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Substantiating Gambling Losses in Tax Court

Many taxpayers who report gambling winnings and losses don’t maintain satisfactory records of their gambling activity.  Page 12 of this IRS publication states:

You must keep an accurate diary or similar record of your losses and winnings.  Your diary should contain at least the following information:

  • The date and type of your specific wager or wagering activity.
  • The name and address or location of the gambling establishment.
  • The names of other persons present with you at the gambling establishment.
  • The amount(s) you won or lost.

The publication goes on to provide types of sufficient documentation specific to the type of wagering activity.

As I’ve said before, the amount of detail asked from the IRS in this regard is excessive.  If you merely present that excuse to the IRS, however, you will likely lose every time.  Alternatively, taxpayers conjure up various methods to prove the amount of gambling losses reported on their tax return is accurate.

The method employed by William Jones in his recent U.S. Tax Court case came up very short.

Mr. Jones regularly played slots in Chicagoland area casinos during 2006.  Jones didn’t file a tax return that year.  Instead, the IRS prepared a substitute return for him, and assessed a tax deficiency.  Although not entirely clear from the court’s opinion, let’s presume this deficiency was based upon $7,000 in gambling winnings reported to the IRS on multiple Form W-2Gs.

Jones contended that he also had gambling losses from the tax year of approximately $7,000.  A predictable response from the IRS: OK, prove to us your gambling losses.

Instead of showing any sort of contemporaneous diary of his gambling activity, Jones presented his bank account statements, which showed a balance of $7,531 on December 31, 2005, and a balance of $947 on December 31, 2006.  Jones testified that most of his withdrawals from the account was spent on gambling.  The taxpayer’s theory was “that his losses must have approximately equaled the difference between his beginning-of-year and end-of-year bank account balances.”

Nice try, but that ain’t gonna fly.  Decision in favor of the IRS.

In some instances, however, the court may estimate the amount of a deduction that the taxpayer is entitled to.  To make this estimation, the court requires a basis upon which to make it.  This doctrine is known as the Cohan rule.  One example exhibiting application of the Cohan rule to gambling losses was in the case Doffin v. Commissioner, T.C. Memo. 1991-114.

Mr. Doffin compulsively engaged in pulltab gambling.  Unsurprisingly, Doffin mightily struggled with his finances, so his parents arranged for his paychecks to be deposited with a credit counseling service.  Mr. Doffin pretty much gambled away whatever allowance he received.  Because the court was presented with a very detailed description of the taxpayer’s lifestyle and financial position, the court was able to approximate the taxpayer’s gambling losses.

Had Mr. Jones read the Doffin decision, perhaps his Tax Court case would have turned out differently.

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