruct the dates he gambled, the amount of money won or lost, and the amount of time spent gambling each day. However, the schedule was not provided to respondent until January 4, 2006, and there is no evidence in the record indicating when the schedule was prepared. This evidence was not contemporaneously maintained, and it is inaccurate and unreliable.⁽⁷⁾ Petitioner did not provide his purported daily records, nor did he provide other evidence corroborating the amount of time he devoted to gambling during 2002. Given the lack of reliable evidence, we cannot determine how much time petitioner devoted to gambling during 2002. Unlike the taxpayer in Groetzinger, petitioner spent approximately 20 to 25 hours per week working for Caltex.

Additionally, petitioner’s livelihood did not depend on playing the slot machines. His primary income came from his salary of $42,000 and the passthrough of income of $99,790 from Caltex, of which he was president and 100-percent owner during 2002. By themselves, these facts do not preclude petitioner from being engaged in the trade or business of gambling. However, such factors were considered by the Supreme Court in Groetzinger and are relevant to our determination. See Commissioner v. Groetzinger, 480 U.S. at 24-25, 35-36. We find that these facts weigh against petitioner’s being engaged in the trade or business of gambling. See Jones v. Commissioner, T.C. Memo. 1988-393. Taking into consideration all of the above, we find petitioner was not engaged in the trade or business of gambling in 2002. Therefore, petitioner is not entitled to report his gambling activity on Schedule C. Instead, petitioner must claim his gambling losses as an itemized deduction on Schedule A, as determined by respondent. We sustain respondent’s determination that the amount of tax required to be shown on petitioner’s 2002 Federal income tax return was $40,399, resulting in a deficiency of $17,096.

II. Accuracy-Related Penalty Under Section 6662(a)

Respondent determined petitioner is liable for an accuracy related penalty under section 6662(a) for 2002 of $3,419. Petitioner argues he is not liable for an accuracy-related penalty because he reasonably relied upon the advice of his accountant. Section 6662(a) imposes a penalty in the amount of 20 percent of the portion of the underpayment to which section 6662 applies. As relevant to this case, the penalty applies to any portion of the underpayment that is attributable to any substantial understatement of income tax. Sec. 6662(b)(2).

There is a “substantial understatement of income tax” if the amount of the understatement exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. Sec.6662(d)(1).

The Commissioner bears the burden of production with respect to penalties. Sec. 7491©; Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). Once the burden of production is met, the taxpayer must come forward with evidence sufficient to show that the penalty does not apply. Higbee v. Commissioner, supra at 447.

The tax required to be shown on petitioner’s tax return was $40,399. Ten percent of that amount is less than $5,000. Thus, petitioner’s understatement is substantial if it exceeds $5,000. Petitioner reported an income tax liability of $23,303, resulting in an understatement of $17,096. Respondent has satisfied his burden of production by showing that petitioner’s understatement of tax was substantial.

The accuracy-related penalty is not imposed, however, with respect to any portion of the understatement if the taxpayer can establish he acted with reasonable cause and in good faith. Sec. 6664(c)(1). Reliance upon the advice of a professional may demonstrate a taxpayer acted with reasonable cause and in good faith. Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 98-99 (2000), affd. 299 F.2d 221 (3d Cir. 2002); Freytag v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991); see sec. 1.6664-4©(1), Income Tax Regs. However, a taxpayer’s reliance upon the advice of a professional does not automatically constitute reasonable cause. Neonatology Associates v. Commissioner, supra at 98-99; see sec. 1.6664-4©(1), Income Tax Regs. For a taxpayer to reasonably rely on the advice of a professional, the taxpayer must show: (1) The adviser was a competent professional who had sufficient expertise to justify reliance; (2) the taxpayer provided necessary and accurate information to the adviser; and (3) the taxpayer actually relied in good faith on the adviser’s judgment. Neonatology Associates v. Commissioner, supra at 98-99.

Petitioner testified he relied on his accountant, Mr. Beauregard, to prepare his return, and Mr. Beauregard had prepared his returns since 1993 without incident. However, petitioner did not call Mr. Beauregard as a witness, nor did he introduce evidence which would establish that Mr. Beauregard possessed the requisite expertise.⁽⁸⁾ Because petitioner has not established that Mr. Beauregard was a competent professional who had sufficient expertise to justify reliance, petitioner has not shown that he acted with reasonable cause and in good faith. See sec. 6664(c)(1); Neonatology Associates v. Commissioner, supra at 98-99. Therefore, we find petitioner is liable for an accuracy related penalty under section 6662(a) of $3,419.

III. Conclusion

Petitioner was not engaged in the trade or business of gambling in 2002. For all of the foregoing reasons, we hold petitioner is liable for a deficiency in his 2002 Federal income tax of $17,096 and an accuracy-related penalty under section 6662(a) of $3,419.

In reaching our holdings, we have considered all arguments made, and, to the extent not mentioned, we conclude that they are moot, irrelevant, or without merit.

To reflect the foregoing, Decision will be entered for respondent.

Footnotes:

(1) Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended. All amounts are rounded to the nearest dollar.

(2) Petitioner occasionally played Carribean stud poker, but the slot machine was his preferred game.

(3) Petitioner’s return was prepared by Norman R. Beauregard (Mr. Beauregard), who identified himself on the return as a certified public accountant. There is nothing else in the record regarding Mr. Beauregard’s experience or qualifications.

(4) The income from rental real estate, S corporations, and trusts included a total rental real estate loss of $6,047, a passthrough of income from Caltex of $99,790, and trust income of $15,660.

(5) Respondent also disallowed the claimed personal exemption deduction because petitioner’s adjusted gross income exceeded the allowable amount for such a deduction. Petitioner does not dispute this determination.

(6) The resolution of this issue does not impact the amount of the allowable gambling loss deduction. See sec. 165(d). However, the resolution of this issue does impact the amount of the deficiency. If the gambling loss deduction were shifted from Schedule C to Schedule A, Itemized Deductions, it would increase petitioner’s adjusted gross income, thus limiting under sec. 68 the extent to which itemized deductions other than the gambling loss are allowable.

(7) For example, the schedule of gambling wins and losses indicates petitioner spent 18 days gambling during March 2002, during which he won $9,700 and lost $27,900. However, the gambling summary prepared by petitioner for use in filing his 2002 return indicates petitioner gambled on only 2 days during March 2002, during which time he won $9,700 but lost $31,300. Additionally, the Forms W-2G issued to petitioner for payouts made during March 2002 indicate petitioner won only $8,100. Similar discrepancies appear in other months.

(8) Petitioner did not begin his gambling activity until 2002, and his underpayment of tax arose from claimed deductions for that activity. Mr. Beauregard’s preparation of petitioner’s returns for 1993-2001 does not establish that Mr. Beauregard had sufficient expertise regarding the tax treatment of petitioner’s gambling activity. In fact, despite the clear requirement of sec. 165(d) that gambling losses may be claimed only to the extent of gambling winnings, petitioner claimed gambling losses that exceeded his gambling winnings by $50,650. In addition, the gambling losses were claimed as costs of goods sold. At the least, this calls into question Mr. Beauregard’s expertise.

 

T.C. Memo. 2007-38 UNITED STATES TAX COURT
GEORGE E. AND GLORIA TSCHETSCHOT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9498-03. Filed February 20, 2007.

R disallowed losses in excess of Ps’ winnings from gambling and determined both a deficiency and a penalty for substantial understatement for 2000. After conceding that H’s net gambling losses were not properly deductible, Ps argued that, as a professional tournament poker player, W’s net losses should be treated the same as those of any other professional sport participants. Held: W’s net gambling losses are not exempt from the limitations of sec. 165(d), I.R.C. Held, further: We leave for the parties to determine as part of their computations under Rule 155,Tax Court Rules of Practice and Procedure, whether there was a substantial understatement for the taxable year in issue; if so, Ps are liable for the accuracy-related penalty.

Gloria Tschetschot, pro se. J. Anthony Hoefer, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

ARMEN, Special Trial Judge: Respondent determined a deficiency in petitioners’ Federal income tax for the taxable year 2000 of $10,071, as well as an accuracy-related penalty for a substantial understatement of income tax of $2,014. The grounds for the deficiency were the limitations of section 165(d)as applied to Gloria Tschetschot’s (Mrs. Tschetschot) professional tournament poker playing and George E. Tschetschot’s (Mr. Tschetschot) status as a nonprofessional gambler.⁽¹⁾  At trial, petitioners conceded that Mr. Tschetschot was not a professional gambler but argued that Mrs. Tschetschot’s professional tournament poker playing is not gambling and thus not subject to the limitations of section 165(d) on losses from gambling. Respondent conceded that Mrs. Tschetschot’s business expenses related to her professional gambling activity were deductible [ed. note: against other current-year income only⁽⁷⁾]. Thus, the two issues for decision are: (1) Whether Mrs. Tschetschot’s tournament poker losses are limited by section165(d) to the amount of her tournament poker winnings, and (2) whether a penalty under section 6662(a) for a substantial understatement of income tax is appropriate.


FINDINGS OF FACT At the time the petition was filed, petitioners resided in Cedar Rapids, Iowa.

Mrs. Tschetschot is a database project engineer. She was also a professional tournament poker player in 2000. ⁽²⁾ Mr.Tschetschot is not a professional gambler but occasionally plays slot machines and blackjack while accompanying his wife on her poker tournament trips.

Tournament poker is somewhat different from “live-action”poker. A poker tournament consists of a series of individual events hosted by a casino, and it can last anywhere from several days to 2 weeks. Unlike live-action poker, tournament participants cannot exit the game by cashing out partway through the tournament; tournaments are played until there is one player left with all of the chips.

All tournaments have a “buy-in”, or entrance fee, that is paid by the tournament participants to the tournament organizer. A portion of this amount is an administrative fee kept by the casino hosting the event, and the remainder goes directly into the prize fund “pot” that will ultimately be paid out to the .tournament’s winners. No portion of the administration fee is included in the prize fund, and the entire prize fund is dispersed to winning participants. The buy-in may or may not correlate dollar-for-dollar with the amount of chips received at the start of the tournament, and the chips themselves have no intrinsic monetary value. Although “re-buys” are sometimes allowed, tournament play contemplates that each player has only a fixed number of chips and that each player begins the tournament with the same number of chips. When a player runs out of chips, he or she is out of the game. Cash prizes are awarded to a predetermined number of finishing places in the tournament. Because of the buy-in system, the only monetary loss a tournament participant may incur will be the amount of the buy-ins and any re-buys the participant might make; no participant will be able to bet--or subsequently lose--any greater amount. Similar to live-action poker, however, a player’s tournament success depends on a combination of both luck and skill. ⁽³⁾ A player might have a decent hand, but as Kenny Rogers tells us in “The Gambler”, he or she would still have to “know when to hold ‘em, know when to fold‘em, know when to walk away and know when to run” to actually be a success.

For 2000, the taxable year in issue, Mrs. Tschetschot earned approximately $49,000 in wages. She also participated in nine poker tournament series, winning in excess of $11,000. ⁽⁴⁾

Mrs. Tschetschot claimed a net loss of $29,933 from her "professional gambler” activity in 2000 on her Schedule C, Profit or Loss From Business. Mr. Tschetschot claimed a net loss of $9,000 from his “professional gambler” activity in 2000 on his Schedule C.

Respondent determined a deficiency of $10,071 based on the view that the deductions claimed by petitioners related to their gambling activities were not appropriately Schedule C deductions, but rather deductions allowable on Schedule A, Itemized Deductions, but only to the extent of petitioners’ winnings. Respondent also determined an accuracy-related penalty under section 6662(a) of $2,014.

At trial, petitioners conceded the issue as to Mr.Tschetschot but disputed the determination as to Mrs.Tschetschot. Respondent conceded Mrs. Tschetschot’s status as a professional, as well as the corresponding treatment of certain expenses related to her professional gambling activity.

Respondent maintains that section 165(d) limits Mrs. Tschetschot’s losses and that petitioners remain liable for an accuracy-related penalty. Petitioners contend that Mrs. Tschetschot’s professional tournament poker playing activity is more properly classified as “entertainment and professional sports” than professional gambling and should bear the resulting tax treatment; i.e., that her net loss should not be limited by section 165(d) restricting losses from wagering activities. Petitioners also contend that they do not meet the threshold amount for the imposition of an accuracy-related penalty based on a substantial understatement of income tax.

OPINION.

Tournament Poker ⁽⁵⁾

Central to petitioners’ contention is the thesis that tournament poker, unlike other types of poker, is not a wagering activity.

The term “wagering” has different meanings depending on the context in which the term is used. More often than not, and as it is used in the Internal Revenue Code, the term is synonymous with “gambling”. ⁽⁶⁾

Congress has made a policy decision such that, while section165 generally allows losses to be deducted from gross income, “[l]osses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” ⁽⁷⁾ Sec. 165(d); see also sec. 165(a). However, neither the Internal Revenue Code nor the regulations define what constitutes a wagering activity.

When a term is not defined, we must apply the term’s “plain,obvious, and rational meaning.” Liddle v. Commissioner, 103 T.C.285, 293 n.4 (1994), affd. 65 F.3d 329 (3d Cir. 1995); see also Boyd v. United States, 762 F.2d 1369, 1373 (9th Cir. 1985). According to the dictionary, a “wager” is defined as “something risked or staked on an uncertain event” or “a bet”. Random House College Dictionary (1968). Similarly, “to wager” is defined as: (1) Something risked or staked on an uncertain event; bet; (2) the act of betting. Random House College Dictionary (1973). Courts have often had to differentiate between wagering and related activities on the one hand and those activities not falling into that category on the other. See, e.g., Allen v. U.S. Govt. Dept. of Treas., 976 F.2d 975 (5th Cir.1992) (“tokes” paid as tips to casino dealers are not gains from wagering transactions); Offutt v. Commissioner, 16 T.C. 1214(1951) (betting on horse races is wagering); Libutti v. Commissioner, T.C. Memo. 1996-108 (gambler’s receipt of complimentary goods from a casino was sufficiently tied to gambling participation that they were gains from wagering transactions); Whitten v. Commissioner, T.C. Memo. 1995-508(expenses incurred to be a contestant on Wheel of Fortune were not wagering expenses); Heide v. Commissioner, 2 B.T.A. 451(1925) (playing bridge for stakes is wagering). However, courts have routinely held that poker is a wagering activity. See, e.g., Boyd v. United States, supra. But here, petitioners ask us to treat tournament poker differently than other kinds of poker.

After a careful review of the record, it is clear that while there are differences between tournament poker and other types of poker, ⁽⁸⁾ none rise to the level of meaningful, substantive differences that would warrant different tax treatment under the current Internal Revenue Code.

A. Tournament Poker as a Sporting Event

Petitioners argue that tournament poker is conducted in much the same way as other professional sporting tournaments. Participants pay an entry fee and compete to win prizes through their good fortune and superior skill. But simply because a sport or activity is played or conducted in a tournament setting does not transform the underlying activity into something different. ⁽⁹⁾

Tournament poker play, much like live-action poker, necessitates the use of the word “bet” or “wager” even to describe how the game is played. Petitioners argue that the usage of the word “bet” in this context is insignificant. The Court sees it differently.

Betting is so intrinsic to poker that it is nearly impossible to avoid using a word that implies gambling in any way when discussing the topic. Bets are placed on each hand, and each round of betting has consequences. Whether or not the chips being used to make these bets have immediate and tangible monetary value does not change the fact that the players are still placing bets, hoping to win. This is true even in a tournament setting.

Petitioners agree that the first poker tournaments held were, in fact, “wagering events”. For example, in those early games, “Each participant put up $10,000 and received $10,000 in chips.” The fact that the chips being used to place bets in tournament poker today only bear some fractional relationship to the dollar values of the prizes and/or entry fees does not change the basic nature of the game as a wagering activity.

B. Professional Tournament Poker as a Business

Petitioners also raise an equal protection argument and argue that there is no valid reason to treat tournament poker differently, for tax purposes, from tournament golf or tennis. Petitioners argue that the benefits of being able to offset "exaggerated income” from very successful years by losses sustained in less successful years should be available to professional tournament poker players as much as they are to other professions.

Congress made a policy decision to treat businesses based on wagering activities differently. In the absence of Congressional action, we are not free to correct any perceived unfairness stemming from a rationally based policy choice. In Valenti v. Commissioner, T.C. Memo. 1994-483, the Court noted that treating businesses based on wagering and gambling differently from other businesses is a rational differentiation and not one that rises to the level of being violative of due process or equal protection. See also Steward Mach. Co. v. Davis, 301 U.S. 548,584 (1937) (holding that Congress, like the states, has the freedom to tax businesses differently). Thus, it has been held:

[A] classification that differentiates the business of gambling from other business has “a rational basis, and when subjected to judicial scrutiny, it must be presumed to rest on that basis if there is any conceivable state of facts which would support it.” * * *

Valenti v. Commissioner, supra (quoting Carmichael v. Southern Coal Co., 301 U.S. 495 (1937)).

II. Substantial Understatement of Tax

With respect to a taxpayer’s liability for any penalty, section 7491(c) places on the Commissioner the burden of production, thereby requiring the Commissioner to come forward with sufficient evidence indicating that it is appropriate to impose the penalty. See Higbee v. Commissioner, 116 T.C. 438,446-447 (2001). Once the Commissioner meets his burden of production, the taxpayer must come forward with persuasive evidence that the Commissioner’s determination is incorrect. See id. at 447; see also Rule 142(a); Welch v. Helvering, 290 U.S.111, 115 (1933).

Section 6662(a) imposes a penalty equal to 20 percent of the amount of any underpayment attributable to a substantial understatement of income tax. Sec. 6662(b)(2). An understatement is the amount by which the correct tax exceeds the tax reported on the return. Sec. 6662(d). The understatement is substantial if it exceeds the greater of $5,000 or 10 percent of the tax required to be shown on the return. Sec.6662(d)(1)(A)(i) and (ii).

Section 6664(c)(1) provides that no penalty shall be imposed if the taxpayer demonstrates that there was reasonable cause for the underpayment and the taxpayer acted in good faith. The determination of whether a taxpayer acted with reasonable cause and in good faith depends on the facts and circumstances of the situation and includes an “honest misunderstanding of fact or law”. Sec. 1.6664-4(b)(1)(c), Income Tax Regs. Insofar as Mr.Tschetschot is concerned, petitioners have not demonstrated either good faith or that there was reasonable cause for their position. As to Mrs. Tschetschot, petitioners were clearly aware of the mandate of section 165(d); their wish that it be inapplicable to tournament poker does not constitute the type of misunderstanding contemplated by the statutes or the regulations.

