The old saying “you win some, you lose some” is not true for most recreational gamblers. For them, the saying is more like “you win some, you lose more.” But proving that proves a problem. In Jacob Bright v. Commissioner, Docket No. 10095-22 (May 4, 2023), Judge Buch teaches us how taxpayers can use their player cards to substantiate their wagering losses. There, Mr. Bright reported some $241,000 of wagering gains on his 2019 return, and an equal amount of losses. However, he apparently did not follow best practices—as very nicely explained in this article—of keeping daily contemporaneous records. When audited, the IRS accepted his self-reported income (natch!) but disallowed all the losses for lack of substantiation (double natch!).
In Tax Court, Judge Buch allowed Mr. Bright to introduce reports of his player card activity, from each of the three Casinos he gambled at in 2019. That created a sufficient basis for the Court to use the Cohan rule, albeit differently for each Casino. The Court used this method to estimate $191,000 of losses. In taking this approach for calculating wagering losses, Judge Buch gives us a new idea of “per session” netting worth considering, not only for proving up wagering losses, but also for calculating wagering gains. I would call it a “per establishment” approach. It makes a good bit of sense. Details below the fold.
The Big Picture: Treatment of Gambling Losses
It is not just in Casinos where the odds are against you. Congress has stacked the deductions deck in favor of the government. Even though §165(d) permits taxpayers to deduct wagering losses up to the amount of wagering gains, §62 and §67 combine to make those deductions below-the-line. At best, taxpayers are forced to report an inflated Adjusted Gross Income, which can adversely affect entitlement to various other tax benefits. Worse, this structure also means the §165(d) deduction fights against the standard deduction. And, worst of all, taxpayers may not be able to substantiate their losses sufficiently to even allow any below-the-line deduction!
The basic reason for this seemingly lopsided structure is that gambling is traditionally viewed as a form of recreation. So the costs are nondeductible under the general rules in §262 that disallows deductions for personal expenses. However, just like with other hobbies, a gambling hobby produces some income, as a byproduct of the recreation. Thus, §162(d) partially overrides 262. It works similarly to §183 which permits deductions of hobby costs up to the amount of hobby income. Actually, §162(d) is currently more favorable because, unlike deductions authorized by §183, it is not a miscellaneous itemized deduction that gets sucked into the §67(g) black hole of nothingness until 2026. See Lesson From The Tax Court #200: The Great Divide, TaxProf Blog (Oct. 18, 2021)(reviewing Gregory v. Commissioner, T.C. Memo. 2021-115, where the Court held the taxpayer could not take §183 expenses as above-the-line deductions).
Still, you see how this structure works against taxpayers. For example, in Viso v. Commissioner, T.C. Memo. 2017-154, the taxpayers had failed to report wagering gains of $5,060 on their 2012 return. They had also not elected to itemize, instead taking the standard deduction, which for that year was $12,200 for MFJ returns. Judge Vasquez observed that even though he agreed that the taxpayers had proved wagering losses in excess of $5,060, it would not help them:
“Petitioners’ standard deduction, $12,200, exceeds their potential itemized deduction for gambling losses, $5,060. Thus, petitioners’ election to take the standard deduction resulted in a larger deduction than if they had taken an itemized deduction for their gambling losses.”
So that means the Visos had to pretend they were $5,000 winners in the Casinos when they really were just net losers. Readers can get a wider impression of this big picture in Lesson From The Tax Court: Losing Gambler Gets Twice Lucky In Tax Court, TaxProf Blog (Oct. 26, 2020). And readers can get the pointillist treatment in Bryan Camp, Taxation of Electronic Gaming, 77 Wash. & Lee L. Rev. 661 (2020).
Small Picture: How To Work a Gambler’s Case
Whether preparing a recreational gambler’s return or helping such a client in audit or in court, a practitioner needs to be able to substantiate two items: (1) an income item of gains from “wagering transactions,” §165(d), and (2) a deduction item of losses from wagering transactions.
Accomplishing both of those tasks requires showing a gambler’s history of wagers, including winning wagers and non-winning wagers. Having a player card helps with both of those tasks. Let’s take a closer look.
