How NOT to Deduct Your Gambling Losses On Your Tax Return

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I spent a big chunk of my adult life in Reno, NV and so it’s a little nostalgic for me to watch cases that involve taxes and gambling. (Only we called it gaming back in the day.) You can offset gambling losses against gambling wins. And if you qualify as a professional gambler, you have a business with expenses (including losses) just like any other business. Those are two rules that are then subject to a lot of interpretation. A recent court case shot down one attempt at redefining how to apply them.

In the case of Sjoberg v the Commissioner, Tax Court heard the case of an elderly couple, living on Social Security and some W-2 income, who were recreational gamblers in 2004.In 2004 petitioners were recreational gamblers. In 2004 they received $19,995 in wage income, $1,439 in business income, $10,000 as an IRS distribution, and $20,154 in Social Security benefits. Also in 2004, petitioner Mary E. Sjoberg won a $4,000 slot machine jackpot, which was fully offset by her gambling expenses.

On their 2004 joint Federal income tax return, petitioners did not include the $4,000 jackpot in income and they did not claim their offsetting gambling expenses. Rather, petitioners simply attached a handwritten note to their return disclosing the $4,000 jackpot. Petitioners also treated only $4,704 of their Social Security benefits as includable in income.

The couple had received a W-2G from the casino and so had the IRS. The IRS’s computer kicked out their return because they hadn’t reported numbers to match the reported income. And that meant an audit.

The IRS immediately caught that the $4,000 jackpot should be shown as gross income (part of page one of the Form 1040) and then the loss is shown on a subsequent schedule. However, because the income is shown in gross income that triggers an increase in the tax on the Social Security benefits.

Now this is where it gets interesting. The taxpayers agree that the losses only can be taken to the extent of winnings,but their argument was that because of the way it had to be reported the tax treatment was discriminatory against the elderly. In my favorite line of the case, the taxpayers said that today’s casinos are like “Disneyland” to the elderly, offering all sorts of freebies to entice the elderly into casinos to gamble.

They complained that it is just “too easy” for the elderly to gamble and therefore that the tax rules applicable thereto are outdated and should not be enforced — particularly those rules that affect the taxability of Social Security benefits.

They lost their argument and had to pay the tax PLUS a stiff penalty.

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