An understatement is reduced by the portion of the understatement that is attributable to the tax treatment of an item for which there is substantial authority or with respect to which there is adequate disclosure and a reasonable basis. See sec. 6662(d)(2)(B); sec. 1.6662-4(a), Income Tax Regs. However, no substantial authority exists to support petitioners’ position as to either the inapplicability of section 165(d) to tournament poker or Mr. Tschetschot’s status as a professional gambler. Substantial “authority [exists] for the tax treatment of an item only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment.” Sec. 1.6662-4(d)(3)(i), Income Tax Regs. Types of authority on which a taxpayer may rely include the Internal Revenue Code and regulations, revenue rulings and procedures, technical advice memoranda, and private letter rulings. See sec. 1.6662-4(d)(3)(iii), Income Tax Regs. Additionally, whether or not there was adequate disclosure, there is no reasonable basis to support petitioners’ position on tournament poker given the clear mandate of section 165(d) and the existing case law interpreting it. Accordingly, we are not permitted to make a reduction in the understatement attributable to respondent’s determination on that issue.

In view of respondent’s concession that Mrs. Tschetschot’s expenses are deductible, it is unclear whether there exists a substantial understatement of income tax. We therefore leave for the parties to determine as part of the Rule 155 computation whether there was, in fact, a substantial understatement for the taxable year in issue. If a substantial understatement exists for the year in issue, petitioners are liable for the accuracy-related penalty.

III. Conclusion

The moral climate surrounding gambling has changed since the tax provisions concerning wagering were enacted many years ago. Not only has tournament poker become a nationally televised event, but casinos or lotteries can be found in many States. Further, the ability for the Internal Revenue Service to accurately track money being lost and won has improved, and some of the substantiation concerns, particularly for professionals, no longer exist. That said, the Tax Court is not free to rewrite the Internal Revenue Code and regulations. We are bound by the law as it currently exists, and we are without the ability to speculate on what it should be. Accordingly, we hold that tournament poker is a wagering activity subject to the limitations of section 165(d).

To reflect the foregoing, Decision will be entered under Rule 155.


Footnotes:

(1) Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.

(2) Respondent stipulated this fact for purposes of this case only. There are no substantiation issues in this case.

(3) A court in England recently had the opportunity to decide whether Texas Hold ‘Em was a game of chance or a game of skill, and the jury decided on the former. See http://news.bbc.co.uk/1/hi/england/london/6267603.stm

(4) The amount of Mrs. Tschetschot’s stipulated winnings totals $13,269, whereas she reported only $11,708. Respondent discusses this discrepancy in his post trial brief by saying that "Respondent did not adjust this discrepancy because the unreported winnings would have been offset by allowance of losses that were disallowed.”

(5) The issue related to tournament poker is essentially legal in nature; accordingly, we decide it without regard to the burden of proof.

(6) The legislative history of sec. 23(g) of the Revenue Act of 1934, ch. 277, tit. I, 48 Stat. 680, 689 re-designated sec. 23(h) by the Revenue Act of 1938, ch. 289, 52Stat. 461 and then continued as such in the 1939 Code until enacted as sec. 165(d) in the 1954 Code) uses the terms "wagering” and “gambling” interchangeably.

(7) Sec. 165(d) applies to both professional and recreational gamblers. See, e.g., Boyd v. United States, 762 F.2d 1369 (9thCir. 1985); Offutt v. Commissioner, 16 T.C. 1214 (1951); Heidelberg v. Commissioner, T.C. Memo. 1977-133. One of the consequences to professional gamblers is that the loss carryover provisions of sec. 172 are unavailable for amounts attributable to wagering activity. That is not an issue in this case as Mrs.Tschetschot had other income to absorb her expenses properly deductible as a professional. One of the consequences to nonprofessionals is that they may only deduct gambling losses if they itemize deductions on their tax returns. Sec. 62(a); see also Heidelberg v. Commissioner, supra.

(8) The most significant difference is that unlike playing in a live-action poker game, when one buys into a tournament game, each player receives the same fixed amount of chips. The game is played, and when a player runs out of chips, the player is out of the tournament. The playing continues until one player has all of the chips. It may take a different skill set to play tournament poker because no endless stream of funds is available, and endurance is a crucial factor to a participant’s success.

(9) Similarly, a casino’s decision to issue a Form W2-G,Certain Gambling Winnings, or a Form 1099-Misc., Miscellaneous Income, does not affect the nature of the winnings for tax purposes.

 

NO. CV 04 4001070S : PETER B. STONE : v. CONNECTICUT COMMISSIONER OF REVENUE SERVICES
FEBRUARY 7, 2007

MEMORANDUM OF DECISION

The plaintiff, Peter B. Stone (Stone), brings this appeal contesting the decision of the commissioner of revenue services (commissioner) disallowing the plaintiff’s deduction of gambling losses against gambling winnings and the imposition of additional income tax assessments against the plaintiff for the calendar years 1998 and 1999 (hereinafter the taxable years).

During the taxable years, the plaintiff resided in New Milford, Connecticut and was a full-time salaried employee of Xerox Corporation until his retirement in October 1999. The plaintiff also was a sole proprietor of Peter Stone Canvas, a part-time seasonal business which manufactured, repaired and installed canvas products. The plaintiff further owned and managed commercial income-producing real estate.

The plaintiff claims to be a professional gambler, a person who is in the trade or business of gambling, and indicated so when he filed Schedule C1⁽¹⁾ of his 1998 and 1999 federal income tax return forms 1040. See Plaintiff’s Exhibits 1 and 3.

During the taxable year 1998, the plaintiff played slot machines at various casinos for a total of 43 days and was issued forms W-2G⁽²⁾ by casinos reporting slot machine winnings. On Schedule C of his 1998 federal return, the plaintiff reported gambling gross receipts of $44,464 and expenses of $44,464 resulting in $0 net profit. See Plaintiff’s Exhibit 1.

During the taxable year 1999, the plaintiff played slot machines at various casinos for a total of 22 days and was issued forms W-2G.⁽³⁾ On Schedule C for his 1999 federal return, the plaintiff reported gambling gross receipts of $120,170 and expenses of $120,170 resulting in $0 net profit. See Plaintiff’s Exhibit 3.

On his Connecticut state income tax return, form CT-1040, Stone reported both his federal adjusted gross income and Connecticut adjusted gross income for 1998 as $83,748.⁽⁴⁾ See Plaintiff’s Exhibit 2. For 1999, Stone reported his federal adjusted gross income and Connecticut adjusted gross income as $27,888 on form CT-1040. See Plaintiff’s Exhibit 4.

The plaintiff testified that he gambled regularly on slot machines at various New Jersey and Connecticut casinos where he typically placed five to ten bets per minute on $5 slot machines. The plaintiff’s friend Kathryn Ruzek (Ruzek) accompanied Stone on all of his gambling trips and kept detailed records of his gambling activities on post-it notes. Ruzek recorded the dates and hours of Stone’s attendance at the various casinos and the specific slot machines he played, the amount of money he spent, including all checks and ATM withdrawals made, and the amount of jackpots. Following each gambling trip, Ruzak placed the post-it notes in a manila envelope. During the tax filing season, Ruzak entered the information written on the post-it notes⁽⁵⁾, forms W-2G, credit card records and checks into a computer spreadsheet. The plaintiff’s accountant then used the spreadsheet to prepare the plaintiff’s federal and state income tax return forms.

The plaintiff testified that he read gambling instructional materials and periodicals to study slot machines, especially the payouts from different types of slot machines. During the taxable years, the plaintiff was rated in the top 1-2% of gambling patrons by New Jersey and Connecticut casinos. According to the plaintiff, the casinos rate players based upon the total amount of money gambled and treat rated players with “respect” by providing them with privileges such as access to lounge areas, food and parking. In 4 addition, the plaintiff was invited to play in slot machine casino tournaments during the taxable years.

“Income derived from wagering transactions is includible in gross income under the provisions of section 61 of the Internal Revenue Code.” Rev. Proc. 77-29, 1977-2 CB 538. Section 165 (d) of the Internal Revenue Code provides that “[l]osses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” 26 U.S.C. 165 (d).

On the federal level, gambling winnings and losses are reported on form 1040 in one of two ways. If the taxpayer is engaged in the business of gambling, the taxpayer files Schedule C to form 1040 and reports the business income or loss from gambling on line 12 of form 1040. If the taxpayer is not a professional gambler, the taxpayer reports gambling winnings on line 21 of form 1040 and files Schedule A to form 1040 in order to itemize deductions attributable to gambling losses to the extent of gambling winnings.

It is the commissioner’s position that the plaintiff (1) was not a professional gambler during the taxable years, (2) was not eligible to file Schedule C to form 1040 and to report zero income on line 12 of form 1040 and (3) owes additional income tax on the plaintiff’s gambling winnings.

As an example, the plaintiff reported on his 1998 federal form 1040 that he was a professional gambler and that his adjusted gross income was $83,748. See Plaintiff’s Exhibit 1. If the plaintiff was not a professional gambler during the taxable year 1998 and therefore, not eligible to file Schedule C, he would have reported his gambling winnings in the amount of $44,464 on line 21 of his 1998 federal form 1040 and increase his adjusted gross income to $128, 212.

In contrast to the federal level, non-professional gamblers filing their Connecticut state income tax returns must report all winnings as gross income. Connecticut income tax liability starts with a taxpayer’s “properly reported” federal adjusted gross income. General Statutes § 12-701 (a) (19) provides, in relevant part, as follows: “‘Adjusted gross income’ means the adjusted gross income of a natural person with respect to any taxable year, as determined for federal income tax purposes and as properly reported on such person’s federal income tax return.” (Emphasis added.)

Taking the federal adjusted gross income, §12-701 (a) (20) allows taxpayers to modify their Connecticut adjusted gross income with a list of additions and subtractions. Unless taxpayers filing Connecticut income tax returns have a trade or business from which to deduct business expenses, ordinary gambling losses cannot be deducted from a taxpayer’s Connecticut adjusted gross income, unless specifically allowed by statute. This is so “[b]ecause deductions and exemptions from otherwise taxable income are matters of legislative grace . . . .” D. A. Pincus & Co. v. Meehan, 235 Conn. 865, 873, 670 A.2d 1278 (1996).

Having outlined the factual background and statutory context, the issue in this case is whether the plaintiff’s gambling activities during the taxable years constituted a trade or business that would have permitted the plaintiff to file a Schedule C to his federal return and deduct his gambling losses to the extent of his gambling winnings. The resolution of this issue is fact-oriented. See Commissioner v. Groetzinger, 480 U.S. 23, 35-36, 107 S. Ct. 980, 94 L. Ed. 2d 25 (1987) (60-80 hours per week, 48 weeks per year devoted to parimutuel wagering on dog races constitutes professional gambling). See also Pacific Indemnity Ins. Co. v. Aetna Casualty & Surety Co., 240 Conn. 26, 31, 688 A.2d 319 (1997) (“business pursuits means a continued or regular activity that is conducted for the purpose of profit, such as a trade, profession or occupation”).

In Groetzinger, the court determined that the term “trade or business” was difficult to define under the Internal Revenue Code. The court further stated that “the difficulty rests in the Code’s wide utilization in various contexts of the term ‘trade or business,’ in the absence of an all-purpose definition by statute or regulation, and in our concern that an attempt judicially to formulate and impose a test for all situations would be counter productive, unhelpful, and even somewhat precarious for the overall integrity of the Code.” Groetzinger, 480 U.S. 36. Recognizing that cases of this nature should be decided on the facts, the Groetzinger court considered the following factors in its analysis of whether the taxpayer’s gambling activities rose to the level of a trade or business: “if one’s gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business within the meaning of the statutes with which we are here concerned.” Id., 35. The commissioner has adopted the Groetzinger factors for the purpose of determining whether a person is a professional gambler.

The facts in the present case are not as clear as those in Groetzinger because the plaintiff Stone was employed full-time by Xerox Corporation until October 1, 1999, conducted a part-time seasonal canvas products business, owned income-producing real estate and spent 43 days in 1998 and 22 days in 1999 casino slot machines gambling.

The commissioner argues that the plaintiff must be engaged in gambling full-time and pursue gambling to produce income for a livelihood in order for the plaintiff to be engaged in gambling as a trade or business. However, in Connecticut, it is not necessary that a business activity be the principal occupation rather than a part-time or supplemental activity. See Pacific Indemnity Ins. Co. v. Aetna Casualty & Surety Co., 240 Conn. 32.

The court is mindful that the Groetzinger court recognized that the term “trade or business” is difficult to define. The lesson learned from Groetzinger is that no formulae or test can be developed that can be applied universally to all cases. In fact, the Groetzinger court stated that “the Code has never contained a definition of the words ‘trade or business’ for general application, and no regulation has been issued expounding its meaning for all purposes. Neither has a broadly applicable authoritative judicial definition emerged. . . .” Groetzinger, 480 U.S. 27.

The Treasury Regulations (regulations), in effect pursuant to §183 of the Internal Revenue Code, provide that “[t]he determination whether an activity is engaged in for profit is to be made by reference to objective standards, taking into account all of the facts and circumstances of each case. Although a reasonable expectation of profit is not required, the facts and circumstances must indicate that the taxpayer entered into the activity, or continued the activity, with the objective of making a profit. . . . In determining whether an activity is engaged in for profit, greater weight is given to objective facts than to the taxpayer’s mere statement of his intent.” Treas. Reg. § 1.183-2 (a).⁽⁶⁾

The facts and circumstances in the present case indicate that the taxpayer was engaged in gambling activity with the objective of making a profit. The plaintiff testified that he believed he was pursuing an income goal for a livelihood and kept track of his wagering for this purpose.

With regard to what factors contribute to whether a taxpayer engages in an activity for profit, the regulations under § 183 provide nine factors to consider: “

• (1) the extent to which the taxpayer carries out the activity in a businesslike manner;

• (2) the expertise of the taxpayer or his advisors;

• (3) the time and effort expended by the taxpayer in carrying on the activity;

• (4) the expectation that assets used in the activity may appreciate in value;

• (5) the success of the taxpayer in other similar or dissimilar activities;

• (6) the taxpayer’s history of income or losses attributable to the activity;

• (7) the amount of occasional profits, if any, which are earned;

• (8) the taxpayer’s financial status; and

• (9) any elements of personal pleasure or recreation in the activity. Treas. Reg. § 1.183-2 (b) (1)-(9). ”Westbrook v. Commissioner, 68 F.3d 868, 876 (1995).

In consideration of the second factor listed in the regulations, the plaintiff argues that skill is involved in order to successfully play casino slot machines. The commissioner produced as an expert witness, Professor Robert Hannum (Professor Hannum), a full professor of statistics at the University of Denver with a special interest in the mathematics of gambling. Professor Hannum testified that the playing of slot machines requires no skill since skill requires an exercise of judgment that affects the outcome of the play. As discussed above, the plaintiff studied gambling techniques and slot machines; however, playing slot machines is squarely a game of chance without the player affecting his success each time the slot machine is engaged.

Professor Hannum discussed how there is a house advantage in playing casino slot machines and that there is a mathematical advantage programmed into the slot machines by the casino operators. According to Professor Hannum, a 92% payback to the player is average; therefore, a slot machine player can expect to lose approximately $8 out of every $100 played. Professor Hannum also noted that a player can be a winner at slot machines over a shot period of time, but in the long-term, a player will lose. In Professor Hannum’s opinion, a slot machine player cannot be a professional gambler because he or she would not have the expectation of making a profit. Under Professor Hannum’s theory, a slot machine player can never have a profit motive.

The plaintiff contends that he had a profit motive because he exhibited an expectation of winning at slot machines in the taxable years 1998 and 1999. In those years, the plaintiff reported slot machine winnings of $44,464 and $120,174, respectively. However, Professor Hannum’s opinion, that a slot machine player cannot win over the long-term, is supported by the plaintiff’s tax returns for 1998 and 1999. In those taxable years, the plaintiff had gambling losses equal to or greater than his gambling winnings.

During the taxable year 1998, the plaintiff had $83,748 listed as federal adjusted gross income on his federal and Connecticut income tax return forms consisting of $46,902 in wages, $373 in taxable interest, a business loss of $3,193 from the canvas operation and a taxable portion for pensions and annuities of $39,666. See Plaintiff’s Exhibits 1 and 2. For the taxable year 1999, the plaintiff had $27,888 listed as federal adjusted gross income on his federal and Connecticut income tax returns consisting of $45,821 in wages, $61 in taxable interest, a business loss of $5,494 from the canvas operation and a loss of $12,500 from the real estate rental.

The court accepts Professor Hannum’s opinion as credible that, regardless of a player’s study of slot machine payouts and instructional materials, a gambler cannot exercise such skill as to affect the payout of slot machines because the machines are programmed to cause the player to lose in the long run. Furthermore, the key test here for determining whether a taxpayer is engaged in the trade or business of gambling is not skill when playing slot machines, but the expectation of winning or having “profit motive”.

Although the plaintiff believes he will be successful playing slot machines and this belief is unrealistic from a statistical basis, it is difficult for the court to find that a slot machine gambler has no subjective expectation of winning. See, e.g., Busch v. Commissioner of Revenue, 713 N.W.2d 337, 349 (Minn. 2006), where the Minnesota Supreme Court reversed the decision of the Minnesota Tax Court and held that “the taxpayer’s expectation of profit from a given activity need not always be reasonable for the activity to qualify as a trade or business.”⁽⁷⁾

In addressing the first profit motive indicator listed in the regulations, the plaintiff did conduct his gambling activities in a businesslike manner by keeping detailed records of the days he gambled, the types and numbers of machines played and his winnings and losses.

