It’s No Gamble! The Lesson is: Keep Good Records

Tax law requires, it should be no surprise, that all winnings from gambling be reported as income. In fact, those gross casino winnings you may have are to be reported on the “other income” line on page 1 of Form 1040. And we know you’ll be disappointed to hear that your costs of gambling are deductible, but only as “miscellaneous itemized deductions” if you itemize, and even then they are limited to the amount of gross earnings from gambling. In other words, if you had a net loss for the year from gambling activities, you may not deduct the loss—no carryovers, no carrybacks, nothing!

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Here’s another thing for you to consider. The IRS expects you to keep a record of both your winnings and your cost of gambling (wagers). As is the case for most income and expenses, you must be able to substantiate what you are reporting. This is usually not much of a problem for the income, as the payer is to provide you with a W2-G for gambling winnings. The amounts won which require reporting differ depending on what type of betting is done, but slot machine winnings must be reported if they exceed $1,200 on a wager.

But the documentation of the wagers is not as easy: you should keep a log showing date, winnings and wager expense for each wager. Although you might make it through an IRS audit with less documentation, you shouldn’t count on it. In fact, you would not want to operate as the taxpayer did in a Tax Court case last year. The taxpayer, Jacqueline D. Burrell, in the words of the Court, “frequented gambling casinos for recreation several times each week, primarily playing slot machines. (She) gambled in cash; she did not track her daily winnings and losses.”

Ms. Burrell, the taxpayer in Burrell v. Commissioner (T.C. Memo 2014-217, October 14, 2014) was audited and Ms. Burrell’s gambling activity was one of the areas the IRS examined and made changes to.

In the examination, to substantiate her gambling losses, Ms. Burrell provided documents for 2 of the 3 years under audit, which listed the dates she gambled, the names of the casinos, and the daily amounts of cash she brought to the casino. She also provided ATM receipts and cash advance receipts from the casinos frequented, and a letter from 3 of the casinos for several of the years, stating the amounts the petitioner lost in some of the years being audited.

In the end, the auditor allowed all of the loss amounts reported on the casino letters, as well as the amounts set forth in the ATM receipts and cash advance receipts. Ms. Burrell did not get to deduct the rest. She had other (non-casino) issues with the IRS as well, and in the end owed $115,916 in tax, and $23,184 in accuracy related penalties, and of course paid interest on it all.

But be wary of this: the Tax Court said, in part: “Taxpayers are required to maintain “permanent books of account or records***as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return…” And, “On the basis of the casino letters and other documents, as well as petitioner’s oral explanations and the virtual certainty that she had slot machine losses during the years involved (emphasis added), the IRS conceded that petitioner was entitled to deduct approximately…70% of the aggregated reported gambling losses for the three years involved. The evidence in this case is not sufficient for us to hold that petitioner is entitled to deductions for gambling losses in amounts greater than those (the IRS) conceded.” The message is clear: even though the Court believed that it was virtually certain that Ms. Burrell lost money in her gambling activities, the Court accepted the IRS conclusion that she wasn’t entitled to deduct as much as she won because there was insufficient evidence for it.

The lesson is this: if you don’t have evidence, and the IRS doesn’t agree with you, the Tax Court is very unlikely to do so.

So take our advice, and that of the IRS and Tax Court, and if you gamble, keep very good records at the time of what and when you win and what and when you wager. You’ll be glad you did at tax time, and ecstatic if you get audited.

 

Joe

The City Wire: Document Retention

In his article ‘Document Retention‘, published this week in The City Wire, David puts the old rule of seven years to the test as he discusses the importance of a well defined document retention system.

So now that another year has ended, many businesses have employees looking for space to move the 2014 files and records so they will have room to store  2015 information. With this process comes depletion of cognitive energy spent on deciding what old documents can be shredded or deleted from the server. Ah, if there was only an easy answer.

Read David’s article at The City Wire.

Is It Worth Your Effort?