(1) Reporting Gains
Normally, a taxpayer does not need to prove income! However, there is a great deal of uncertainty about what are the wagering gains that must be reported as income. That is because a wagering gain is only that payment that exceeds the relevant wager. And what constitutes the relevant wager has changed over time.
For decades the IRS took a “per-transaction” approach to determining gains. Each winning transaction was a separate reportable item of income to the extent that the winning amount exceeded the bet placed. The relevant wager was the single wager associated with the single wagering transaction. So taxpayers were supposed to add up all their winning transactions to get “wagering gains.” That’s what got reported as gross income. The Tax Court explained this approach in Bonparte v. Commissioner, T.C. Memo. 2017-193:
“A wagering transaction results in a gain if the winning exceeds the cost of the wager. A wagering transaction results in a loss if the cost of the wager exceeds the winning. The gains for all wagering transactions for which there is a gain are totaled. See sec. 1.165-10, Income Tax Regs. These are the gains from wagering transactions within the meaning of section 165(d). Gross income is increased by this total gain.”
However, the IRS changed its approach in 2008 from a “per-transaction” method of calculating wagering gains to a “per-session” method. Chief Counsel Advice 2008-11 (Dec. 5, 2008) (“Reporting of Wagering Gains and Losses”) tells us that a “taxpayer recognizes a wagering gain if, at the end of a single session of play, the total dollar amount of wagers placed by the taxpayer on electronically tracked slot machine play during that session exceeds the total dollar amount of wagers placed by the taxpayer on electronically tracked slot machine play during that session.” (emphasis supplied).
The per-session approach basically allows taxpayers to aggregate total wagers placed during the single session of play to offset total payouts received during the session. For example, in Shollenberger v. Commissioner, T.C. Memo 2009-306, the taxpayers went to a Casino on March 29, 2005 with $500 and walked out later that day with $1,600 jingling in their pockets, partly because they hit a $2,000 slot-machine jackpot. They deposited that $1,600 the next day. The Court held they had gross income of $1,100 from that session despite their receipt of a W-2G showing payment of $2,000. Notice that those folks actually cashed out at the end of their session of play.
One difficulty with the per-session approach is figuring out what period of time counts as a “session.” For example, the Shollenbergers wanted to combine all their various trips to Casinos in 2005. They wanted to make the entire year a single session. Judge Thornton rejected that, rightly observing that “To permit a casual gambler to net all wagering gains or losses throughout the year would intrude upon, if not defeat or render superfluous, the careful statutory arrangement that allows deduction of casual gambling losses, if at all, only as itemized deductions, subject to the limitations of section 165(d).”
So you have to identify sessions with wagering gains and sessions with wagering losses. The problem is that the IRS takes an inconsistent position on what constitutes a “session.” And the concept is very difficult to apply to electronic accounts.
For taxpayers, the IRS takes the position that a session can never exceed 24 hours and must end, at the latest, at midnight. See Notice 2015-21. This was a notice of a proposed Revenue Ruling that would give taxpayers a safe harbor method for determining wagering gains and losses on slot machine play. As far as I can tell, the proposed Rev. Rul. has not, to date, been finalized or issued. And a good thing too because the position taken there contradicts the position taken for Casinos.
For Casinos, Treas. Reg. §1.6041–10 also permits reporting on a per-session basis, which it calls the “information reporting period.” However, the IRS does not require Casinos to automatically end a session at midnight. Instead, the Casinos may determine the start and end point of a “gaming day.” Thus, in 1.6014-10(g)(1), example 5 posits a Casino with a gaming day that starts at 3 am and ends at 2:59 am the following morning. It posits a taxpayer who has two reportable wins (one of $1,500 and one of $5,000) and another non-reportable win ($800). There, the regulation says the Casino can choose to issue a single W-2G for $6,500 rather than two separate W-2G’s.
The obvious problem here is that if the taxpayer in the example had their first reportable win before midnight and their second one after midnight, they would need to account for two sessions of play and not one session of play under the rules in Notice 2015-21. What that means is that for each session the taxpayer will need to have records to show whether they ended the session with a gain, despite the amounts reported on the W-2G.