The third indicator, time and effort expended, does not support a finding that the plaintiff’s gambling activities were conducted in such depth and with adequate continuity and regularity because the plaintiff gambled only 43 days in 1998 and 22 days in 1999. The court concurs with the commissioner that the plaintiff’s visits to the casinos were irregular and infrequent during the taxable years and that the plaintiff’s time was limited by his full-time work for Xerox and the approximately 350 hours devoted to his canvas business.⁽⁸⁾

As to the fourth indicator, there was no evidence offered to show that the plaintiff had an expectation that assets used for his gambling would appreciate in value. As to the fifth and sixth indicators, there is nothing to support the plaintiff’s contention that he has a successful history of winning while playing slot machines during the taxable years. Although the plaintiff reported substantial jackpots in the years 2000 through 2003, the present issue is whether the plaintiff was engaged in a trade or business as a gambler in the taxable years 1998 and 1999. The plaintiff’s financial status during the taxable years, as represented by his pension income, wages, canvas business earnings, and rental income, was sufficient to maintain a gambling lifestyle. It was not the winnings from gambling at the slot machines that sustained the plaintiff’s lifestyle, but his other income which was unrelated to gambling.

For the seventh and eighth indicators, the plaintiff did not make a profit and his financial status does not appear to have changed. As to the final indicator, there is no evidence to support a finding that the plaintiff considered his gambling activities during the taxable year to be a hobby or purely for pleasure. While the plaintiff’s gambling activities did not rise to the level of being engaged in a trade or business, his subjective intent appears to be more like a compulsion to gamble rather than just a hobby.

Upon review of all the indicators and the court’s analysis of each, it is necessary to consider the standard of proof needed by the plaintiff to be successful in this appeal. In Leonard v. Commissioner of Revenue Services, 264 Conn. 302, the Supreme Court has recognized that, in a taxpayer’s challenge of the commissioner’s imposition of a deficiency assessment in tax matters, it is the taxpayer’s burden to prove that a deficiency assessment is in error by presenting clear and convincing evidence. See also Gavigan v. Commissioner of Revenue Services, 89 Conn. App. 111, 114, 871 A.2d 1101 (2005), citing Leonard.

Under the court’s analysis of the facts, the plaintiff has met two of the nine indicators listed above in the regulations, namely, profit motive and conducting gambling activities in a businesslike manner. Under these circumstances and with the high standard of proof required of the plaintiff to show the commissioner’s error, the court concludes that the plaintiff has not sustained his burden.⁽⁹⁾ The plaintiff has failed to prove that he was a professional gambler operating in the trade or business of gambling sufficient to claim his gambling losses against his gambling winnings during the taxable years.

The plaintiff raises a constitutional issue that the plaintiff’s equal protection rights have been violated under the Fourteenth Amendment of the United States constitution and article first, §20, of the Connecticut constitution. As a result of the commissioner classifying the plaintiff as a non-professional gambler, it is the plaintiff’s contention that the commissioner gives unequal treatment to the gambling winnings of professional and non-professional gamblers. The plaintiff argues that there is no rational basis for the commissioner to discriminate against non-professional gamblers by taxing them on gross gambling winnings, while professional gamblers are taxed on net winnings, and cites Stewart Dry Goods Co. v. Lewis, 294 U.S. 550, 566, 55 S. Ct. 525, 79 L. Ed. 1054 (1935) (Kentucky tax law unconstitutional by imposing higher tax rate on retailers with large gross sales and lower tax rate on retailers with lower gross sales).

The constitutional issue here is not the disparity in taxing one taxpayer from another based on the size of gambling winnings. Instead, there is a rational basis for the legislature to impose a tax on professional gamblers that is different from how nonprofessional gamblers are treated. Professional gamblers and non-professional gamblers are simply not in the same class. See the distinction discussed above, on the federal level, of a professional gambler filing Schedule C to form 1040 to report gambling winnings and losses versus a non-professional gambler filing Schedule A to form 1040.

Accordingly, judgment may enter in favor of the defendant denying the plaintiff’s appeal for the taxable years, without costs to either party.

Arnold W. Aronson
Judge Trial Referee


From curriculum vitae of State's expert witness:
• Peter B. Stone v. Commissioner of Revenue Services, State of Connecticut (July 2006) – Whether or not: (1) the plaintiff is a professional gambler in the trade or business of gambling under the Internal Revenue Code, 26 D.S.C. §162(a); (2) the Department of Revenue Services' income tax is discriminatory as applied to Plaintiff and other individuals categorized by the Commissioner as non professional gamblers; (3) the State impermissibly discriminates against individuals based upon the type of gambling activity engaged in; and (4) the State selectively enforces income reporting requirements against those winning larger sums of money in gambling activities.

Footnotes:
(1) IRS Profit or Loss from Business form.

(2) IRS Certain Gambling Winnings form. Operators of slot machines are required to furnish forms W-2G to those winners who receive a winning payout of $1,200 or more. See, e.g., Plaintiff’s Exhibit 13.

(3) See, e.g., Plaintiff’s Exhibit 14.

(4) Taxpayers are required to list any additions and subtractions to the federal adjusted gross income on lines 30-37 and lines 38-47, respectively, of Schedule 1 to form CT-1040.

(5) Ruzek testified that she discarded the post-it notes once the information written upon them was entered into the spreadsheet.

(6) Although there is no general incorporation of federal tax concepts into our state tax laws, incorporation of federal tax principles makes sense where applicable to the issue at hand. See Bell Atlantic NYNEX Mobile, Inc. v. Commissioner of Revenue Services, 273 Conn. 240, 261-62, 869 A.2d 611 (2005).

(7) The court notes that the Busch decision resolved in the taxpayer’s favor by placing the burden of proof on the commissioner rather than the taxpayer. However, Connecticut follows the rule that the burden of proving an error in a deficiency assessment is on the taxpayer. See Leonard v. Commissioner of Revenue Services, 264 Conn. 286, 302, 823 A.2d 1184 (2003).

(8) “[T]he Plaintiff’s visits to the casinos during the Taxable years were irregular and infrequent. To this end, during the Taxable year 1998, the Plaintiff visited casinos only two days each in May and June, three days in September, one day in October and zero days in November. During the Taxable year 1999, the Plaintiff visited casinos only one day each in March, May and September, and zero days in January, April and October.” (Defendant’s post-trial brief, p. 16.) See also Leite v. Commissioner of Revenue, Appellate Tax Board (Mass.), Docket No. C268746 (November 10, 2006) (54 days of slot machine gambling does not constitute the trade or business of gambling); Erbs v. Commissioner, T.C. Summary Opinion 2001-85 (semi-retired taxpayer’s 89 sporadic visits to casino throughout taxable year not trade or business of gambling). In addition, the evidence was not clear on how many days in 1998 and 1999 Stone spent gambling in New Jersey casinos versus Connecticut casinos.

(9) The parties filed briefs discussing the clear and convincing evidence standard. Even assuming that a less demanding standard of proof is considered, namely, the preponderance of the evidence standard, the court is not persuaded that the plaintiff would narrow the evidentiary gap to be successful in this appeal. See also Gavigan v. Commissioner of Revenue Services, 99 Conn. App. 903 (2007) (affirmed per curiam trial court’s use of clear and convincing evidence standard).

 

T.C. Summary Opinion 2005-109
UNITED STATES TAX COURT
JIMMIE L. CLEMONS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 20040-03S. Filed August 1, 2005.  Jimmie L. Clemons, pro se.

Jeanne Gramling and Blake W. Ferguson, for respondent.  GOLDBERG, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect at the time the petition was filed. The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

Respondent determined a deficiency in petitioner’s Federal income tax of $1,601 for the taxable year 2001.(1) After concessions,(2) the issue for decision is whether petitioner must include in his gross income gambling winnings of $44,833 for taxable year 2001.(3) The amount of petitioner’s Social Security benefits received during taxable year 2001 that must be included in his 2001 gross income is a computational matter and will be resolved by our decision on the unreported gambling income issue.

(1) At trial, respondent conceded that the amount of the deficiency for taxable year 2001 set forth in the notice of deficiency was not correct. Instead, respondent claims that the correct deficiency is $1,046.

(2) At trial, respondent conceded that petitioner was entitled to Schedule A deductions for taxable year 2001 of $44,833 and $500 for gambling losses and charitable contributions, respectively.

(3) If the $44,833 gambling winnings are included in petitioner’s gross income, he must also include Social Security benefits received of $8,690 in his gross income for taxable year 2001 pursuant to sec. 86.

Background

Some of the facts have been stipulated and are so found.  The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioner resided in Flat Rock, North Carolina, on the date the petition was filed in this case.

Petitioner timely filed his Federal income tax return for the 2001 taxable year. On Form 1040, U.S. Individual Income Tax Return, for taxable year 2001, petitioner reported capital gain income of $1,663.13. Petitioner did not report any other income.  Petitioner also claimed a personal exemption and the standard deduction. Petitioner did not attach a Schedule A, Itemized Deductions, to his Form 1040.

During taxable year 2001, petitioner was retired.  Petitioner gambled at Harrah’s Cherokee Smokey Mountain Casino (Cherokee Casino), and during taxable year 2001, petitioner received gambling winnings of $44,833 from Cherokee Casino.  Both petitioner and respondent received seven Forms W-2G, Certain Gambling Winnings, for taxable year 2001, all seven of which were from Cherokee Casino in the amounts of $16,000, $2,500, $4,000, $4,000, $4,500, $12,583, and $1,250, for a total of $44,833. Petitioner attached these Forms W-2G to his 2001 Form 1040, but, as previously stated, he did not report the amounts as gross income. From these Forms W-2G, respondent determined that petitioner had unreported gambling income of $44,833 for taxable year 2001.

Accordingly, in the notice of deficiency for taxable year 2001, dated November 3, 2003, respondent determined that petitioner must include gambling winnings in the amount of $44,833 in his gross income. Respondent also determined that - 4 - petitioner was entitled to Schedule A itemized miscellaneous deductions in the amount of $44,523, rather than the standard deduction, and respondent further determined that petitioner must include taxable Social Security benefits of $8,690 in his gross income for taxable year 2001. The taxable Social Security income was computed at 85 percent of the total amount of $10,244, which petitioner received as Social Security benefits during taxable year 2001.

After the issuance of the notice of deficiency, but before trial, respondent conceded that he failed to allow petitioner a personal exemption and understated the allowable itemized miscellaneous deductions in his computation of the deficiency reflected in the notice of deficiency.

As previously noted, at trial, respondent conceded that petitioner was entitled to Schedule A itemized miscellaneous deductions of $45,333, consisting of $44,833 for gambling losses incurred by petitioner during taxable year 2001 and $500 for charitable contributions made by petitioner during taxable year 2001. Respondent also conceded, at trial, that the correct amount of the deficiency for taxable year 2001 was $1,046.

Discussion

As a general rule, the determinations of the Commissioner in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving the Commissioner’s determinations to - 5 - be in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). As one exception to this rule, section 7491(a) places upon the Commissioner the burden of proof with respect to any factual issue relating to liability for tax if the taxpayer maintained adequate records, satisfied the substantiation requirements, cooperated with the Commissioner, and introduced during the Court proceeding credible evidence with respect to the factual issue. We decide the issue in this case without regard to the burden of proof. Accordingly, we need not decide whether the general rule of section 7491(a)(1) is applicable in this case. See Higbee v. Commissioner, 116 T.C. 438 (2001). 

Petitioner contends that his $44,833 gambling winnings need not be included in his gross income because he had gambling losses to offset these winnings. Respondent, however, contends that petitioner must include his gambling winnings in his gross income and is then entitled to a Schedule A miscellaneous itemized deduction for his gambling losses. 

The present problem seems to be that petitioner steadfastly rejects or ignores certain basic principles of the Federal income tax laws. Petitioner wishes to net his winnings and losses and, on his tax return, report in gross income only the amount of any net gambling winnings. Petitioner considers as “actual income” only his capital gain proceeds and any net gambling winnings.  Petitioner is in error.

Section 61(a) defines gross income as “all income from whatever source derived,” including gambling, unless otherwise provided. McClanahan v. United States, 292 F.2d 630, 631-632 (5^th Cir. 1961). The Supreme Court has consistently given this definition of gross income a liberal construction “in recognition of the intention of Congress to tax all gains except those specifically exempted.” Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430 (1955); see also Roemer v. Commissioner, 716 F.2d 693, 696 (9^th Cir. 1983) (all realized accessions to wealth are presumed taxable income, unless the taxpayer can demonstrate that an acquisition is specifically exempted from taxation), revg. 79 T.C. 398 (1982).

Section 62 defines adjusted gross income and allows expenses of a trade or business and certain employee business expenses to be deducted from gross income. These deductions are sometimes referred to as deductions “above the line,” meaning simply that they are deducted from gross income to arrive at “adjusted gross income.” Gamblers who are engaged in a trade or business of gambling may be able to deduct their gambling losses above the line; indeed, courts have based their decisions in some cases on the proposition that such a professional gambler may net losses against winnings for purposes of determining what is includable in gross income. See Winkler v. United States, 230 F.2d 766 (1^st - 7 - Cir. 1956); Green v. Commissioner, 66 T.C. 538 (1976). This is not the present case.

In the case of a taxpayer not engaged in the trade or business of gambling, gambling losses are allowable as a miscellaneous itemized deduction, but only to the extent of gains from such transactions. See sec. 165(d); McClanahan v. United States, supra; Winkler v. United States, supra; Gajewski v.  Commissioner, 84 T.C. 980 (1985); Lutz v. Commissioner, T.C.  Memo. 2002-89; see also Stein v. Commissioner, T.C. Memo. 1984-403; Umstead v. Commissioner, T.C. Memo. 1982-573. 

The parties agree that, during taxable year 2001, petitioner received gambling winnings of $44,833 at the Cherokee Casino.  The parties further agree that petitioner incurred gambling losses, during taxable year 2001, in excess of $44,833.  Petitioner did not report the aforesaid gambling winnings as gross income on his 2001 Federal income tax return. Instead, petitioner merely offset his gambling income with his sustained gambling losses and did not report either of these amounts on his 2001 Federal income tax return.

Petitioner presented no evidence to show that he was a professional gambler, nor did he contend that he was a professional gambler. On the basis of the evidence in the record, we conclude that petitioner was a recreational gambler and not a professional gambler. Therefore, the gambling losses incurred by petitioner during taxable year 2001 are allowable only as an miscellaneous itemized deduction on Schedule A, to the extent of gains from gambling. See sec. 165(d); sec. 1.165-10, Income Tax Regs. Thus, petitioner must include his gambling winnings in his adjusted gross income and is entitled only then to a Schedule A miscellaneous itemized deduction, to the extent of his gains from gambling, for his gambling losses. See sec.  165(d); sec. 1.165-10, Income Tax Regs. 

Reviewed and adopted as the report of the Small Tax Case Division.
To reflect respondent’s concessions and our resolution of the disputed matters, Decision will be entered under Rule 155.
 

T.C. Summary Opinion 2005-3
UNITED STATES TAX COURT
PANSY V. PANAGES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 16154-03S. Filed January 4, 2005.
Pansy V. Panages, pro se.
Paul K. Voelker, for respondent.

COUVILLION, Special Trial Judge: This case was heard pursuant to section 7463 in effect when the petition was filed.(1) The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority.

(1) Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the year at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

Respondent determined a deficiency of $6,161 in petitioner’s Federal income tax for 2001, and a section 6662(a) penalty of $1,232.

The issues for decision are: (1) Whether petitioner’s gambling activity amounted to a trade or business under section 162, thereby allowing her to deduct gambling losses on Schedule C, Profit or Loss From Business, of her Federal income tax return, and (2) whether petitioner is liable for the section 6662(a) penalty.

Some of the facts were stipulated. Those facts, with the exhibits annexed thereto, are so found and are made part hereof.  Petitioner’s legal residence at the time the petition was filed was Sparks, Nevada.

Before entering the flower business, petitioner completed her freshman year of high school and had some floral industry training. Petitioner then opened a flower shop in Reno, Nevada.  The Flower Bucket Florist (flower shop) was organized as a corporation with petitioner as the sole stockholder. At the time of trial, petitioner’s flower shop was open 12 hours a day, Monday through Saturday, and a few hours on Sunday. The flower shop paid petitioner a $66,310 salary during 2001.

In addition, petitioner operated as sole stockholder another business, F.B. Wholesale, Inc. (F.B. Wholesale), which was a wholesale market that purchased flowers from growers and brokers and then resold the flowers to retail florists. The flower shop is one of F.B. Wholesale’s customers. F.B. Wholesale paid petitioner a $7,200 salary during 2001. Finally, petitioner earned $26,160 in rent from two other businesses and $4,848 in the lease of a portion of her home to an elderly lady. 

During the year in issue, petitioner was nearly 70 years of age and had begun making plans for retirement. As a result, she began training her two daughters to assume control of the flower shop; however, petitioner was still actively involved in the flower shop during 2001. Because petitioner planned to hand over management of the flower shop to her daughters, when she turned 65, she began looking for other ways to supplement her monthly Social Security benefits.

Petitioner believed she had a talent for winning at slot machines and began playing the machines at different locations.  She eventually gambled almost exclusively at one grocery store (Smith’s) that had the type of machines she liked, known as progressive machines. She began cultivating relationships with some of the grocery employees and started “tipping” them so they would alert her to what machines had not “paid out” recently.

Petitioner usually played the machine or machines that had gone the longest without a winner. On her 2001 tax return, she deducted as business expenses $6,000 in tips she paid grocery employees for that information. Petitioner estimated she spent 20 to 25 hours a week playing the slot machines at Smith’s. All of her gambling occurred after the flower shop was closed for the evening. Smith’s was on the route petitioner traveled from the flower shop to her home.

During 2000, petitioner contacted an Internal Revenue Service (IRS) agent for information on how to file her income tax return as a professional gambler. Petitioner never sought information from other professional gamblers as to what was required to become a professional gambler for tax purposes. She was reluctant to publicize her status as a professional gambler because of a perceived stigma attached to that occupation. She discussed her tax status as a professional gambler only on one occasion with an IRS agent. She was advised by the agent to simply file a Schedule C with her income tax return and was advised of her responsibility to pay self-employment taxes on any profit realized. Because petitioner reported a loss on her 2001 return, she did not pay any self-employment taxes.(2)

(2) There is no evidence in the record that, in her quest to qualify as a professional gambler, petitioner inquired or received any information that a basic and fundamental requisite of a trade or business, including that of a professional gambler, is that the activity be engaged in for profit. 

