IRS Examinations of Gaming Returns on the Rise

Last year we warned you that the IRS was targeting gambling returns for audit. This has proven to be true, as the number of gambling-related audit engagements that we have had so far this year is greater than any other year since we started this business. Also, we have had a number of consultations with gamblers who filed as professionals using Schedule C. In several instances, the IRS rejected the Schedule C and changed these players to amateurs, putting their winnings on Form 1040, Page 1, and losses on Schedule A. It seems the new IRS has decided to use the original Supreme Court case of Goetzinger vs. Commissioner as its rational for changing these returns. In this case, the Supreme Court stated, "If one's gambling activity is pursued full time, in good faith, and with regularity for the production of income for a livelihood, and is not a mere hobby, it is trade or business within the meaning of the statute." The IRS has interpreted "full time" as not having other employment. This is being done in spite of a number of U.S. Tax Court cases that have allowed taxpayers with full-time jobs to file as professionals - that is, as businesses, reporting their gambling on Schedule C with the ability to deduct their gambling-relating expenses. As decided in numerous Tax Court cases, any net loss from a gambling business cannot be claimed.

We are currently assisting a taxpayer who, in the year in question, had a full-time job but also spent more than 40 hours a week pursuing his gambling activity, which was profitable. The client quit his full-time job in a subsequent year and now relies on gambling for his income. The client was unsuccessful in his attempts to appeal the IRS' findings, and has decided to go to the Tax Court for relief. We are currently preparing a brief to be presented to the Tax Court that will argue that a person can have two "full-time" pursuits of income. We are relying on Tax Court cases that have allowed taxpayers with full-time jobs to be treated as professional gamblers. This case has been placed on the Tax Court docket, but no date has been assigned yet. Normally, the Tax Court kicks the case back to the IRS for a final appeal before hearing it, but this has not yet occurred.

Another client is going to appeal the IRS' decision himself, using Tax Court cases that have upheld multiple occupations. However, he gambles only one or two days a week and his income from gaming amounted to only 10 percent of his total income.

We will advise you of the outcome of both of these cases. If this has happened to you, please send us an E-mail so that we can get a handle on the scope of this new IRS position.

We were involved in an audit of a full-time professional gambler recently, in which the client had to produce the documents that supported his gambling winnings and losses. Unfortunately, the client did not send us the documentation until the day before the audit, which did not give us time to review the material in depth prior to the audit. The documentation consisted of a small wire-bound notepad as his diary. Also submitted were recap sheets by month on columnar accounting paper with each day listed and totals for winnings and losses. When we got into the audit, the auditor added up the diary entries and compared them to the recap sheet totals. They did not match. The auditor made the comment that it appeared to him that the diary "was prepared yesterday," which it did. It appeared to be new as it was in very good condition, which one would not expect if it had been carried around and used on a daily basis. The auditor decided to accept the recap sheets as the actual results. Neither of these documents agreed with the numbers the client had sent us when we prepared his return, and therefore he was assessed additional tax. There was no room for us to defend the figures on his return. The lesson to be learned from this is: Keep your diary as you go, and make sure that whether you use recap sheets or not, the totals you report to your tax preparer agree with those on your documentation. Also, give your representative time to review your documentation. You should get this information to your representative at least two weeks before the audit date so that he has time to find any discrepancies that may exist. Otherwise, he cannot properly defend your return.

We have another client who files as a recreational player and whose gambling losses are being audited. The client received W-2Gs from slot play that totaled six figures, and claimed that total as winnings and the same amount as losses. We have statements from most of the casinos involved that the coins in/out statements indicate that the client lost money. However, when speaking with the auditor regarding this case, he made the statement, "He will never be able to substantiate the losses." This is very scary, and we think we will have to request a change of auditor. But the mere fact that this is the mindset of some of the auditors, whether expressed or not, seems to indicate that audits are going to be much tougher than in the past. The fact that the one auditor took the time to add up the winnings and losses in the client's diary was a new experience for us. In the past, they sampled a few entries and compared them to what was on the recap sheet. If a client does not provide a recap sheet, we prepare one to verify that the numbers reported match. We cannot afford surprises, such as the one we encountered in the audit discussed earlier. Do not forget that when you sign your return, you are attesting, under penalties of perjury, "I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and compete." The onus is on you, not the preparer.

Editor's note: As enrolled agents, in addition to tax preparation, Yolanda Smulik-Roche and Roger C. Roche are licensed by the Treasury Department to represent and defend clients before the IRS nationwide. Their book, The Tax Guide for Gamblers, is the most comprehensive one on the subject. See their website at www.rbstaxes.com for more information regarding their practice, articles, and useful tax links. They do business as R.B.S. Tax Services, are located in Las Vegas, Nevada, and can be reached at (800) 829-7271. They also maintain an office in California. They do business by appointment only.