A second problem with the per-session approach for taxpayers is the tension with the third-party reporting requirements followed by Casinos, even if the rules for what counts as a session were consistent. The tension comes from how a per-session approach changes what counts as the relevant wager for determining gain. Casinos do not have to follow a session approach. They can still issue their W-2Gs on a per-transaction basis. If the taxpayer reports gains on a per-session basis, however, then the W-2G becomes even more inaccurate. It not only omits accounting for the single wager associated with the single transaction reported, but it also omits accounting for all wagers—winning and non-winning wagers—placed during the session (or “information reporting period”). Thus, the W-2G becomes even an even less appropriate proxy for income.
You see this problem in the Viso case described above. There, Mr. Viso received three W-2Gs, each reporting a payment of more than $1,200 and totaling $5,060. Mr. Viso attempted to argue that those payments were not his gains from those wagering transactions because the W-2G’s did not reflect the relevant wagers. The Tax Court rejected that argument with this reasoning:
“Although petitioners introduced evidence of losses at another Casino (in addition to lottery tickets and sporting bets), the record contains no evidence specifying how much petitioner husband bet to produce the winnings reflected on the Forms W-2G. In certain situations we may estimate the amount of a reduction in income even if the taxpayer fails to keep records, but only if the taxpayer presents sufficient evidence to establish a rational basis for making the estimate. Since we have no basis for estimating the amounts of petitioner husband’s bets, we hold that petitioners must include gambling winnings of $5,060 in their gross income.” Op. at 6 (citations omitted).
Thus, being able to substantiate the relevant wagers is important for establishing accurate gains from wagering activities. It’s also important, of course, to prove losses.
(2) Proving Losses
The per-session approach allows a taxpayer to net all wagers made during a session with all payments received to calculate a net gain or net loss from the session. The per-session approach, however, does not permit taxpayers to net all wagers made over the course of a year at all Casinos against all payments received for the entire year from all Casinos. As Judge Thornton explained in Shollenberger, that would render §165(d) meaningless.
So how should a taxpayer substantiate those wagering losses incurred during the year that cannot be netted against gains in calculating the results of a session? The IRS has some old, wacky, guidance on how a taxpayer should substantiate wagers in Rev. Proc. 77-29. Old? Yes. It says a taxpayer is supposed to track each wagering transaction. That’s the now-abandoned per-transaction approach. Now, the player should track each session: starting amount, ending amount. Wacky? Yes. It says the taxpayer is supposed to track even the “Name(s) of other person(s) (if any) present with taxpayer at gambling establishment.” Really? So you need to get the name of the slot-machine player next to you? And only the name? Do you have to ask for identification or can you just accept their response of “John Smith”?
Still, we all know that it’s the taxpayer’s responsibility to substantiate deductions and, as I explain above, it’s critical to the taxpayer’s ability to properly report income that the taxpayer track all non-winning wagers in a session.
So the trick for proving losses from wagering transactions is to see which wagers one can aggregate. That is, one must determine the relevant “session” for the particular Casino or other gaming establishment and then be able to identify the wagers made.
We learn today how Casino player accounts can help.
Facts and Lesson: Player Accounts and a Per-Establishment Approach
Mr. Bright had a gambling habit that “made life financially difficult for him.” Op. at 12. Judge Buch notes that in 2019 Mr. Bright cashed “most of his paychecks to gamble” and that “bank account records show that his account frequently had a low or negative balance in 2019.” Id.
In 2019 he gambled mostly at three Casinos: Mystic Lake; Treasure Island (MN, not NV); and Diamond Jo Worth. At each Casino he almost always used a player card. That allowed him to get reports from each of the three Casinos for his 2019 play activity.
For 2019 Mr. Bright received 24 W-2G’s, all from slot machine payouts: 2 from Diamond Jo; 5 from Treasure Island; and 17 from Mystic Lake. Mr. Bright had his 2019 return prepared for him. But the preparer apparently confused compulsive gambling with professional gambling and thus had him file a Schedule C reporting over $241,000 of gross receipts from his “business” and an equal amount of §165(d) deductions. No one was sure how the return preparer came up with either figure. The W-2Gs totaled just over $110,500 and while Mr. Bright undoubtedly won more than reported there, it appears there were no records. Still, for some reason, his return preparer reported some $241,000 of income from wagering transactions.