On Schedule C of her 2001 return, petitioner listed “Professional Gambler” as her principal business and reported negative income of $5,050 and $8,129 in expenses for a total loss of $13,179. Petitioner kept records verifying the exact dates and amounts of her winnings, tips, and ATM charges and attached those records to her Schedule C. Respondent agreed at trial that petitioner kept meticulous records. Nevertheless, on her Form 1040, U.S. Individual Income Tax Return, petitioner listed her occupation as “Floral Manager”.

For gambling to reach the level of a trade or business activity it must be “pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and * * not a mere hobby”. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). The Supreme Court, in Groetzinger, held that a taxpayer who spent between 60 and 80 hours per week at dog races qualified as a professional gambler even though the taxpayer received income during the year from interest, dividends, capital gains, and salary earned before his job was terminated.  Likewise, a taxpayer who spent 35 hours a week at a horse track after losing his job as a salesman and who was seeking a new sales job qualified as a professional gambler for purposes of section 162. Rusnak v. Commissioner, T.C. Memo. 1987-249. 

Unlike the taxpayers in the cited cases, petitioner did not pursue gambling full time. She gambled regularly but only after she finished working at her flower shop. She frequently stopped at Smith’s to play the slot machines on her way home from work.  As she reported on her tax return, her occupation was “floral manager”. The fact that petitioner earned income from investments and rent does not in and of itself bar her from being a professional gambler. Petitioner, however, does not qualify as a professional gambler because her situation does not satisfy the test laid out by the Supreme Court. In Commissioner v. Groetzinger, supra at 33, the Court stated that, if a taxpayer “devotes his full-time activity to gambling, and it is his intended livelihood source, it would seem that basic concepts of fairness * * * demand that his activity be regarded as a trade or business”. Petitioner’s livelihood was not her winnings from slot machines; instead, her primary income came from her flower shop. Her gambling was not a trade or business under section 162. Consequently, petitioner may not deduct her losses on a Schedule C but must itemize them.(3)

(3)If petitioner qualified as a professional gambler forpurposes of sec. 162, she still could claim her losses only to the extent she had gains. Sec. 165(d); Praytor v. Commissioner, T.C. Memo. 2000-282. Because petitioner does not qualify as a professional gambler, it is not necessary to address whether petitioner may deduct ATM charges and tips to grocery store employees as expenses because her slot machine losses alone exceeded her winnings; therefore, she may not deduct the charges or tips. In the notice of deficiency, respondent disallowed all of petitioner’s claimed deductions for gambling losses and other expenses in excess of gambling income. That computation is sustained by the Court.

Respondent determined a section 6662(a) penalty of $1,232 against petitioner. Section 6662(a) provides for a 20-percent addition to tax for any underpayment to which the section applies. Respondent determined that section 6662(b) applies to petitioner because (1) petitioner was negligent or disregarded rules or regulations, or (2) petitioner’s deficiency represented a substantial understatement of income tax. 

Negligence is defined as “any failure to make a reasonable attempt to comply with the provisions of this title”, and disregard includes “careless, reckless, or intentional disregard.” Sec. 6662©. The Court holds that petitioner was not negligent, nor did she disregard rules or regulations when she filed as a professional gambler on her 2001 tax return. She consulted with an IRS agent and inquired as to how to file her tax returns as a professional gambler. She then followed the guidelines of the agent, which were simply to include a Schedule C with her income tax return. The Court finds petitioner’s testimony credible. Petitioner kept adequate records verifying her level of gambling activity and attached the records to her Schedule C. In addition, once petitioner received the notice of deficiency from respondent, she ceased her gambling activity while awaiting a decision by this Court. Petitioner’s actions amount to reasonableness under section 6662('c) and her actions are not considered by the Court to be “careless, reckless, or intentional disregard.”

Section 6662(b) also provides an addition to tax in the amount of 20 percent for any “substantial understatement of income tax.” A substantial understatement is defined as the 4 At trial, respondent agreed that, if the Court held that petitioner was not a professional gambler, she could deduct her gambling expenses as itemized deductions. In addition, respondent conceded that petitioner was also entitled to itemized deductions of $200, $458, and $1,376, respectively, for charitable contributions, taxes, and interest.  greater of 10 percent of the tax required to be shown on the return or $5,000. Sec. 6662(d)(1)(A). Petitioner’s understatement does amount to more than $5,000; however, she qualifies for a reduction of the understatement. Sec.  6662(d)(1)(B). Section 6662(d) provides for a reduction of the understatement if the taxpayer supplied the relevant facts affecting the tax treatment on the return and if there was a reasonable basis for the tax treatment. Sec. 6662(d)(2)(B)(ii).  As previously discussed, petitioner attached adequate records to her 2001 income tax return, and she had a reasonable basis for believing she qualified as a professional gambler simply by filing a Schedule C. Therefore, petitioner’s understatement for purposes of determining whether it amounts to a “substantial understatement of income tax” is reduced to zero. Sec.  6662(d)(1)(A). Petitioner is not liable for the section 6662(a) penalty.4

Reviewed and adopted as the report of the Small Tax Case Division. Decision will be entered under Rule 155.

T.C. Memo. 2004-161
UNITED STATES TAX COURT
EDWARD D. HAMILTON AND YOLONDA B. HAMILTON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 8352-03. Filed July 12, 2004.  Edward D. Hamilton and Yolonda B. Hamilton, pro sese.

Angelique M. Neal, for respondent.

MEMORANDUM OPINION

LARO, Judge: This case is before the Court for decision without trial. See Rule 122.(1) Petitioners petitioned the Court to redetermine an $8,793 deficiency in their 2000 Federal income tax. We decide whether petitioners’ lottery winnings are includable in their adjusted gross income for purposes of applying the $25,000 offset of section 469(i). We hold they are.(2)

(1)Rule references are to the Tax Court Rules of Practice and Procedure. Section references are to the applicable versions of the Internal Revenue Code.

(2)We decide this case on its merits and without regard to which party bears the burden of proof

Background

The facts in this background section are obtained from the parties’ stipulation of facts and the exhibits submitted therewith. Petitioners resided in Los Angeles, California, when their petition was filed.

Petitioners filed a joint 2000 Form 1040, U.S. Individual Income Tax Return. They reported on that return the following items of income (loss) which they realized during 2000:

Wages $118,053
Interest 4,731
Refunds 872
Rental real estate (22,300)
California State lottery winnings 136,041
Total income 237,397

The rental real estate is a “passive activity”, sec. 469©(2), in which petitioners actively participated.

Discussion

Respondent determined that the phase-out rules of section 469(i)(3) preclude petitioners from currently deducting any of their rental real estate loss. Under that section, individual taxpayers such as petitioners who actively participate in a rental real estate activity and who may otherwise deduct up to $25,000 of a rental real estate loss, see sec. 469(i)(1) and (2), must reduce that $25,000 figure by 50 percent of the amount by which their adjusted gross income exceeds $100,000, see sec.  469(i)(3). We understand petitioners to be making three arguments in support of their claim that respondent’s determination is wrong. First, petitioners argue that their lottery winnings are not includable in their 2000 gross income because they are neither professional nor part-time gamblers.  Second, petitioners argue that their lottery winnings are not includable in their adjusted gross income for purposes of section 469(i)(3). Third, petitioners argue that, if their first two arguments are wrong, the Court should recognize that they are in a tight financial bind and apply equitable principles to allow them to deduct at least half of their rental real estate loss.

We disagree with petitioners’ first argument that their 2000 gross income does not include their lottery winnings. The wide reach of section 61(a) brings within a taxpayer’s gross income all accessions to wealth, United States v. Burke, 504 U.S. 229, 233 (1992), and an accession to wealth on account of gambling winnings is no exception, see, e.g., Lyszkowski v. Commissioner, T.C. Memo. 1995-235 (and cases cited therein), affd. without published opinion 79 F.3d 1138 (3d Cir. 1996). Contrary to petitioners’ claim, an accession to wealth on account of gambling winnings is includable in an individual taxpayer’s gross income whether he or she is a professional gambler, a part-time gambler, or simply a onetime gambler. Id.

Nor do we agree with petitioners’ second argument that their adjusted gross income under section 469(i)(3) does not include their lottery winnings. For purposes of the income tax provisions of the Internal Revenue Code, the term “adjusted gross income” is defined by section 62 as gross income less certain enumerated deductions, none of which is relevant here. While section 469(i)(3)(F) also enumerates certain other adjustments which affect that term for purposes of section 469(i)(3), all of those enumerated adjustments are inapplicable as well. 

We conclude that petitioners’ lottery winnings are includable in their adjusted gross income for purposes of section 469(i)(3). Although petitioners as a third argument essentially invite this Court to apply some principle of equity to arrive at a contrary result, we decline to do so. This Court is not authorized to ignore such a clear expression of Congress’ intent as applies here. Flight Attendants Against UAL Offset v.  Commissioner, 165 F.3d 572, 578 (7^th Cir. 1999).

All arguments for a contrary holding have been considered, and those arguments not discussed herein have been found to be without merit. Accordingly, Decision will be entered for respondent.

T.C. Memo. 2003-301
UNITED STATES TAX COURT
RUTHE G. OHRMAN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5667-02. Filed October 29, 2003.
Steven B. Hval, for petitioner.
Nhi T. Luu-Sanders, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COHEN, Judge: This proceeding was commenced under section

6015 for review of respondent’s determination that petitioner is not entitled to relief from joint and several liability for 1999 with respect to a joint return filed with Steven F. Ohrman (Mr. Ohrman). The issues for decision are: (1) Whether petitioner is eligible for relief from joint and several liability under section 6015(b); (2) whether petitioner is liable under section 6015)('c)(4) to the extent she received disqualified assets notwithstanding a valid election under section 6015('c) and (3) whether respondent abused his discretion in denying petitioner’s request for relief from joint and several liability under section 6015(f).

Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue. All dollar amounts have been rounded to the nearest dollar.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. At the time the petition in this case was filed, petitioner resided in Portland, Oregon.

Background

Petitioner and Mr. Ohrman were married in Seattle, Washington, on March 26, 1988. On September 9, 1994, petitioner and Mr. Ohrman purchased a personal residence on Birdshill Road in Portland, Oregon (Birdshill residence). At the time of trial in March 2003, petitioner was 53 years old and Mr. Ohrman was 56 years old.

Petitioner attended college for at least 2 years and worked towards a teaching degree, but she did not graduate. From 1985 to 1995, petitioner worked as a lending officer at two large banks. While working as a lending officer, petitioner dealt with real estate agents and reviewed mortgage loan applications.  Petitioner became a full-time homemaker when her grandniece Alexa moved into her home in 1995.

Mr. Ohrman has worked for Spicers Paper, Inc. (Spicers Paper), in Gresham, Oregon, as its regional manager for the Portland, Oregon, and Seattle, Washington, divisions for several years including 1999. As of the time of trial, Mr. Ohrman’s salary was $135,000 per year, and his take-home pay was approximately $6,800 per month.

Mr. Ohrman’s Gambling Addiction

Mr. Ohrman has an admitted gambling addiction. Petitioner first became aware of Mr. Ohrman’s gambling in 1993. In 1998, Mr. Ohrman enrolled in Project STOP (the State of Oregon gambling treatment center) to seek treatment for his gambling addiction.  Petitioner participated in Project STOP’s “significant other” program to support Mr. Ohrman. While participating in Project STOP, Mr. Ohrman revealed to petitioner that he had accrued approximately $200,000 in outstanding gambling debts on various joint credit cards held in Mr. Ohrman’s and petitioner’s names.  Mr. Ohrman graduated from Project STOP on December 19, 1998, and received a Certificate of Achievement.

During the Project STOP program, petitioner was advised to block Mr. Ohrman’s ability to obtain money. Pursuant to this advice, petitioner took control of the family finances in 1999.  Petitioner wrote checks to pay the bills, reviewed monthly bank statements, and maintained a file drawer in the Birdshill residence where she kept the family’s financial records. In addition, petitioner removed Mr. Ohrman’s name from their joint checking account at U.S. Bank (U.S. Bank checking account) as well as from their joint money market savings account at U.S.  Bank. Petitioner also obtained quarterly credit reports under her name to check for inquiries and new credit during 1999.  Petitioner, however, did not remove Mr. Ohrman’s name from either the $60,000 home equity line of credit held by petitioner and Mr. Ohrman with Wells Fargo Bank (Wells Fargo home equity line of credit) or the joint checking account petitioner and Mr. Ohrman maintained at Key Bank in Seattle.

After she took control of the family finances, petitioner had Mr. Ohrman’s wages from Spicers Paper deposited directly into her U.S. Bank checking account during 1999. Petitioner was the only authorized signer on the U.S. Bank checking account, and Mr. Ohrman had no access to this account. Mr. Ohrman’s wages provided the only income source from which petitioner paid her family’s ongoing living expenses, including Mr. Ohrman’s pre-1998 gambling debts. Despite petitioner’s efforts, Mr. Ohrman’s gambling addiction persisted through 1999.

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Mr. Ohrman’s Early Withdrawals From His Retirement Account During 1999, Mr. Ohrman was the owner of an individual retirement account (IRA) at Dean Witter Reynolds (Dean Witter account). The Dean Witter account was a rollover account set up by petitioner and Mr. Ohrman in 1997. Petitioner was present with Mr. Ohrman when the Dean Witter account was established.

Thereafter, petitioner maintained a file for the Dean Witter account and placed the monthly account statements into a notebook. As of February 28, 1999, the Dean Witter account had a total asset value of $454,406.

Petitioner was the designated beneficiary of the Dean Witter account, but her written consent was not required to make an early withdrawal. Petitioner was aware of how much money was in the Dean Witter account in 1998 and 1999, and she believed there was approximately $700,000 in the account at one point in 1998.  Because of the size of the Dean Witter account, petitioner solicited promises from Mr. Ohrman before and during 1999 that he would not use any of the funds in the Dean Witter account for gambling.

Despite his promises to petitioner, Mr. Ohrman withdrew $79,000 in early distributions from the Dean Witter account in 11 separate transactions from March 19 to December 21, 1999, to fund his gambling addiction. Petitioner neither knew about nor consented to these early distributions, nor did petitioner sign any of the IRA distribution request forms. Mr. Ohrman was the only person who endorsed the distribution checks.

Statements for the months of March, April, May, June, July, and August 1999 for the Dean Witter account were received at the Birdshill residence. These monthly statements showed that withdrawals totaling $44,000 were taken from the Dean Witter account in the following amounts: March, $5,000; April, $5,000;

May, $8,000; June, $5,000; July, $13,000; and August, $8,000. In September 1999, Mr. Ohrman changed the address on the Dean Witter account statements from the Birdshill residence to his work address at Spicers Paper. Consequently, the monthly statements for September, October, November, and December 1999 for the Dean Witter account were sent to Mr. Ohrman’s work address.  Mr. Ohrman opened an individual checking account at Wells Fargo Bank (Wells Fargo checking account) prior to December 8, 1998, and he used this checking account throughout 1999 in connection with his gambling. Mr. Ohrman opened the Wells Fargo checking account without petitioner’s knowledge or consent.  Mr. Ohrman also obtained credit cards in his name alone after graduating from Project STOP. These credit cards were used to fund his gambling addiction and were not known to petitioner until June 2001. The early withdrawals taken by Mr. Ohrman from the Dean Witter account during 1999 were used at least in part to pay down the gambling debt attributable to these credit cards.

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On April 15, 2000, petitioner and Mr. Ohrman filed a joint 1999 Federal income tax return (joint 1999 return), Form 1040, U.S. Individual Income Tax Return, and attachments. Petitioner prepared the joint 1999 return on her home computer using Turbo Tax, a tax preparation program. Although two Forms 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for 1999 were sent to Mr. Ohrman at the Birdshill residence—one indicating a gross distribution and taxable amount of $71,000 from the Dean Witter account and the other indicating a gross distribution and taxable amount of $8,000 from the Dean Witter account—the $79,000 in distributions withdrawn by Mr. Ohrman from his Dean Witter account was not reported on the joint 1999 return filed by petitioner and Mr. Ohrman.

The $79,000 withdrawn by Mr. Ohrman from the Dean Witter account was taxable income, the omission of which from the joint 1999 return resulted in an understatement of tax attributable to an erroneous item of Mr. Ohrman. At the time petitioner signed the joint 1999 return, she did not have actual knowledge of the early distributions from the Dean Witter account.

On May 29, 2001, respondent issued a letter of proposed changes to petitioner’s and Mr. Ohrman’s reported tax liability for 1999. This letter proposed that petitioner and Mr. Ohrman owed an additional $42,927 (consisting of $32,217 in deficiency, $6,443 in accuracy-related penalty, and $4,267 in interest) for 1999. The letter of proposed changes was received by petitioner at the Birdshill residence in early June 2001. Within a few days after receiving respondent’s letter of proposed changes, petitioner confronted Mr. Ohrman and learned of the early distributions from the Dean Witter account.

Legal Separation Proceedings and Transfer of Assets

Within 1 week after receipt of respondent’s letter of proposed changes, petitioner met with Laura Rackner (Rackner), an attorney in Portland who specializes in divorce and family law, for advice. During this meeting, petitioner told Rackner that she received respondent’s letter of proposed changes for 1999.  In addition, petitioner told Rackner that Mr. Ohrman was a compulsive gambler and that she wanted to be protected from his gambling-related debt.

Rackner informed petitioner that there was a possibility that she could obtain relief from joint and several liability for the 1999 tax deficiency. After hearing Rackner’s advice, petitioner told Rackner that she wanted a financial separation from Mr. Ohrman. Accordingly, petitioner provided assets and liabilities information to Rackner, including the value of the Birdshill residence and the value of the funds in Mr. Ohrman’s Dean Witter account and in his 401(k) retirement account. On June 21, 2001, petitioner filed for a legal separation from Mr. Ohrman in Clackamas County (Oregon) Circuit Court.  On June 25, 2001, petitioner and Mr. Ohrman signed a Stipulated Judgment for Unlimited Separation (separation agreement), and Mr. Ohrman conveyed his interest in the Birdshill residence to petitioner. Rackner drafted the separation agreement for petitioner.

On July 3, 2001, Circuit Court Judge Patrick D. Gilroy signed the separation agreement in the matter of Ohrman v.  Ohrman, Case No. DR0106592. Mr. Ohrman was not represented at any point during the proceedings for legal separation. Upon execution of the separation agreement, Mr. Ohrman conveyed to petitioner his interest in the Birdshill residence. Petitioner also received ownership of a 1998 Lexus automobile, the Dean Witter account, and a 401(k) retirement account that had been held in Mr. Ohrman’s name. In addition, Mr. Ohrman was required to pay to petitioner spousal support as follows: (1) $6,000 per month, commencing on July 1, 2001, until the Birdshill residence was sold and the sales transaction was completed; (2) $5,000 per month for 12 months thereafter; (3) $4,000 per month for 66 months thereafter; and then (4) $1,500 per month indefinitely.