Leon and Margaret Daniels owned nine vehicles back in 2005 and 2006 and they used them in connection with their business, A1 Carpet Cleaning, an unincorporated business. A1 Carpet Cleaning, as the name suggests, cleaned carpet and upholstery. The nine vehicles consisted of a 1988 Jeep, a 1986 Cadillac, a 1975 Chevrolet Nova, a 1994 Lincoln Continental, four vans and a 1965 Ford pickup truck.

The IRS has strict rules regarding automobile deductions.

Are you protecting yourself from an automobile deduction disaster?

Most business owners understand that the Internal Revenue Code allows the deduction of automobile and truck expenses when incurred in connection with business. However the Daniels were audited by the Internal Revenue Service and the IRS disallowed the expenses incurred for use of four of the vehicles used in the business in 2005 and 2006. Apparently the Daniels felt the IRS was wrong so they exercised their right to take the matter to the U.S. Tax Court. They told their story to the U.S. Tax Court, but the Tax Court agreed with the IRS and upheld the disallowance of the deduction and told the Daniels to pay the $30,427 of additional taxes and penalties due the U.S. Treasury because of the IRS adjustment to their income taxes. So what went wrong for the Daniels?

In addition to business use, the Daniels used the Jeep, the Cadillac, the Nova and the Lincoln for some personal use. Their fatal mistake was they did not keep a mileage log to document the business use of the four vehicles nor did they keep receipts for the vehicle expenses.

There is a long standing rule, the Cohan Rule, which states that when a taxpayer establishes that he or she paid or incurred a deductible expense but does not establish the amount of the expense, an estimate of the expense can be used. However, there must be sufficient evidence in the record to permit the IRS or the court that the taxpayer incurred the expense in at least the amount allowed.

The problem with vehicle expenses is that there is a pesky Internal Revenue Code section, Section 274(d), which makes the Cohan Rule inapplicable for certain classes of expenses. Expenses falling under the rules of Section 274(d) have stricter requirements for documentation than other types of expense. The types of expense ruled by Section 274(d) are traveling, entertainment or recreation, gifts and listed property. Listed property includes passenger automobiles.

In the exact words of the Internal Revenue Code’s Section 274(d), “No deduction or credit shall be allowed…unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer’s own statement (A) the amount of such expense or other item, (B) the time and place of the travel, entertainment, amusement, recreation, or use of the facility or property, or the date and description of the gift, (C) the business purpose of the expense or other items, and (D) the business relationship to the taxpayer of persons entertained, using the facility or property, or receiving the gift.”

The Tax Court wrote in their opinion, “Petitioners did not comply with the strict substantiation requirements of section 274(d). They [the Daniels] did not maintain a contemporaneous diary, calendar or mileage log of their business travel and have failed to prove that they otherwise made a record of the alleged business use of each vehicle at or near the time of the use. The did not retain receipts for the expense reported, did not otherwise produce documentary evidence of the expense reported, and did not establish the total business miles driven during the years at issue. Instead, petitioners [the Daniels] offered general and uncorroborated testimony, along with a handwritten summary sheet of expense and an estimate of the business use of each vehicle. Such evidence does not have the high degree of probative value necessary to elevate it to the credibility of a contemporaneous log. Accordingly, we conclude that petitioners have failed to substantiate their claimed vehicle expense deductions under section 274(d)….”

The Potts paraphrase of this code section and the lesson to be learned is that if you want to make sure you can deduct your business expenses for travel, entertainment, gifts and most passenger automobiles, then you had better document in some way the amount, time, place, business purpose and, if applicable, the business relationship of any person you spent money on in order to get your deduction. Documentation usually requires some form of ink and some type of paper or digital equivalent.

The other five vehicles? It doesn’t say, but they either did not fall under the definition of “listed property” and therefore did not have to meet as strict requirements as the four passenger vehicles of which the expenses were disallowed or they had records to substantiate their expenses.

 

David

Source: Daniels v Commissioner, U.S. Tax Court, 5828-12S, February 24, 2014, Unpublished, T.C. Summary Opinion 2014-16