Beware, IRS Crackdown on Gamblers is Now in Full Force!

The IRS recently affirmed that it is taking a much closer look at amounts claimed as gambling winnings on line 28, "Miscellaneous Income," of the 1040 form, especially in cases in which the amount claimed is exactly the same as the total amount of the W2-Gs issued to the taxpayer throughout the year. This has been our experience as well as that of many other licensed tax preparers. Tax Analyst, in a recent edition of its Weekly Tax Review, reported, "However, the reality of gambler record keeping means that the reporting of gross winnings seems often, or usually, to take place only to the extent of information returns filed with the federal government, while deducting losses in an amount deemed equal to the winnings but without convincing support." In simpler terms, the only winnings that get reported on the typical gambler's tax return are those for which they received a W2-G. (This is a multipart form that is issued to the IRS by the casino/cardroom when, in one transaction, a gambler wins an amount equal to or greater than a specified amount per the IRS.)

Reporting only "signers" (W-2Gs received) as one's total gambling winnings is a practice that is quite prevalent, and now has become a "red flag" for the IRS for further investigation. As reported by Tax Analyst, a U.S. Tax Court ruling issued earlier this year was on point regarding this practice of reporting only "signers." The case involved a gambler who also ran an illegal bookmaking business frequented by drug dealers, and who had been arrested by the FBI as a middleman in a cocaine sale. The major issue in his case was the taxability of the money he received from the FBI for serving as an undercover informant to get his sentence reduced to five years' probation on the cocaine charge. We, however, are interested in his gambling activities and how they were reported.

While the undercover drug investigation was ongoing, the taxpayer was allowed to continue his bookmaking business and his personal gambling activities, which included betting at various racetracks and casinos. During 1991, his gambling generated 10 W-2G information returns from the three racetracks he had frequented, with reported winnings totaling $22,031.60. The taxpayer included slightly less than this as "miscellaneous income" on his Form 1040, apparently overlooking one of his W-2Gs. He reported no income from his bookmaking, or his casino or other gambling, and claimed an itemized deduction for gambling losses of $19,690. The IRS disallowed that loss in its entirety.

The taxpayer admitted that he had failed to substantiate his gambling loss deduction. He testified at trial that he had once had a shoe box full of losing tickets that would have substantiated his $19,690 of claimed losses. He claimed that it had been lost by the surreptitious moving about that accompanied the termination of the undercover investigation.

At trial, the Tax Court judge's questions from the bench confirmed that the winnings reported on the 1040 return were only those reported on information returns provided by the IRS. He then asked the taxpayer, "You received other gambling winnings in that year, correct?" The taxpayer replied that he had, and added, "I also had a lot of losses." The judge then asked, "You won other money at the racetrack, correct?" The taxpayer agreed that he had.

In his case opinion, the judge therefore commented that there was also evidence that petitioner (the taxpayer) had winnings other than from betting at racetracks. For example, the FBI agents with whom the taxpayer cooperated during the undercover investigation were aware that he had "sizeable losses and sizeable winnings at the racetracks and casinos." The judge concluded, "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 the petitioner during 1991. Accordingly, we find that the petitioner has failed to prove that the losses from wagering transactions claimed as a deduction on his 1999 return do not exceed the gains from such transactions as required by (Internal Revenue Code) section 165(d), and we sustain respondent's disallowance of the wagering losses claimed on petitioner's 1999 return."

What the judge seemed to be saying was that a loss under section 165(d) of the Internal Revenue Code will be allowed only if the taxpayer can prove both the amount of the gambling winnings and the amount of the gambling losses, and will be disallowed if either element (winnings or losses) is not established. In other words, the days of merely reporting winnings equal to the W-2Gs that you received are over.

You will seldom succeed in persuading either the IRS or a court that limiting winnings to those reported to the IRS by payers meets the requirements of the tax law.

IRS (and state) auditors are awakening to the fact that W-2G winnings are only a part of the total winnings for anyone who gambles, especially those who wager only small amounts. In fact, some industry experts expect to see a study one of these days that will estimate the non-W-2G winnings of the average gambler as a percentage of the W-2G winnings for various types of wagers and gambling games, followed by compute-generated notices of deficiency for both federal and state income taxes.

We soon will discuss more ramifications of this ruling and other recent rulings, including their effect on the professional gambler who uses a Schedule C.

Our business is now headquartered in Las Vegas. Our new mailing address is: RBS Tax Service, 8170 W. Cheyenne, Suite 109, Box 177, Las Vegas, NV 89129. We accept questions and comments regarding our columns by mail and E-mail: [email protected]. We are now accepting new clients; see our ad elsewhere in this publication or contact us at (800) 829-7171 or (702) 804-0439.