Pursuant to the separation agreement, Mr. Ohrman has been required to maintain medical, dental, and hospital insurance on petitioner. He has also been required to maintain life insurance through his employer and through Transamerica with petitioner as beneficiary. Additionally, Mr. Ohrman was required to pay, defend, indemnify, and hold harmless petitioner for 19 specified credit cards held in his name in addition to all other credit cards, loans, debts, notes, encumbrances, credit lines, equity lines, or other financial obligations in his name, with the exception of an Alaska Airlines Visa account.

Finally, Mr. Ohrman agreed to:

pay, defend, indemnify and hold * * * [petitioner] harmless from any claim made by any taxing agency arising out of tax returns previously filed by the parties. * * * [Mr. Ohrman] shall be liable, indemnify and hold * * * [petitioner] harmless from the tax liabilities resulting for 1999, 2000 and 2001. * * *

[Mr. Ohrman] shall be responsible for communicating with the taxing agencies and do all that is necessary to protect * * * [petitioner] from the tax obligation.

Excluding the right to spousal support, insurance coverages, and the 1998 Lexus, petitioner received assets with an approximate fair market value of $782,000 under the separation agreement. The fair market value of the Birdshill residence as of June 2001 was approximately $500,000. The true and actual stated consideration in the Bargain and Sale Deed transferring Mr. Ohrman’s interest in the Birdshill residence to petitioner was $0. The 401(k) retirement account had a value of $36,581 on March 31, 2001. The Dean Witter account had a value of $246,234 on May 31, 2001. Under the separation agreement, Mr. Ohrman retained only his personal belongings, which consisted of clothing, items stored in the garage of the Birdshill residence, his tools, and a 1997 Honda automobile.

Petitioner’s and Mr. Ohrman’s Relationship After Their “Financial

Separation”

Although petitioner and Mr. Ohrman were legally separated as of July 2001, they continued to reside together. They remained at the Birdshill residence until June 20, 2002. On June 10, 2002, petitioner sold the Birdshill residence for $520,000.  Petitioner received $63,087 in proceeds from the sale of the Birdshill residence.

After the sale of the Birdshill residence, petitioner and Mr. Ohrman rented a room together at a hotel in Portland from June 21, 2002, through July 15, 2002. On July 15, 2002, petitioner purchased a new personal residence on Carlton Street in Portland (Carlton residence) for $363,000. Petitioner made a downpayment of $79,438 to purchase the Carlton residence. In petitioner’s Uniform Residential Loan Application for the purchase of the Carlton residence, dated July 17, 2002, petitioner listed assets with a total value of $940,000 and reported a net worth of $525,373. Petitioner and Mr. Ohrman have resided together at the Carlton residence from July 20, 2002, to at least March 2003.

In addition to residing together, petitioner and Mr. Ohrman have been raising their grandniece Alexa together as parents.

Petitioner and Mr. Ohrman were awarded full custody of Alexa on

·        12 -

February 24, 2002. Petitioner and Mr. Ohrman have also continued to socialize together as a couple since their legal separation.  Petitioner has remained in control of the family finances since the legal separation and has used Mr. Ohrman’s monthly support payments to pay her family’s ongoing living expenses, consisting of the monthly mortgage payment on the Carlton residence, the utilities, the monthly payment due on her Alaska Airlines Visa credit card, the house and car insurance premiums, and groceries for Mr. Ohrman, Alexa, and herself. In addition to making the monthly support payments to petitioner, Mr. Ohrman pays at least an additional $1,800 per month for Alexa’s schooling, his gambling debt, health insurance for petitioner and Alexa, and life insurance.

Revenue Agent McConnell’s Examination

On December 10, 2001, respondent sent a statutory notice of deficiency to petitioner and Mr. Ohrman for 1999. In the notice of deficiency, respondent determined that petitioner and Mr. Ohrman are liable for a deficiency in income tax of $31,515 and a section 6662(a) accuracy-related penalty in the amount of $6,303. On March 10, 2002, petitioner timely filed her Petition for Determination of Relief from Joint and Several Liability on a Joint Return under section 6015(b), (c), and (f) in response to the statutory notice of deficiency.

·        13 -

In August 2002, Revenue Agent Joan McConnell (McConnell) was assigned to examine petitioner’s qualification for relief from joint and several liability under section 6015. McConnell interviewed petitioner on September 11, 2002. During this interview, petitioner told McConnell that monthly statements for the Dean Witter account came to the Birdshill residence during 1999, but she did not open them because they were not addressed to her. Additionally, petitioner explained to McConnell that she obtained the legal separation from Mr. Ohrman in order to protect herself financially. Petitioner also provided to McConnell a written response to respondent’s Innocent Spouse Questionnaire at this interview and signed it under penalties of perjury.  McConnell interviewed Mr. Ohrman on October 31, 2002. When questioned during this interview about the transfer of assets to petitioner, Mr. Ohrman told McConnell that the legal separation and transfer of assets were his ideas and that he did not feel that petitioner should have to pay for his mistakes.

McConnell referred to Rev. Proc. 2000-15, 2000-1 C.B. 447, to determine whether petitioner should be granted equitable relief under section 6015(f) for the 1999 tax deficiency. Based upon her analysis of the facts and circumstances of petitioner’s case, McConnell determined that petitioner did not qualify for equitable relief under section 6015(f). McConnell concluded that petitioner received a transfer of disqualified assets from Mr. Ohrman. In addition, McConnell concluded that petitioner had reason to know of at least some of the distributions from the Dean Witter account.

OPINION

Generally, married taxpayers may elect to file a joint Federal income tax return. Sec. 6013(a). After making the election, each spouse is jointly and severally liable for the entire tax due for that taxable year. Sec. 6013(d)(3). A spouse (requesting spouse) may, however, seek relief from joint and several liability by following procedures established in section 6015. Sec. 6015(a). A requesting spouse may request relief from liability under section 6015(b) or, if eligible, may allocate liability according to provisions under section 6015©.  Sec. 6015(a). If relief is not available under section 6015(b)

or ©, an individual may seek equitable relief under section

6015(f).

Section 6015(b) Analysis

Section 6015(b) provides, in pertinent part, as follows:

SEC. 6015(b). Procedures For Relief From

Liability Applicable to All Joint Filers.—

(1)  In general.—Under procedures prescribed

by the Secretary, if—

(A) a joint return has been made for a taxable year;

(B) on such return there is an understatement of tax attributable to erroneous items of 1 individual filing the joint return;

(C) the other individual filing the joint return establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement;

(D) taking into account all the facts and circumstances, it is inequitable to hold the other individual liable for the deficiency in tax for such taxable year attributable to such understatement; and

(E) the other individual elects (in such form as the Secretary may prescribe) the benefits of this subsection not later than the date which is 2 years after the date the Secretary has begun collection activities with respect to the individual making the election, then the other individual shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent such liability is attributable to such understatement.

The requirements of section 6015(b)(1) are stated in the

conjunctive. Accordingly, a failure to meet any one of them

prevents a requesting spouse from qualifying for relief offered

therein. Alt v. Commissioner, 119 T.C. 306, 313 (2002).

There is no dispute that petitioner satisfies subparagraphs

(A) and (B) of section 6015(b)(1). Moreover, respondent does not argue that petitioner’s election was untimely under section 6015(b)(1)(E). Respondent contends, however, that petitioner failed to meet the requirements of subparagraphs © and (D) of section 6015(b)(1). Petitioner argues that she has met all of

·        16 -

the requirements for equitable relief set forth in section 6015(b)(1) and is entitled to relief from joint and several liability for the joint 1999 return.

Section 6015(b)(1)(C) requires that the requesting spouse establish that in signing the return she did not know, and had no reason to know, that there was an understatement. The parties have stipulated that petitioner did not have actual knowledge of the understatement at the time she signed the joint 1999 return.  In deciding whether petitioner has carried her burden of proof in establishing that she had no reason to know of the understatement in the joint 1999 return, witness credibility is an important consideration. See Penfield v. Commissioner, T.C. Memo. 2002-254; Ishizaki v. Commissioner, T.C. Memo. 2001-318. In this case, as discussed below, various inconsistencies in the assertions of petitioner and Mr. Ohrman undermine the reliability of their generalized assertions that petitioner had no reason to know of the withdrawals from the Dean Witter account. Therefore, we are not required to accept them. See Geiger v. Commissioner, 440 F.2d 688 (9^th Cir. 1971), affg. T.C. Memo. 1969-159.

Petitioner believed that there was approximately $700,000 in the Dean Witter account at one point in 1998. In an effort to protect this amount, she solicited promises from Mr. Ohrman before and during 1999 that he would not use any of the funds in the Dean Witter account for gambling. Petitioner was aware of how much money was in the Dean Witter account in 1998 and 1999 because she was present with Mr. Ohrman when the account was established and had maintained a file for the account’s monthly statements.

While Mr. Ohrman may have been deceitful in hiding the actual withdrawals from the Dean Witter account from petitioner, the account statements showing these withdrawals were sent to the Birdshill residence for the months of March, April, May, June, July, and August 1999. These statements show that withdrawals totaling $44,000 were taken from the Dean Witter account during these months. Mr. Ohrman changed the address on the Dean Witter account to his work address in September 1999.

It is not clear from the testimony or the evidence before us what happened to the Dean Witter account statements for the months of March, April, May, June, July, and August 1999.  Petitioner does not account for these six monthly account statements in her written response to respondent’s Innocent Spouse Questionnaire. Specifically, in petitioner’s response to question No. 22 of the Innocent Spouse Questionnaire, she provided information only as to Mr. Ohrman’s changing the address on the Dean Witter account statements for the months of September, October, November, and December 1999 and his evasiveness about the account statements for those months.

·        18 -

When McConnell interviewed petitioner on September 11, 2002, she inquired as to the Dean Witter account statements for the 6 months of March through August 1999. Petitioner told McConnell that monthly statements for the Dean Witter account came to the Birdshill residence during 1999, but she did not open them because they were not addressed to her. When questioned at trial, however, petitioner was not so forthcoming with an explanation as to what happened to the Dean Witter account statements for the 6 months of March through August 1999.  Petitioner testified that she could not remember getting any statements during 1999 for the Dean Witter account at the Birdshill residence. Therefore, when examined in their totality, petitioner’s response on the Innocent Spouse Questionnaire, her response to McConnell during their interview of September 11, 2002, regarding the delivery of the Dean Witter account statements to the Birdshill residence during 1999, and her response at trial about these statements are vague, inconsistent, and evasive.

Mr. Ohrman also provided testimony as to what happened to the Dean Witter account statements for the 6 months of March through August 1999. Mr. Ohrman testified that he would leave work and “chase the mailtruck” in order to prevent the Dean Witter account statements from reaching the Birdshill residence.

He also testified that, when petitioner asked about the Dean

·        19 -

Witter account statements, he would show her statements that he had “doctored up” in order to hide his withdrawals from the Dean Witter account. When asked about the whereabouts of these “doctored up” statements on cross-examination, however, Mr. Ohrman acknowledged that neither he nor petitioner had provided them and that “they were thrown away” by him or petitioner.

The Dean Witter account statements were not the only source of information indicating that Mr. Ohrman had taken the early withdrawals during 1999. Two Forms 1099-R for 1999 were also sent to the Birdshill residence—one indicating a gross distribution and taxable amount of $71,000 from the Dean Witter account and the other indicating a gross distribution and taxable amount of $8,000 from the Dean Witter account. On the Innocent Spouse Questionnaire, petitioner stated that the two Forms 1099-R were sent to Mr. Ohrman’s work address. This statement is inconsistent with the address clearly shown on both Forms 1099-R.  Petitioner is a fairly well-educated individual who had gained experience with financial matters as a result of her 10 years of employment as a lending officer with two large banks.

Petitioner took complete control of her family’s finances in 1999 as a result of Mr. Ohrman’s gambling addiction, was aware of the existence and magnitude of the Dean Witter account, and prepared the joint 1999 return by herself. A reasonable person in petitioner’s position would have been put on notice by Mr. Ohrman’s evasion and deception with respect to the Dean Witter account statements. Petitioner was well aware of the extent of Mr. Ohrman’s past gambling and that he needed access to money in order to continue gambling. Even though petitioner had knowledge of these facts, she did not keep close watch over the Dean Witter account. Although petitioner also suffered difficult personal circumstances during 1999, she was able to retain control of other aspects of the family finances. Therefore, when we consider the entire record of this case, we conclude that petitioner has not established that she had no reason to know of the understatement when she signed the joint 1999 return.

We also conclude that petitioner has not satisfied the requirements of subparagraph (D) of section 6015(b)(1). Taking into account all the facts and circumstances of petitioner’s case, it is not inequitable to hold her liable for the 1999 tax deficiency because the tax-avoidance purpose of the separation agreement is apparent from the evidence. First, a proposed tax liability of nearly $43,000 prompted petitioner to meet with Rackner for advice in early June 2001. Second, petitioner told Rackner about the proposed tax deficiency during this meeting, and Rackner informed her that relief from joint and several liability might be available. Third, with the knowledge that relief from joint and several liability might be available to her, petitioner instructed Rackner to draft the separation agreement whereby she would be financially separated from Mr. Ohrman. Fourth, pursuant to this separation agreement, petitioner received approximately $782,000 in assets that had previously been held in Mr. Ohrman’s name along with spousal support amounting to at least $4,000 per month for a minimum period of 78 months, leaving Mr. Ohrman stripped of nearly all of his assets and monthly income. Finally, petitioner and Mr. Ohrman have continued their marital relationship since their legal separation was finalized in July 2001 and have continued to use Mr. Ohrman’s income to pay the family’s ongoing living expenses.

In Doyle v. Commissioner, T.C. Memo. 2003-96, we denied a taxpayer relief from joint and several liability under section 6015(b)(1)(D) because she and her family had engaged in a systematic plan to put their assets beyond the reach of respondent’s legitimate collection activities. Similarly, in Pierce v. Commissioner, T.C. Memo. 2003-188, we denied a taxpayer relief under section 6015(b)(1)(D) when the object of a series of transactions entered into by the taxpayer was to shield assets from creditors, which ultimately included respondent. In both cases, we concluded that granting relief to taxpayers in such circumstances would wrongfully permit them to shield themselves from Federal tax liabilities by using section 6015.

·        22 -

In this case, petitioner has presented no credible nontax reason for the transfer of assets pursuant to the separation agreement. Mr. Ohrman’s gambling addiction, long known to her, did not cause a legal separation. Petitioner reacted to that situation by taking practical control of the family finances.

These circumstances lead us to the ultimate conclusion that

petitioner obtained a legal separation in order to shield as many

assets and as much of the family’s income as possible from the

1999 tax deficiency.

Furthermore, it is not inequitable to hold petitioner liable

for the 1999 tax deficiency because she would not suffer a major financial hardship as a result. Petitioner holds assets that she could use to pay the 1999 tax deficiency. In addition, her family’s living expenses are all paid from Mr. Ohrman’s earnings.

Therefore, although her circumstances may be unfortunate, they do

not compel relief from joint and several tax liability under

section 6015(b).

Section 6015© Analysis

Because petitioner cannot avoid liability for the deficiency

arising from the joint 1999 return under section 6015(b), we now

turn our attention to her claim for relief from joint and several

liability under section 6015©. Section 6015© allows a

taxpayer, who is eligible and so elects, to limit his or her

liability to the portion of a deficiency that is properly

·        23 -

allocable to the taxpayer as provided in section 6015(d). Sec.  6015©(1). Under section 6015(d)(3)(A), generally, any items that give rise to a deficiency on a joint return, e.g., the unreported early distributions from the Dean Witter account, shall be allocated to the individual filing the return in the same manner as it would have been allocated if the individual had filed a separate return for the taxable year.

A taxpayer is eligible to elect the application of section 6015© if, at the time the election is filed, the taxpayer is legally separated from the individual with whom the taxpayer filed the joint return to which the election relates. Sec.  6015©(3)(A)(i)(I). Furthermore, the election under section 6015© must not be made later than 2 years after the date on which respondent has begun collection activities with respect to the taxpayer making the election. Sec. 6015©(3)(B).

Respondent does not contend that petitioner’s election under section 6015© was untimely. Therefore, petitioner is eligible to elect the application of section 6015© to limit her liability for the 1999 tax deficiency.

The issue with which we are faced in this case, however,

deals with the application of section 6015©(4) to the transfer

of assets from Mr. Ohrman to petitioner pursuant to the

separation agreement. Specifically, we must decide whether the

amount of the 1999 tax deficiency for which petitioner can be

·        24 -

held liable under section 6015©(1) may be increased as a result of a transfer of disqualified assets under section 6015©(4).  Under section 6015©(4)(A), the portion of the deficiency for which the taxpayer electing the application of section 6015© is liable (without regard to section 6015©(4)(A)) is increased by the value of any disqualified asset transferred to the taxpayer. The term “disqualified asset” means any property or right to property transferred to the taxpayer making the election under section 6015© (i.e., petitioner) by the other individual filing such joint return (i.e., Mr. Ohrman) if the principal purpose of the transfer was the avoidance of tax or payment of tax. Sec. 6015©(4)(B)(i).

Under section 6015©(4)(B)(ii), there is a presumption that any asset transfer that occurs after the date that is 1 year before the first letter of proposed deficiency is sent by respondent has as its principal purpose the avoidance of tax or payment of tax. (The letter of proposed deficiency allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals. Sec. 6015©(4)(B)(ii)(I).) This presumption, however, does not apply to any transfer made pursuant to a decree of divorce or separate maintenance or a written instrument incident to such a decree. Sec.

6015©(4)(B)(ii)(II); see also sec. 71(b)(2)(B) (explaining that

the term “divorce or separation instrument” means a written

•     25 -

separation agreement). Consequently, this presumption is not applicable in this case because the transfer of assets from Mr. Ohrman to petitioner took place pursuant to a written separation agreement.

