At the start of prior tax years, I have advised readers to maintain a complete record of their gambling transactions and otherwise prepare in a prudent fashion for possible dealings with the Internal Revenue Service.
Unfortunately, it had become increasingly difficult for bettors to define what a prudent course of action is. A gambler who lies cheats on his taxes may be courting trouble, but one who acts honestly and hews to the IRS guidelines is courting financial disaster.
Bettors often complain, with justification, that they hear different interpretations of the IRS rules every time they talk to a different agent. So I asked the IRS national headquarters here if it could provide some definitive guidelines for gamblers.
I was particularly interested in the situation (described in a recent column here) faced by a professional gambler who was being assessed for a far-fetched "minimum tax" payment. The charge seemed to be the product of some demented revenue agent's imagination, but Mark Rocawich, chief of the examination section at IRS, said the application of the minimum tax to bettors was a proper reading of the tax laws.
IRS rules specify: "Income derived from wagering transactions is . . . includible in gross income. Losses . . . may be claimed only as an itemized deduction."
Thus a gambler who wagers $200,000 during a year and made a $20,000 profit would list $200,000 as his gross income and claim a $180,000 deduction for losses. But the IRS would then treat his return like that of a rich man who pocketed $200,000 in income and deducted $180,000 for depreciation and other write-offs, and sock the gambler for a minimum tax payment of about $10,000.
This is patently ridiculous. The gambler's financial situation is little different from that of a grocery-store owner who grosses $200,000 and pays out $180,000 in expenses. The government would have no trouble perceiving his income as $20,000, not $200,000.
"The difference," Rocawich said, "is that a grocery store is in a trade or business. A gambler is not."
A case went before the U.S. Tax Court in 1975 that would provide the basis for the IRS' view of gambling. Alfred Gentile of Liverpool, N.Y., had derived all his income from wagering over the previous four years, and the IRS tried to collect the self-employment tax that is imposed on people who have their own trade or business.
The court ruled against the IRS: "A trade or business involves something more than the production of income for federal income tax purposes. Upon stepping up to the betting window, petitioner was not holding himself out as offering any goods or services to anyone. . . Accordingly we hold that petitioner's wagering activities were not the carrying on a trade or business." p
Because a gambler is not engaged in a business, the IRS forbids him to handle his taxes the way the grocery-store owner does, by using Schedule C, "Profit or Loss from Business or Profession." The gambler is asked to fill out his tax return in a fashion that makes him vulnerable to the minimum tax. If a gambler pushed $300,000 through the mutuel windows and lost $100,000, he would still be technically required to list the $200,000 he collected as income. "He would owe a minimum tax even though he lost," Rocawich said, hastening to add that Congress passes the laws and the IRS only enforces them.
The Gentile decision in 1975 also gave the IRS a basis for disallowing deductions for expenses that a gambler incurs. If a horseplayer declares a profit he may think he is entitled to deduct the costs of programs, racing forms and transportation. But Rocawich said he may not; the gambler can't have business expenses because again, he is not in business.
Another tax court decision suggests otherwise, however. In 1971 a taxpayer named James Shiosaki claimed deductions for the costs of frequent trips to Las Vegas, where he was employing a system for wagering on craps. The court indicated that expenses would be deductible in a "transaction motivated by a profit-seeking purpose," but threw out Shiosaki's claims because he had lost $50,000 over the previous decade. The decision left the door open for a profit-making gambler to deduct expenses, but there still has not been a case that confirms this right.
Where does all this leave the average horseplayer?
During the course of 1981, tens of thousands of racetrackers will collect large payoffs from which the IRS will immediately confiscate a 20 percent withholding tax. These bettors are entitled to get their money back if they do not made a net profit for the year. Since they cannot avoid all dealings with the IRS, I recommend the following course of action:
1. Do not get someone else to sign withholding-tax forms at the track for you. This is dangerous; bettors have been convicted of felonies and sent to jail for this seeminlgy innocuous offense. It is also stupid; if a gambler is legally entitled to the money that has been withheld, he should not surrender it without a fight just because he feels intimidated by the IRS.
2. Keep accurate records of all you gambling transactions. The only way to recover money that has been withheld is to document offsetting losses. This record-keeping isn't as burdensome as it sounds. When you go to the track, note all your bets on the program, total the day's profit or loss and save all your programs. More meticulous horseplayers might maintain a ledger summarizing all these transactions. Saving tickets might be helpful, too, but it is not essential.
3. If you have declared net gambling winnings in this or any recent year, claim all your reasonable gambling-related expenses as a deduction. In the eyes of one court at least you are entitled to them, and the worse thing the IRS can do is disallow them. More likely, you will be able to do some bargaining with your auditor.
4. Unless you want to invite a minimum-tax assessment and possible bankruptcy, disregard the IRS' absurd guidelines and simply list your net profits under gross income. If the government does try to collect a minimum tax, get a lawyer and fight. It seems inconceivable that any court could uphold regulations that mock common sense, that make citizens pay huge taxes on "income" that never existed.