IRS Targeting Those Who File as Professionals

The Automated Under Reporting (AUR) unit of the IRS, located near Holtsville, New York, is the part of the return processing system that utilizes computers to examine all returns to verify the math and then flag them based on so-called secret criteria in addition to errors in math. At that point, humans then examine the flagged returns and determine whether to issue a notice of deficiency to the taxpayer. We have learned that one thing that triggers a flag is filing as a professional (that is, using Schedule C of your return to report your gambling activity). The IRS does not have the personnel to examine all of the returns that the computer flags, so the computer randomly kicks out only a certain number of returns. The returns selected for rejection by the IRS are reworked to reflect filing as an amateur, which means that winnings are moved from Schedule C to Form 1040 as "other income," losses are moved from Schedule C to Schedule A as "other miscellaneous deductions," and all related expenses reported on Schedule C are disallowed. The tax is recalculated and a notice of deficiency issued to the taxpayer.

A number of gamblers who received such notices came to us for assistance. First, we replied to a notice with a letter of disagreement, or in some cases were able to discuss it with a manager at the UAR. So far, the IRS has stonewalled our arguments that the taxpayers meet all of the criteria that must be met to be recognized as professional gamblers.

To refresh your memory, the criteria is that you must gamble with continuity and regularity with an expectation of a profit. You must pursue your gambling activity "full time" for the production of income for a livelihood. The IRS seems to be going after those who have another job or a substantial source of income, such as a pension, investments, and so on. The strategy seems to be to force these "lucky" gamblers to go to tax court or pay their deficiencies, both of which can cost a substantial sum of money. Taxpayers who have smaller deficiencies may choose to pay the amount of the deficiency rather than go to Tax Court, due to its cost. You may not know this, but when you petition the Tax Court to hear your case, it is always "kicked back" to a senior appeals officer for one last appeal. Oftentimes, an agreement is reached, because the IRS does not want to spend the money on a Tax Court case. Note that the only issue in these cases is whether you are or are not a professional gambler; they are not auditing any of your numbers.

We recently completed our first defense of a taxpayer caught in this web. She had another full-time job that paid her approximately $100,000. This was the reason given by the IRS for denying her professional gambler status. The IRS concluded that there was no way she could pursue her gambling full time, and that her salary provided her a livelihood. Her net gambling winnings reported was only $2,794. She decided to petition the Tax Court herself, and then retained us to prepare a defense of her position that she is a professional gambler. For Tax Court, the defense must be presented in the form of a "brief." She was unaware that there was one more appeal available to her. We were contacted by the appeals officer to schedule the pre-Tax Court conference, as it is called. We prepared a brief that presented our reasons that she is a true professional gambler. The brief cited previous Tax Court cases in which professional gambler status has been upheld even though the taxpayers maintained full-time jobs or reported losses. We also included other arguments based on the IRS Code and Regulations.

The result was that the auditor upheld her professional status by issuing what is known as a "no change" decision. Things that worked in her favor were proper record keeping, which included the number of hours she spent on her gambling activity, and reporting more income than was reported on W-2Gs. Reporting income based only on W-2Gs is a big red flag and is not acceptable to the IRS, because it knows you must have had some winnings that were less than the amount required for the issuance of a W-2G.

We currently are working on several more such cases, and will report any new pertinent facts or circumstances that affect the IRS' decisions.

If you have any questions regarding tax regulations as they apply to gaming that you would like to see answered in Card Player, please mail/e-mail them to us. We will keep your identity confidential. If you would like to utilize our professional services or order our book, The Tax Guide for Gamblers, please call (800) 829-7271. For more information, see our ad in this issue.