Respondent argues that the burden of proof under section 6015©(4) is on petitioner because of the language of section 6015©(2) and caselaw interpreting section 6015©. Conversely, petitioner contends that respondent has the burden of proof because of the language of section 1.6015-3©(3)(iii), Income Tax Regs., and the legislative history of section 6015©. We need not resolve this dispute, however, because the preponderance of the evidence establishes that the principal purpose of the transfer was the avoidance of tax.

Respondent contends that the facts of this case show that petitioner and Mr. Ohrman intentionally and purposely obtained a legal separation and transferred assets in an attempt to shield these assets from respondent’s effort to collect the 1999 tax deficiency. Petitioner primarily argues that, because the transfer of assets from Mr. Ohrman to petitioner took place pursuant to the equitable distribution rules of Oregon family law, the transfer did not have as its principal purpose the avoidance of tax or payment of tax. For the reasons set forth below, respondent’s argument is persuasive on this matter.

·        26 -

Petitioner’s use of State family law as a vehicle to lend

legitimacy to Mr. Ohrman’s transfer of assets and income to her

is the type of abuse that Congress expressly intended to stop by

adding paragraph (4) to section 6015©. While the State of

Oregon’s equitable distribution rules provided the mechanism for

the transfer of Mr. Ohrman’s assets and income to petitioner,

they do not negate the principal purpose for which the transfer

occurred, the avoidance of tax. As discussed in detail above,

the separation agreement was a way for petitioner to enjoy the

benefits of the family assets and income without satisfying the

1999 tax deficiency. Accordingly, we hold that petitioner

received a transfer of disqualified assets under section

6015©(4).

The next step in the section 6015© analysis is to decide the amount by which petitioner’s liability for the 1999 tax deficiency should be increased because of the transfer of disqualified assets. Under section 6015©(4)(A), the portion of the deficiency for which petitioner is liable is increased by the value of the disqualified assets that were transferred to her.

In this case, petitioner’s portion of the 1999 tax deficiency

would have been zero absent the transfer of disqualified assets

because of her eligibility to make an election to limit her

liability under section 6015©(3). The value of the

disqualified assets petitioner received, however, far exceeds

·        27 -

petitioner’s liability for the 1999 tax deficiency.

Consequently, her election under section 6015© does not allow her to avoid liability for those taxes.

Section 6015(f) Analysis

Section 6015(f) provides an additional opportunity for relief to those taxpayers who do not otherwise meet the requirements of subsection (b) or (c) of section 6015.

Specifically, section 6015(f) gives respondent the discretion to grant equitable relief from joint and several liability if “taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax”.  We have jurisdiction to review respondent’s denial of petitioner’s request for equitable relief under section 6015(f).  Jonson v. Commissioner, 118 T.C. 106, 125 (2002); Butler v.  Commissioner, 114 T.C. 276, 292 (2000). We review such denial of relief to decide whether respondent abused his discretion by acting arbitrarily, capriciously, or without sound basis in fact.  Jonson v. Commissioner, supra at 125; Butler v. Commissioner, supra at 292. The review of respondent’s denial of petitioner’s request for relief under section 6015(f) is a question of fact.  Cheshire v. Commissioner, 115 T.C. 183, 198 (2000), affd. 282 F.3d 326 (5^th Cir. 2002). Petitioner bears the burden of proving that respondent abused his discretion. Washington v.

Commissioner, 120 T.C. 137, 146 (2003); see also Alt v.

·        28 -

Commissioner, 119 T.C. 306, 311 (2002) (“Except as otherwise provided in section 6015, petitioner bears the burden of proof.”); Jonson v. Commissioner, supra at 113 (same).  As directed by section 6015(f), respondent has prescribed procedures to use in determining whether a relief-seeking spouse qualifies for relief under section 6015(f). At the time that petitioner filed her Petition for Determination of Relief from Joint and Several Liability on a Joint Return, March 10, 2002, those procedures were found in Rev. Proc. 2000-15, 2000-1 C.B.  447. Section 4.01 of Rev. Proc. 2000-15, 2000-1 C.B. at 448, lists seven threshold conditions that must be satisfied before respondent will consider a request for relief under section 6015(f). The threshold conditions are as follows:

(1) The requesting spouse filed a joint return for

the taxable year for which relief is sought;

(2) Relief is not available to the requesting

spouse under [section] 6015(b) or 6015(c);

(3) The requesting spouse applies for relief no

later than two years after the date of the Service’s

first collection activity after July 22, 1998, with

respect to the requesting spouse;

(4) * * * the liability remains unpaid. * * *

(5) No assets were transferred between the spouses

filing the joint return as part of a fraudulent scheme

by such spouses;

(6) There were no disqualified assets transferred

to the requesting spouse by the nonrequesting spouse.

If there were disqualified assets transferred to the

requesting spouse by the nonrequesting spouse, relief

will be available only to the extent that the liability

·        29 - exceeds the value of such disqualified assets. For this purpose, the term “disqualified asset” has such

meaning given such term by section 6015©(4)(B); and (7) The requesting spouse did not file the return with fraudulent intent.

Id. A requesting spouse must satisfy all seven threshold conditions before respondent will consider his or her request for equitable relief under section 6015(f). Id. We have upheld the use of these procedures in reviewing a negative determination.  See Washington v. Commissioner, supra at 147; Jonson v.

Commissioner, supra at 125.

Respondent denied petitioner’s request for equitable relief

under section 6015(f) because she did not meet all seven of the

threshold conditions listed above. Specifically, respondent

concluded that petitioner received a transfer of disqualified

assets from Mr. Ohrman in violation of the sixth condition of

Rev. Proc. 2000-15, sec. 4.01. Respondent reached this

conclusion by considering the time line of events beginning with

petitioner’s receipt of the May 29, 2001, letter of proposed

changes to petitioner’s and Mr. Ohrman’s reported tax liability

for 1999, the transfer of assets from Mr. Ohrman to petitioner

pursuant to the separation agreement, and statements made by

petitioner and Mr. Ohrman during their separate interviews with

respondent. Petitioner maintains that she did not receive a

transfer of disqualified assets; thus, petitioner argues that she

·        30 -

has satisfied the threshold requirements of Rev. Proc. 2000-15, sec. 4.01.

Because we decided that petitioner received a transfer of disqualified assets from Mr. Ohrman, we conclude that petitioner does not meet all seven of the threshold conditions of Rev. Proc.  2000-15, sec. 4.01. Accordingly, we conclude that respondent did not abuse his discretion by acting arbitrarily, capriciously, or without sound basis in fact in denying petitioner’s request for equitable relief under section 6015(f).

Conclusion

We hold that respondent did not err in denying petitioner

relief from joint and several liability under section 6015 with

respect to the joint return filed with Mr. Ohrman for 1999. We

have considered the arguments of the parties not specifically

addressed in this opinion. Those arguments are either without

merit or irrelevant to our decision.

To reflect the foregoing,

Decision will be entered

for respondent.

T.C. Summary Opinion 2001-140

UNITED STATES TAX COURT

LEROY VERNON AND ANNE J. SATRANG, Petitioners v.  COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 1459-00S. Filed September 10, 2001.  Leroy V. Satrang, pro se.

J. Anthony Hoefer, for respondent.

LARO, Judge: This case was heard pursuant to the provisions of section 7463 in effect when the petition was filed. The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority.

Respondent determined a $7,066 deficiency in petitioners’ 1996 Federal income tax and a related $1,413 accuracy-related penalty for negligence under section 6662(a). Following the parties’ concessions, and our dismissal of the case as to Anne J.

·        2 -

Satrang for lack of prosecution, we must decide whether Leroy Vernon Satrang (petitioner) may deduct his alleged gambling losses. We hold he may not. We also must decide whether petitioner is liable for the accuracy-related penalty determined by respondent. We hold he is. Unless otherwise indicated, section references are to the Internal Revenue Code as applicable to the subject year, Rule references are to the Tax Court Rules of Practice and Procedure, and dollar amounts are rounded to the nearest dollar.

Some facts have been stipulated and are so found. The stipulated facts and the exhibits submitted therewith are incorporated herein by this reference. Petitioners are husband and wife, and they resided in Sioux City, Iowa, when their petition was filed.

Petitioner, a civil engineer by profession, is a

recreational gambler who bets primarily on horse races. During

the subject year, he won at least 29 of his gambling bets and

received a total of at least $32,050 in gambling winnings. He

reported none of those winnings on his 1996 Federal income tax

return even though he received Forms W2-G, Gambling Winnings,

listing those winnings. He asserts that none of the winnings are

taxable to him because his gambling losses during that year

totaled more than $70,000. His employer paid $51,600 to

·        3 -

1 For example, petitioner testified that during 1996 he had

“taken home” approximately $75,000 of his salary from his employer and that he gambled away most of that amount and some of his savings. The record, however, reveals clearly that petitioner’s gross salary was only $51,600 and that, of that amount, he took home at the most $37,265.  petitioner during 1996 and withheld $14,335 of that amount for Federal and State taxes.

Respondent determined that petitioner’s gross income includes the $32,050 in gambling winnings shown on the Forms W2-G. Petitioner admits that he received those winnings and that he did not report any of them on his 1996 Federal income tax return.  Petitioner contends that he also had gambling losses for that year which exceeded his winnings.

Petitioner’s gambling winnings are includable in his gross income. Sec. 61(a); Commissioner v. Glenshaw Glass Co., 348 U.S.  426 (1955). As to his alleged gambling losses, petitioner bears the burden of proving that he sustained gambling losses and, if so, the amount of those losses. Stein v. Commissioner, 322 F.2d 78 (5^th Cir. 1963), affg. T.C. Memo. 1962-19. Section 165(d) provides that “Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.”

Petitioner relies primarily on his testimony to prove his

allegation. We find his testimony to be incredible and decline

to rely on it.1 Although we acknowledge that petitioner most

likely had some gambling losses during the year, we are unable to

·        4 -

determine (either with specificity or by estimation) the amount of those losses on the basis of the record at hand. Given the fact that petitioner bears the burden of proof on this issue, we sustain respondent’s determination with respect to it. See Mayer v. Commissioner, T.C. Memo. 2000-295; Zielonka v. Commissioner, T.C. Memo. 1997-81; see also Finesod v. Commissioner, T.C. Memo.  1994-66.

As to the accuracy-related penalty for negligence, section 6662(a) and (b)(1) imposes a 20-percent accuracy-related penalty on the portion of an underpayment that is due to negligence or intentional disregard of rules or regulations. Negligence includes a failure to attempt reasonably to comply with the Code.  Sec. 6662©. Disregard includes a careless, reckless, or intentional disregard. Id. An underpayment is not attributable to negligence or disregard to the extent that the taxpayer shows that the underpayment is due to the taxpayer’s reasonable cause and good faith. Secs. 1.6662-3(a), 1.6664-4(a), Income Tax Regs.  Reasonable cause requires that the taxpayer exercise ordinary business care and prudence as to the disputed item. United States v. Boyle, 469 U.S. 241 (1985); see also Estate of Young v.  Commissioner, 110 T.C. 297, 317 (1998).

On the basis of the record, we sustain respondent’s determination of the accuracy-related penalty. Petitioner has failed to prove respondent’s determination wrong.

·        5 -

To reflect respondent’s concession,

Decision will be entered

under Rule 155.

T.C. Summary Opinion 2001-92

UNITED STATES TAX COURT

PAUL S. LEBLANC, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 13599-99S. Filed June 22, 2001.  Paul S. LeBlanc, pro se.

Linda A. Neal, for respondent.

DINAN, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect at the time the petition was filed. The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the year in issue.

·        2 -

Respondent determined a deficiency in petitioner’s Federal income tax of $504 for the taxable year 1996.  The issue for decision is whether requiring petitioner to include unreported gambling winnings in income violates the constitutional right to equal protection.  Some of the facts have been stipulated and are so found.The stipulations of fact and the attached exhibits are incorporated herein by this reference. Petitioner resided in Gretna, Louisiana, on the date the petition was filed in this case.

Petitioner filed a joint Federal income tax return for 1996 with his now deceased wife, Jacquelyn S. LeBlanc. Petitioner’s wife received a Form W-2G, Statement for Recipient of Certain Gambling Winnings, reflecting 1996 slot machine winnings of $1,773.61. However, no income from gambling was reported on their return. In the statutory notice of deficiency, respondent determined that petitioner had unreported gambling income of $1,773.

Gross income generally includes income from whatever source derived, including gambling winnings. See sec. 61(a); Umstead v.

Commissioner, T.C. Memo. 1982-573. Gambling losses generally are

allowed to the extent of the gambling winnings for the taxable

year. See sec. 165(a), (d). A nonprofessional gambler may claim

·        3 -

such losses as itemized deductions if he elects to forgo the standard deduction. See sec. 63.

Petitioner admits that his wife received slot machine winnings in the amount of $1,773 in 1996, that this amount was not reported on their tax return, and that this amount is income subject to the Federal income tax. Petitioner argues that the taxation of the gambling winnings in his case is “unequal treatment under the law,” in violation of the “equal protection as well as equal treatment” afforded by the United States Constitution. Petitioner argues that certain taxpayers escape taxation on their gambling winnings because casinos do not issue informational returns for all taxpayers who receive such winnings.  Although the Equal Protection Clause in the Fourteenth Amendment limits the powers of the States, there is no comparable clause explicitly applicable to Federal legislation. However, the Due Process Clause of the Fifth Amendment has been construed as imposing an equal protection requirement in respect of classification to the extent that “discrimination [resulting from such classification] may be so unjustifiable as to be violative of due process.” Bolling v. Sharpe, 347 U.S. 497, 499 (1954) (fn. ref. omitted).

In evaluating whether a statutory classification violates equal protection, we generally apply a rational basis standard.

·        4 -

See Regan v. Taxation With Representation, 461 U.S. 540, 547 (1983). We apply a higher standard of review only if it is found that the statute (1) impermissibly interferes with the exercise of a fundamental right, such as freedom of speech, or (2) employs a suspect classification, such as race. See, e.g., id.; Harris v. McRae, 448 U.S. 297, 322 (1980). Neither of these exceptions applies in this case. Under the rational basis standard, a challenged classification is valid if rationally related to a legitimate governmental interest. See City of Cleburne v.

Cleburne Living Ctr., Inc., 473 U.S. 432, 440 (1985); City of New

Orleans v. Dukes, 427 U.S. 297, 303 (1976). Legislatures have

especially broad latitude in creating classification and distinctions in tax statutes. See Regan v. Taxation With Representation, supra at 547.The informational return which petitioner’s wife received in this case was required by section 6041 and the accompanying regulations. As a general rule, a person engaged in a trade or business who makes a payment to an individual in excess of $600 must provide an informational return to the Secretary of the Treasury (or his delegate) and to the individual. See sec.

6041(a), (d). A person engaged in a trade or business who pays

winnings to an individual of $1,200 or more from a bingo game or

slot machine play, or of $1,500 or more from a keno game, must

provide such an informational return. See sec. 7.6041-1(a),

·        5 -

Temporary Income Tax Regs., 42 Fed. Reg. 1471 (Jan. 7, 1977).  This latter return must be made on a Form W-2G. See sec. 7.6041-1©, Temporary Income Tax Regs., supra; see also sec.  31.3402(q)-1(f), Employment Tax Regs. (Form W-2G payer reporting requirements for purposes of withholding). In determining the amount won from such games, the amount wagered is deducted from the winnings in a keno game, but is not deducted in a bingo game or slot machine play. See sec. 7.6041-1(b)(1), (2), Temporary Income Tax Regs., supra. Winnings from more than one game are not aggregated. See sec. 7.6041-1(b)(5), Temporary Income Tax Regs.

Legislation enacted in 1917 added informational reporting

requirements to the Internal Revenue Code similar to the current

provisions under section 6041. See Act of October 3, 1917, ch.63, tit. XII, sec. 1211, 40 Stat. 300. The Senate report accompanying this legislation stated:

That the provisions of the law requiring withholding at the source of the tax due on profits or incomes of resident taxable persons be repealed and instead there be substituted “information at the source,” where the amount of income received in any taxable year and paid over to the taxable person exceeds $800 for any taxable year. * * * The proposed amendment is conducive to a more effective administration of the law in that it will enable the Government to locate more effectively all individuals subject to the income tax and to determine more accurately their tax liability. This is of prime importance from a viewpoint of collections.

In addition to this very important consideration, the

changes will result in the saving of annoyance and

expense to taxpayers and withholding agents in

lessening of expense to the Government, and in

·        6 -

simplifying administration, and in increased effectiveness * * * It is the Treasury Department’s judgment, based upon close observation and study of the practical workings of the withholding feature of the income-tax law as well as of the general requirements of administration, that information at the source is a foundation upon which the administrative structure must be built if the income-tax law is to be rendered most effective and if due regard is to be paid to economy and simplicity of administration and to the imposition of no greater burden and expense upon taxpayers than is necessary for effective administration. [S. Rept. 103, 65^th Cong., 1^st Sess. (1917), 1939-1 C.B. (Part 2) 56, 67-68.]We find petitioner’s argument to be without merit. There is no provision in the Internal Revenue Code which relieves a taxpayer from liability for the income tax on gambling winnings if the winnings are not reported by the payer. Thus, petitioner essentially is arguing that he has not been afforded equal protection because those taxpayers whose winnings were not reported on informational returns have an easier time evading the Federal tax laws. The statutory requirements for informational returns classifies individuals according to the amount of gambling winnings they pay to others. These classification requirements are rationally related to the legitimate governmental interest of balancing the need for reporting requirements to ensure compliance with the tax laws and the need to avoid imposing excessive burdens on covered individuals.  Requiring a casino to report every dollar won from every slot machine would undoubtedly be such a burden.

·        7 -

An aspect of petitioner’s argument apparently is that the casino was not complying with the law by not issuing informational returns when required. Petitioner has provided no evidence supporting this assertion, and even if he had it is unclear how such noncompliance by the casino would bear on an equal protection claim by petitioner.

We hold that requiring petitioner to include unreported gambling winnings in income does not violate the constitutional right to equal protection.

Reviewed and adopted as the report of the Small Tax Case Division.

To reflect the foregoing,

Decision will be entered

for respondent.

T.C. Summary Opinion 2001-85

UNITED STATES TAX COURT

ELDRON U. ERBS, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 1890-00S. Filed June 13, 2001.  Eldron U. Erbs, pro se.

James M. Klein and Mark J. Miller, for respondent.

DINAN, Special Trial Judge: The proceedings in this case

were conducted pursuant to the provisions of section 7463 of the

Internal Revenue Code in effect at the time the petition was

filed. The decision to be entered is not reviewable by any other

court, and this opinion should not be cited as authority. Unless

otherwise indicated, subsequent section references are to the

Internal Revenue Code in effect for the year in issue, and all

·        2 -

Rule references are to the Tax Court Rules of Practice and Procedure.

Respondent determined a deficiency in petitioner’s Federal income tax of $2,532 for the taxable year 1996.  The issue for decision is whether petitioner was engaged in the trade or business of gambling in 1996.

This case was submitted fully stipulated pursuant to Rule

122. All of the facts stipulated are so found. The stipulations

of fact and the attached exhibits are incorporated herein by this

reference. Petitioner resided in Oakdale, Wisconsin, on the date

the petition was filed in this case. Petitioner’s audit commenced on July 2, 1998.  Petitioner is semiretired. During the year in issue, he was engaged in a business in which he purchased and sold antiques.

He incurred a loss of $3,415 in this business. Also during 1996,

petitioner visited the Ho-Chunk Casino in Baraboo, Wisconsin, on

at least 89 occasions. Ho-Chunk Casino produced a Player Coin

Report which indicates petitioner had “coin-in” and “coin-out”

amounts during the year of $368,166.95 and $341,530.20,

respectively. Petitioner made bank withdrawals from automated

teller machines in connection with his Ho-Chunk gambling activity

on 88 separate dates. The following summarizes on a monthly basis the number of days he made withdrawals:

Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.

3 11 3 3 11 6 9 13 10 17 2 0

·        3 -

We treat these numbers as the approximate number of times petitioner visited the casino in each month. He would normally visit the casino during late evening and early morning hours, averaging 9 hours per visit.

Petitioner received six Forms 1099 in 1996 for gambling

winnings. On his 1996 Federal income tax return, he reported the

amounts indicated on the Forms 1099 as his only winnings from

gambling. He reported this income of $10,538 on Schedule C,

Profit or Loss From Business, claiming no cost of goods sold or

expenses other than gambling losses of $10,538, resulting in zero

net profit. Petitioner reported $27,865 in adjusted gross income, consisting of the following:

IRA distributions $26,600

Social Security benefits 3,052

Interest 1,628

Business loss (antique sales) (3,415)

Adjusted gross income 27,865

In addition, petitioner received $9,530 in nontaxable net Social Security benefits. The occupation stated on his return was “retailer”.  Respondent determined that petitioner’s gambling activity was not an activity entered into for profit. Accordingly, respondent recharacterized petitioner’s gambling income and determined that petitioner’s gambling losses were deductible as an itemized deduction rather than as a trade or business expense.

Respondent also determined that petitioner was entitled to

·        4 -

itemized deductions in lieu of the claimed standard deduction and allowed petitioner an additional itemized deduction for the payment of taxes. Finally, a computational adjustment was made to the amount of taxable Social Security benefits. Petitioner disputes respondent’s determination that he was not engaged in the trade or business of gambling.

Ordinary and necessary expenses paid in carrying on a trade or business generally are deductible under section 162(a). A taxpayer who is engaged in the trade or business of gambling may deduct gambling losses and expenses, if otherwise permitted, only to the extent of the taxpayer’s gambling winnings. See secs.  162(a) and 165(d); Valenti v. Commissioner, T.C. Memo. 1994-483.

A taxpayer who is not engaged in the trade or business of

gambling also may deduct such losses and expenses to the extent

of their winnings, but must do so under section 165(a). A deduction under section 165(a) reduces a taxpayer’s taxable income only if the taxpayer elects to forgo the standard deduction. See sec. 63.Resolving the question whether a taxpayer is engaged in a trade or business “requires an examination of the facts in each case.” Commissioner v. Groetzinger, 480 U.S. 23, 36 (1987)

(quoting Higgins v. Commissioner, 312 U.S. 212, 217 (1941)). The

Supreme Court in Commissioner v. Groetzinger, supra, addressing

·        5 -

1That the taxpayer in Groetzinger gambled “with a view to

earning a living from such activity” was not disputed by the

Commissioner. See Groetzinger v. Commissioner, supra at 24 n.2

(quoting Groetzinger v. Commissioner, 82 T.C. 793, 795 (1984)).

the question whether a full-time gambler who gambled solely for

his own account was engaged in a trade or business, stated:

to be engaged in a trade or business, the taxpayer must be

involved in the activity with continuity and regularity and

* * * the taxpayer’s primary purpose for engaging in the

activity must be for income or profit. A sporadic activity,

a hobby, or an amusement diversion does not qualify. * * *

we conclude that if one’s gambling activity is pursued full

time, in good faith, and with regularity, to the production

of income for a livelihood, and is not a mere hobby, it is a

trade or business within the meaning of the statutes with which we are here concerned. Respondent Groetzinger satisfied that test in 1978. Constant and large-scale effort on his part was made. Skill was required and was applied. He did what he did for a livelihood, though with a less-than-successful result. This was not a hobby or a passing fancy or an occasional bet for amusement. Id. at 35-36.

After his employer terminated his position in February 1978, the

taxpayer in Groetzinger devoted the remainder of the year to

parimutuel wagering, primarily on greyhound races. During this

time, he spent 6 days a week for 48 weeks at the track and spent

a substantial amount of time studying racing forms, programs, and

other materials. In all, he devoted 60 to 80 hours each week to

gambling-related activities. After February, he had no

employment or profession other than gambling. He received $6,498

in non-gambling income from interest, dividends, capital gains,

and salary earned prior to termination.1

·        6 -

2Respondent has not challenged petitioner’s deduction of the

loss from the antiques business, so we need not address the accuracy of petitioner’s treatment of the activity as a business.  In this case, petitioner’s visits to the casino were not continuous or regular. Petitioner points to the total number of hours he spent at the casino over the course of the year, and argues that he averaged 20 hours per week gambling. However, his visits to the casino throughout the year were very sporadic. The number of monthly visits rose as high as 17 in October, but in December he made no visits and in several other months he made only 2 or 3. Petitioner also argues that the amount of time he spent in his antique sales business is similar to the amount of time he spent in the gambling activity.2 The aggregate amount of time spent in the activity is not as determinative as the fact that petitioner had little continuity or regularity to his visits. Finally, petitioner argues that the sporadic nature of his gambling was dictated by his knowledge of “how the machines were cycling or if the machines were being adjusted to reduce players odds.” We do not accept this argument, both because it is not supported by any evidence and because we do not find it plausible that petitioner had knowledge of when the video poker machines were producing higher payoffs which was sufficiently accurate or specific to dictate when he should visit the casino.

The primary purpose of petitioner’s gambling activity was

for amusement, not for profit: His activity, although

•     7 -

substantial, was more consistent with a hobby than a trade or

business. He argues that he spent a significant amount of time

studying “cycles” of video poker machines, reading publications

relating to video poker, and practicing on his own video poker machine in order to “achieve greater success while gambling.” These efforts would be consistent with a desire to win money.  However, the desire to win money is consistent with gambling purely for its entertainment or recreational aspects, and we find that petitioner gambled primarily for this reason rather than primarily for profit.

Finally, we note that petitioner is semiretired and in 1996 received a substantial amount of income: Excluding his business loss of $3,415, he received over $40,000 in interest, individual retirement account distributions, and Social Security benefits.  This income and petitioner’s semiretired status indicate that he was not relying upon gambling for his livelihood.

In his trial briefs, petitioner discusses the material

participation requirements of section 469 and the regulations

thereunder. First, petitioner points to the references in these

provisions to 500 hours of participation in an activity, arguing

that he was in the trade or business of gambling because he

devoted nearly twice that amount of time. See, e.g., sec. 1.469-

5T(a)(1), Temporary Income Tax Regs., 53 Fed. Reg. 5725 (Feb. 25,

1988). These provisions govern whether a trade or business is

·        8 -

passive and do not address the more fundamental question of

whether an activity constitutes a trade or business. Second,

petitioner argues that instructions for the Schedule C provide

that there are no “limitations on losses” for nonpassive

activities (i.e., activities which meet the material

participation requirements). It is true that section 469 imposes

no additional limitations on such losses, but the losses are

still subject to the more general limitations discussed above.We hold that petitioner was not engaged in the trade or business of gambling in 1996.

Reviewed and adopted as the report of the Small Tax Case Division.

To reflect the foregoing,

Decision will be entered

for respondent.

T.C. Memo. 2001-36

UNITED STATES TAX COURT

JUAN RODRIGUEZ, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 4624-97. Filed February 14, 2001.  Juan Rodriguez, pro se.

George D. Curran, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WHALEN, Judge: Respondent determined the following deficiencies in, additions to, and penalty with respect to petitioner’s Federal income tax for 1990, 1991, and 1993:

·        2 -

Penalty and Addition to Tax

Year Deficiency Sec. 6651(a) Sec. 6554 Sec. 6662(a)

1990 $2,284 $571 $150 -0-

1991 2,374 -0- –0- $475

1993 24,654 6,164 1,035 –0-

After concessions, the issues for decision are: (1) Whether petitioner is entitled to deduct wagering losses in the amount of $19,690 for the taxable year 1991; (2) whether petitioner must include in gross income a payment in the amount of $100,000 that he received during 1993 from the Federal Bureau of Investigation (FBI) and, if so, whether he is entitled to deduct a portion of such amount as relocation expenses; (3) whether petitioner is liable for the accuracy-related penalty under section 6662(a) for the taxable year 1991; (4) whether petitioner is liable for the addition to tax under section 6651(a)(1) for failure to file a timely return for 1993; and (5) whether petitioner is liable for the addition to tax under section 6654 for failure to pay estimated income tax for the taxable year 1993. Unless stated otherwise, all section references in this opinion are to the Internal Revenue Code as in effect during the years in issue.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits - 3 - are incorporated herein by this reference. Petitioner resided in Philadelphia, Pennsylvania, when he filed his petition in this case.

At one time, petitioner operated an illegal bookmaking business that was frequented by a number of drug dealers.  In 1987, he was arrested by the FBI while acting as a middleman in a transaction involving the purchase and sale of two kilograms of cocaine. The criminal drug charges stemming from his arrest carried a maximum prison sentence of 80 years and fines of $2 million. In order to avoid incarceration on such charges, petitioner pleaded guilty to a narcotics charge and agreed to work as an undercover informant for the Philadelphia office of the FBI. In return, the FBI agreed to bring petitioner’s cooperation to the attention of the judge at the time of sentencing.  In March 1988, petitioner and the FBI initiated an undercover investigation of money laundering and drug trafficking in the Philadelphia area. The investigation was assigned the code name Metroliner. The investigation took place at petitioner’s off-track betting parlor where petitioner also conducted his illegal bookmaking operation.  Petitioner played a central role in the investigation.  He introduced five undercover FBI agents to drug traffickers, money launderers, and gamblers. He made over - 4 - 150 tape recordings, both audio and video, documenting 72 transactions consisting of 23 drug purchases and 49 money laundering transactions. While under surveillance, subjects of the investigation purchased 31 kilograms of cocaine and laundered $5 million in drug proceeds from seven different drug organizations operating in and around Philadelphia. As a result of the Metroliner investigation, 91 persons were indicted and $2.5 million was seized.  Petitioner testified in five trials, the last of which ended in July 1993. Ultimately, because of his cooperation, petitioner was sentenced to 5 years’ probation on the drug charges mentioned above.

During 1991 or 1992, operation Metroliner was

terminated upon short notice. Due to the circumstances

surrounding the termination of the undercover investigation,

petitioner lost certain personal property, including a safe containing some of his personal records. After the investigation was terminated, petitioner declined to enter the witness protection program.

The FBI paid petitioner subsistence and other expenses while the FBI’s investigation continued. Generally, this consisted of monthly payments, that began at $1,500 in 1991, and increased to $2,000 in 1992, and further increased to $3,000 in the middle part of 1992 when the - 5 - indictments were unsealed and petitioner became a witness for the Government. These payments ended in the summer of 1993 at the conclusion of the last trial.  Mr. Paul D. Allen, Jr., Supervisory Special Agent of the FBI, wrote a letter to the United States Attorney’s Office, dated July 7, 1993, stating that between October 1987 and the present “Mr. Rodriguez has been paid by the FBI a total of $84,424.77 all of which has been for expenses.” Mr. Allen’s letter further states:

These expenses were for items such as rent, utilities, food/subsistence, transportation (automobile, gas, oil, tolls, maintenance, insurance), clothing, child support, medical/dental and other miscellaneous living expenses.

In a letter to the Internal Revenue Service, dated March 27, 1995, Mr. Allen stated: “Mr. Rodriguez was paid a total of $75,400.00, all of which was considered to be reimbursement for expenses he incurred during the investigation.”

Petitioner executed receipts for expense reimbursements in the aggregate amount of $81,732.30. Three of the receipts, totaling $4,500, are dated after July 7, 1993, the date of Mr. Allen’s letter to the United States Attorney’s Office mentioned above.

·        6 -

Based upon petitioner’s cooperation in the Metroliner investigation and his testimony during the criminal trials, the FBI made a lump-sum payment to petitioner of $100,000.  A telex from the Philadelphia office of the FBI requesting the Director of the FBI to authorize the payment states as follows:

REQUEST OF THE BUREAU: BUREAU AUTHORITY IS REQUESTED TO EFFECT A LUMP SUM PAYMENT OF $100,000 TO CAPTIONED COOPERATING WITNESS (CW) FOR HIS COOPERATION IN PHFILE 245B-PH-224 ENTITLED “METROLINER”. THIS LUMP SUM PAYMENT REPRESENTS A SHARE OF THE VALUE OF UNITED STATES CURRENCY, CERTIFICATES OF DEPOSIT, VEHICLES, RESIDENCES, FARMS, AND BUSINESS LOCATIONS SEIZED AS A DIRECT RESULT OF THE COOPERATION FURNISHED BY THE [COOPERATING WITNESS].

Mr. Allen’s letter of March 27, 1995, to the Internal Revenue Service describes this payment as follows:

At the conclusion of the case, Mr. Rodriguez was paid a lump sum of $100,000. These funds were to offset relocation expenses and compensate Mr. Rodriguez for his efforts during the investigation.

Mr. John R. Thomas, Special Agent of the FBI, stated in a letter dated May 16, 1995, to a revenue agent of the Internal Revenue Service, that the lump-sum payment given to petitioner at the conclusion of the case was “for any and all claims he may have had, to include: services rendered, relocation, reimbursement for reasonable and - 7 - necessary authorized expenditures, and the like. Our files do not disclose an allocation of these funds.” Petitioner executed a receipt on or about September 30, 1993, which states as follows: “On this date I, Tony Rodriguez, received $100,000 from the FBI as witnessed by the two Special Agents of the FBI whose signatures appear below mine.” At that time, petitioner actually received a cash payment of $90,000 and the cancellation of an advance of $10,000 that had previously been made on August 6, 1993, in anticipation of the lumpsum payment. The receipt for the advance payment that was executed by petitioner states that it was paid “for services”.

Petitioner expected to receive more than the $100,000 from the FBI. His understanding was that the FBI could pay him a maximum of $250,000. He expected the FBI to pay him the maximum amount because the operation had been so successful. He later sued the FBI and six agents of the FBI in the United States District Court for the Eastern District of Pennsylvania attempting to obtain more money.  His suit was transferred by the District Court to the United States Court of Federal Claims. See Rodriguez v. FBI, 876 F. Supp. 706 (E.D. Pa. 1995). His suit was unsuccessful.

·        8 -

While the undercover investigation was ongoing, petitioner was permitted to continue his illegal bookmaking business and to retain the net proceeds from that business.

Petitioner also continued his gambling activities, including

betting at various racetracks and casinos. During that time, petitioner received sizeable winnings and incurred sizeable losses from his gambling activities. Special Agents of the FBI were aware of petitioner’s gambling at racetracks and casinos.

Petitioner attached to his 1991 Federal income tax

return 10 Statements for Certain Gambling Winnings on Form

W-2G that report the following gross winnings, Federal and

State tax withholding, and net winnings from three racetracks:

Gross Fed. Tax St. Tax Net

Date Winnings Wheld. Wheld. Winnings

N.J. State Sports & Exposition Auth. 01/08/91 $8,140.00 $1,626 $244 $6,270.00

N.J. State Sports & Exposition Auth. 01/12/91 5,527.50 1,105 166 4,256.50

N.J. State Sports & Exposition Auth. 03/09/91 626.20 -0- -0- 626.20

N.J. State Sports & Exposition Auth. 03/09/91 626.20 -0- -0- 626.20

Garden State Race Track, Inc. 05/16/91 652.80 -0- -0- 652.80

N.J. State Sports & Exposition Auth. 05/30/91 685.00 -0- -0- 685.00

Philadelphia Park - GRI 06/28/91 2,241.50 447 -0- 1,794.50

Philadelphia Park - GRI 07/30/91 1,801.20 359 -0- 1,442.20

N.J. State Sports & Exposition Auth. 08/01/91 918.60 -0- -0- 918.60

Philadelphia Park - GRI 11/11/91 812.60 -0- -0- 812.60

22,031.60 3,537 410 18,084.60

Petitioner also attached a handwritten schedule to his 1991 return that lists 9 of the 10 payments reported on the Forms W-2G. The handwritten schedule does not list the - 9 - payment from Garden State Race Track, Inc., shown above, in the amount of $652.80.

On line 22 of his 1991 return, petitioner reported other income from “Race Track” in the amount of $21,379.  This amount is $652.60 less than the aggregate winnings reported on the Forms W-2G attached to his return. The record does not explain why petitioner reported only $21,379 of the $22,031.60 shown on the Forms W-2G that are attached to petitioner’s return. Petitioner reported no income from his gambling at casinos or from his other gambling activities.

For taxable year 1991, petitioner claimed a deduction for “gambling losses” in the amount of $19,690.  Petitioner’s return does not give any details concerning this deduction, such as the identity of the payees, the dates, or the amounts paid. This amount is claimed as miscellaneous itemized deduction. Thus, petitioner’s 1991 return does not claim that petitioner is in the trade or business of gambling. Petitioner also claimed a credit of $3,537, the aggregate amount of Federal tax withheld from the winnings reported on the Forms W-2G attached to his return.

·        10 -

Petitioner never filed a Federal income tax return for 1993. Respondent prepared a return for that year, which determined that petitioner owed tax on the $100,000 lumpsum payment.

In the subject notice of deficiency, respondent made adjustments to petitioner’s income for 1990, 1991, and 1993. The adjustments for 1990 were resolved by the parties and are no longer at issue in this proceeding.  Respondent made the following adjustments to petitioner’s taxable income for 1991 and 1993:

1991 1993

Exemptions -0- ($2,350)

Compensation (FBI) -0- 100,000

Itemized deduction/

standard deduction $16,290 (3,700)

Total adjustments 16,290 93,950

The notice describes the adjustment disallowing the gambling losses claimed in 1991 as follows:

For the taxable year ending December 31, 1991, you have failed to substantiate the claimed gambling losses of $19,690. Since this was the only claimed itemized deduction, you are now entitled to the standard deduction of $3,400.  Accordingly, your taxable income is increased $16,290.

The notice describes the adjustment increasing petitioner’s compensation from the FBI in 1993, as follows:

·        11 -

Compensation you received from the Federal Bureau of Investigation for services rendered in [sic] includible in income. Accordingly, your taxable income for 1993 is increased $100,000.

OPINION

Petitioner asks the Court to redetermine two of the adjustments made in the subject notice of deficiency, the disallowance of gambling losses in 1991 in the amount of $19,690, and the inclusion in gross income of the lump-sum payment of $100,000 from the FBI in 1993. Petitioner also seeks redetermination of the accuracy-related penalty under section 6662(a) for tax year 1991 in the amount of $475, and of the addition to tax under section 6651(a)(1) in the amount of $6,164 for failure to timely file his return for tax year 1993.

At trial, petitioner presented no evidence regarding

the addition to tax under section 6654 for failure to pay

estimated tax with respect to his 1993 tax, and he made no

reference to it in his posttrial brief. Therefore, we

consider this issue waived or abandoned. See Bradley v.  Commissioner, 100 T.C. 367, 370 (1993) (“Petitioner has not pursued this line of objection on brief, and we consider it abandoned.”). We hereby sustain respondent’s determination with respect to the addition to tax under section 6654 for 1993.

·        12 -

Wagering Loss Deduction

The first issue for decision is whether petitioner is entitled to deduct wagering losses in the amount of $19,690 for the taxable year 1991. As noted above, respondent disallowed all of the wagering losses claimed by petitioner because petitioner had failed to substantiate the deduction. In his posttrial brief, petitioner acknowledges that he did not substantiate this deduction, but he argues that some amount should be allowed as a deduction. His brief states as follows: “Although it is true the petitioner did not produce complete and accurate records of gambling losses after seven years time, some allowance should have been made for the losses sustained”.  Respondent argues that petitioner did not prove the amount of his gambling losses or that his gambling losses exceeded the amount of his unreported gambling winnings.  Section 165(d) allows taxpayers to deduct losses from wagering transactions to the extent of the gains from such transactions. In order to establish entitlement to a deduction for wagering losses in this Court, the taxpayer must prove that he sustained such losses during the taxable year. See Mack v. Commissioner, 429 F.2d 182 (6^th Cir.  1970), affg. T.C. Memo. 1969-26; Stein v. Commissioner, 322 F.2d 78 (5^th Cir. 1963), affg. T.C. Memo. 1962-19. He must - 13 - also prove that the amount of such wagering losses claimed as a deduction does not exceed the amount of the taxpayer’s gains from wagering transactions. See sec. 165(d).  Implicitly, this requires the taxpayer to prove both the amount of his losses and the amount of his winnings. See Schooler v. Commissioner, 68 T.C. 867, 869 (1977); Donovan v. Commissioner, T.C. Memo. 1965-247, affd. per curiam 359 F.2d 64 (1^st Cir. 1966). Otherwise, there can be no way of knowing whether the sum of the losses claimed on the return is greater or less than the taxpayer’s winnings. See Schooler v. Commissioner, supra at 869. For example, if the taxpayer, in addition to the winnings reported on his or her return, received other winnings that were not reported, then the taxpayer must prove that the losses claimed in his or her return exceeded the unreported winnings in order to be entitled to deduct any such losses.

See id.; Donovan v. Commissioner, supra. The amount

deductible in this situation is the amount of the claimed

losses which exceeds the unreported winnings, as long as

such excess is less than the winnings reported on the

taxpayer’s return. See sec. 165(d); Schooler v. Commissioner;

supra; Donovan v. Commissioner, supra.  In this case, the “racetrack” winnings reported on petitioner’s 1991 return, $21,379, exceed the “gambling” - 14 - losses deducted on that return, $19,690. Petitioner testified at trial that at one time he had records consisting of a shoe box full of losing tickets from the racetrack that would have substantiated the loss deduction but that those records were lost when the undercover investigation was terminated. Petitioner testified as follows:

THE WITNESS: *** Now, as one of the letters indicates from the FBI, that things were left behind. One of the things that was left behind in the safe was a shoebox of losing [racetrack] tickets that would have served [sic] the $19,000.  Even if we were to accept petitioner’s explanation for his failure to verify the gambling losses claimed on his 1991 return, we could not agree that he has met his burden of proof regarding the gambling losses. Petitioner did not prove the amount of his gambling winnings, both reported and unreported, and, thus, he failed to prove that the amount of the wagering losses claimed on his 1991 return, $19,690, is greater than his unreported gains from wagering transactions.

Petitioner acknowledged during his testimony at trial that he had additional winnings that were not reported on his return. On cross-examination, petitioner testified as follows:

·        15 -

Q Now, these winnings are only based upon on [sic] the forms you received from the Government?  A Right.

Q You received other gambling winnings in that year, correct?

A Yes. I also had a lot of losses.

Q But with respect to the gambling winnings, you won other money at the racetrack, correct?  A Oh, yes.

Thus, petitioner admitted that he had earned gambling winnings at the racetrack in addition to the winnings he reported on his return for 1991.

There is also evidence that petitioner had winnings other than from betting at racetracks. For example, the FBI agents with whom petitioner cooperated during the undercover investigation were aware that he had “sizeable losses and sizeable winnings at racetracks and casinos.” Furthermore, petitioner testified that in 1991 he engaged in other gambling activities. He testified as follows:

Q Did you bet any other activities during 1991?  A I bet summer baseball and I play casinos, the dice, poker, everything.

Q At the casinos?

A I’m a gambler.

Q And you bet—

·        16 -

A I’ll bet anything.

Q—anything and lose, correct?

A Anything you could bet.

When asked whether he reported “income” from those activities, he gave the following vague testimony:

Q Okay. But you don’t have any of that income listed on your 1991 tax return; is that correct?

A Well, there wasn’t any at that time. I was with the FBI at all times. Being with the FBI, they were with me. I didn’t list anything because we would be at the casinos.  We would take drug dealers to the casinos.  And I was always with two agents and I was always risking my life every time I went out because the FBI was a mile away from me.  Q Thank you. But you had other gambling wins that you did not report?

A I don’t think so. I lost that year, because I was winning, too.

There is no evidence in the record that gives us a basis for determining or even guessing the amount of unreported gambling winnings earned by petitioner during 1991. Accordingly, we find that petitioner has failed to prove that the losses from wagering transactions claimed as a deduction on his 1991 return do not exceed the gains from such transactions, as required by section 165(d), and we - 17 - sustain respondent’s disallowance of the wagering losses claimed on petitioner’s 1991 return.

Lump-Sum Payment From FBI

The next issue is whether petitioner is entitled to

exclude from gross income or deduct any or all of the lumpsum

payment received from the FBI in the amount of

$100,000. Petitioner acknowledges that he received the

lump-sum payment, and he testified candidly: “I know I owe

taxes on it.” He testified that the lump-sum payment was

paid in part as his share of the property seized by the

Government during the investigation, in part as consideration

for refusing to join the witness protection program, and in part as reimbursement for the expenses of relocating his family. In his posttrial brief, petitioner focuses on the last of the above three reasons for the lump-sum payment, relocation expenses. He argues that he “incurred substantial expenses and cost associated with moving his family” and that “an allowance for relocation expenses” should be taken into account in computing the taxable amount of this lump-sum payment. Petitioner’s brief states:

·        18 -

While acknowledging that the burden of proof rests upon the petitioner for this issue, common sense would dictate the consideration of some costs associated with moving the petitioner and his family.

Petitioner claims that the Internal Revenue Service had previously agreed “to allocate twenty percent (20%) of this payment toward relocation expenses.” Respondent argues that petitioner is required to include in gross income the entire lump-sum payment of $100,000 received from the FBI. Respondent argues that, except for his self-serving testimony: “Petitioner has not offered any evidence to prove he incurred the expenses claimed or that the alleged expenses were deductible.” We agree with respondent. There is no basis in the record of this case upon which we can find that some or all of the lump-sum payment should be excluded from petitioner’s gross income. According to the record, the FBI intended the payment to award petitioner a share of the seized property, to compensate petitioner for his cooperation, and to defray any relocation expenses he had incurred. The original telex requesting authorization to make the payment states that it “represents a share of the value of United States currency, certificates of deposit, vehicles, residences, farms, and business locations seized as a direct result of the cooperation furnished”. Rewards - 19 - of this kind are includable in gross income. See sec.  1.61-2(a)(1), Income Tax Regs. Similarly, Mr. Allen’s letter of March 27, 1995, states that the payment was to offset relocation expenses and to compensate petitioner.  The receipt for the advance on the lump-sum payment allocates the entire amount to “services”. Compensation payments are includable in the recipient’s gross income.  See sec. 1.61-2(a), Income Tax Regs.  Petitioner cites no authority under which the lump-sum payment would be excluded from gross income. We understand that payments to a Government witness are sometimes considered by the Commissioner as welfare payments to the recipient that are not includable in the recipient’s income. See G.C.M. 37,028 (Mar. 3, 1977) and G.C.M. 37,564 (June 9, 1978). For example, assistance payments made by the Department of Justice under the witness protective program of the Organized Crime Control Act of 1970, Pub. L.  91-452, tit. V, 84 Stat. 922, 933-934, are treated as welfare payments and are excluded from gross income.  See G.C.M. 37,028 (Mar. 3, 1977).

The lump-sum payment made to petitioner in this case was not made under the witness protection program, nor was it made in consideration of petitioner’s declining to enter the witness protection program. Petitioner has shown no - 20 - basis for excluding all or any part of the lump-sum payment in this case.

Petitioner argues that the lump-sum payment was made to reimburse him for “relocation expenses”, and petitioner claims to have incurred relocation expenses “greatly exceeding” the lump-sum payment. However, petitioner presented no proof that he incurred any such relocation expenses. Indeed, in his posttrial brief, petitioner never identifies the payees of such expenses, nor does he give the amounts, dates, and purposes of any such payments.

At trial, he suggested, at one point, that his relocation

expenses consisted of cash payments made to his sons and

his former wife (“I gave each son $5,000, I gave her 10,

and $18,000 to move—“). At another point, petitioner made

reference to “receipts from the moving company” that were

left in the abandoned safe when the undercover investigation

terminated. Petitioner never substantiated any such payments, such as by obtaining duplicate “receipts” from the moving company. Thus, even if the lump-sum payment were excludable from gross income to the extent used to defray relocation expenses, petitioner has not substantiated that he paid any such relocation expenses.  To the extent that petitioner claims to be entitled to deduct some part of the payment as relocation expenses, - 21 - we also agree with respondent that petitioner has not met his burden of proving entitlement to the deduction. See Rule 142(a), Tax Court Rules of Practice and Procedure.  Petitioner does not cite the section of the Internal Revenue Code under which he claims to be entitled to the deduction. See generally secs. 217, 132(a)(6), (g), 82.  Moreover, as described above, he refers to relocation expenses, but he never explains the nature of the expenses that he incurred, or identifies the payees, amounts, or dates of any such payments, nor has he introduced proof that he paid any such expenses.

Accuracy-Related Penalty for 1991

The next issue for decision is whether petitioner is liable for the accuracy-related penalty under section 6662(a), as determined by respondent in the amount of $475.  According to the schedules attached to the notice of deficiency, respondent determined that the entire amount of the underpayment was due to negligence. Under section 6662, a penalty is added to a taxpayer’s tax liability if any portion of an underpayment is attributable to negligence or disregard of rules or regulations. See sec.  6662(b)(1). For this purpose, the term “negligence” includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code. Sec.

·        22 -

6662©. The amount of the penalty is 20 percent of the portion of the underpayment to which section 6662 applies.  See sec. 6662(a).

An exception to imposition of the negligence penalty is provided by section 6664©. Under that exception, “No penalty shall be imposed * * * with respect to any portion of an underpayment if it is shown there was a reasonable cause” for that portion of the underpayment and “the taxpayer acted in good faith”. Petitioner bears the burden of proving that he is not liable for the penalty under section 6662(a). See Vaira v. Commissioner, 444 F.2d 770 (3d Cir. 1971), revg. on another issue 52 T.C. 986 (1969);

Bixby v. Commissioner, 58 T.C. 757, 791 (1972).

Petitioner argues as follows:

Accurate records of gambling losses and winnings are difficult to maintain. The very nature of the business makes this task daunting, if not impossible. The very fact that petitioner reported his gambling winnings and losses in his 1991 income tax return, produced records of this fact seven years later, attests to the degree of effort taken by the petitioner to accurately report his gambling winnings and losses. Before the accuracy-related penalty is imposed, I.R.C.  §6662(b)(1) requires taxpayer negligence or disregard for the rules. In the instant case, the respondent has shown neither exists.  Respondent argues that petitioner has not met his burden of proof under section 6662(a). According to respondent, - 23 - petitioner has not shown that there was a reasonable cause for the underpayment or that he acted in good faith regarding the underpayment.

We agree with respondent. Petitioner’s contention, that maintaining accurate records of gambling losses and winnings is difficult, is legally insufficient to overcome respondent’s determination. The fact is that all taxpayers are required to substantiate deductions under section 165(d), and petitioner is being held to the same standard that is imposed on all taxpayers seeking a deduction under section 165(d). See, e.g., Wolkomir v. Commissioner, T.C.  Memo. 1980-344; Salem v. Commissioner, T.C. Memo. 1978-142;

Myers v. Commissioner, T.C. Memo. 1976-191; Taormina v.

Commissioner, T.C. Memo. 1976-94.

We find that petitioner did not prove that the underpayment with respect to his 1991 return was due to reasonable cause or that he acted in good faith. Accordingly, we sustain respondent’s imposition of an accuracy-related penalty under section 6662(a).

Additions to Tax for 1993

The final issue is whether petitioner is liable for the addition to tax under section 6651(a)(1) for failure to file a timely return for 1993, as determined by respondent in the amount of $6,164. An addition to tax is imposed - 24 - under section 6651(a)(1) for failure to file a return unless such failure is due to a reasonable cause and not willful neglect. See sec. 6651(a)(1). The amount of the addition to tax is 5 percent of the tax required to be shown on the return, if the return is filed within a month of the due date, with an additional 5 percent for each additional month or fraction thereof during which the failure continues, not exceeding 25 percent in the aggregate. See id. Petitioner bears the burden of proving that he is not liable for the addition. See Rule 142(a).

Petitioner argues as follows:

* * * Of the $100,000.00 the petitioner received from the FBI, ninety percent (90%), or $90,000.00 was received after petitioner had worked undercover for the FBI. It was agreed that this payment of $100,000.00 would be used to pay for the enormous cost of relocating the petitioner and his family to Puerto Rico.  Although it is true the FBI did not have the authority to determine the taxability of this payment, it is certainly reasonable for petitioner to rely on the FBI’s position and statements regarding this payment. Respondent correctly states that is the burden of the petitioner to establish this fact. However, due to the highly sensitive nature of the undercover operation (which is ongoing), it can hardly be expected for the petitioner to produce as witnesses the FBI agents responsible for leading the petitioner to believe this payment would not be considered taxable income. It is the position of the petitioner that this $100,000.00 payment is not fully taxable. If plausible disagreement as to the taxability of this income exists to this day, it can surely be said the petitioner had a reasonable expectation - 25 - this payment would not be taxable income; hence reasonable cause and not willful neglect. For these reasons, the respondent’s determination should not be sustained.

Thus, petitioner argues that his failure to file his 1993 return is due to “reasonable cause and not willful neglect”. Sec. 6651(a)(1). Respondent argues that “petitioner failed to timely file an income tax return for the taxable year 1993 and presented no evidence disputing the assertion of the addition to tax.” We find that petitioner’s argument lacks merit.

Petitioner admitted at trial that he received the lump-sum payment of $100,000 from the FBI and he owed tax on the payment. He testified as follows:

THE COURT: * * * Do you admit that $100,000 is

income? * * *

THE WITNESS: I admit that was income. * * *

* * * * * * *

THE WITNESS: I know I owe taxes on it. But I figure a reasonable amount should be used for relocation of me.

Thus, petitioner admittedly earned substantial taxable income during 1993, and he was required to file a return for that year. See sec. 6012(a).

Petitioner’s posttrial brief implies that he relied on the statements of unnamed FBI agents that the subject lump-26 - sum payment “would not be considered taxable income”.  There is no factual basis for such argument in the record of this case. Neither petitioner nor the FBI agent who was called as a witness testified that an FBI agent gave petitioner any such advice. Indeed, petitioner did not even ask the FBI agent about any such statements.  Petitioner does not identify the agent or employee of the FBI who allegedly gave him such advice, nor did he subpoena such person to testify. We do not accept petitioner’s attempt to explain his failure to call the agent to testify on the ground that the undercover operation was ongoing at the time of trial or that it would have been compromised by the agent’s testimony. There is nothing in the record to suggest that the operation was ongoing at the time of trial, but, even if it were, there is no reason to believe that the agent’s testimony concerning statements about the taxability of petitioner’s lump-sum payment would have compromised the operation. Indeed, petitioner exhibited no such reluctance in 1994 when he filed suit against the FBI and six of its special agents seeking a greater share of the money and property that had been seized during the undercover operation. We find that petitioner failed to show that his failure to file a return for 1993 was due to reasonable cause and not willful neglect, and we sustain - 27 - respondent’s determination of the addition to tax under section 6651(a)(1) in the amount of $6,164.

To reflect the foregoing and concessions by the

parties,

Decision will be entered

under Rule 155.

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