On audit the IRS decided his gambling activity was recreational. It accepted his income as reported but disallowed all of his deductions for lack of substantiation.
In Tax Court, proceeding pro-se, Mr. Bright agreed he was no professional. He argued, however, that the preparer had mis-reported his gambling income and that the IRS was wrong to disallow all of his losses.
As to the income item, Judge Buch basically said “too bad, so sad.” Mr. Bright had reported that amount and could now present no evidence to the Court on why it was inflated. “In sum…he has failed to negate his own reporting.” Op. at 11.
The lesson comes on the deduction side. Here, Judge Buch takes a very similar approach to that of Judge Lauber in Coleman v. Commissioner, T.C. Memo. 2020-146, which I blogged about in Lesson From The Tax Court: Losing Gambler Gets Twice Lucky In Tax Court, TaxProf Blog (Oct. 26, 2020). And here is where the Casino player card records really become important.
First, the player card records enable Judge Buch to find that Mr. Bright “suffered substantial gambling losses” in 2019. Op. at 12. Judge Buch explains “Indeed, the Casino reports confirm his testimony, showing that even with some sizable winnings, he lost more than he won for those times when his wins and losses were captured. Although the Casino records do not capture the full picture, they provide a sufficient basis upon which we can make an estimate.” Id.
That is the critical first step in setting up application of the Cohan rule, as I explain in Lesson From The Tax Court: The Structure Of Substantiation Requirements, TaxProf Blog (June 1, 2021). To convince the Court to estimate a proper deduction, a taxpayer must first establish a nexus with the statute that allows the deduction. Here, that statute is §165(d) and so the required nexus is to establish the fact of losses, even if not the exact amount. The player card records do just that. Even though they were not comprehensive (Mr. Bright gambled elsewhere and may not have always used his player card) they were solid evidence that he spent money … a LOT of money … in his recreational gambling hobby.
Second, the player card records enabled Judge Buch to come up with a reasonable amount of losses to deduct against the reported winnings. And here Judge Buch, again echoing Judge Lauber’s approach in Coleman, uses the Cohan doctrine to essentially bypass the per-session approach. Instead, he substitutes a per-establishment approach.
Judge Buch starts by noting that each Casino reports player card activity differently. Mystic Lake reported player activity on a monthly basis, reporting only whether the player’s account reflected a net loss or a net gain for the month. Treasure Island reported only the net annual activity and broke it out by source: slots or the pit area. However, unlike the other two Casinos, it also reported the dollars Mr. Bright spent in each area through his player card. That would be his wagers. Finally Diamond Jo, like Treasure Island, reported only the net annual activity, but apparently only tracked Mr. Bright’s slot machine play that way and did not report his wagers, just his yearly net.
Because of those difference, Judge Buch analyzed Mr. Bright’s activity for each casino separately.
For Mystic Lake, Judge Buch accepted the monthly net loss and then added to that any winnings reported on a W-2G. “For example, his Form W-2G winnings at Mystic Lake for January totaled $8,162, but [since] he had an overall net loss of $1,192, he must have lost $9,354.” Op. at 12.
For Treasure Island, however, Judge Buch had only the yearly net report and so estimated Mr. Bright’s losses by the activity reported for slot machine play separately from activity reported for pit gambling. Again, Judge Buch added any W-2G amounts because “for him to have netted a loss, he must have also lost what he won.” Op. at 14.
Finally, for Diamond Jo, Judge Buch again has no difficulty coming to a conclusion that while the Casino player records showed a yearly bottom line loss of $894, the fact that it also issued 2 W-2Gs totaling $3,568 meant his “losses from wagering transactions” were at least $4,462.
Judge Buch then added the annualized losses from each Casino to conclude that “Mr. Bright suffered gambling losses of at least $191,756.” Op. at 14.
Bottom Line: Mr. Bright’s almost constant use of player cards at each Casino saved him. It allowed him to prove that he had some “losses from wagering transactions” within the ambit of §165(d). And it allowed him to give the Court a basis on which to estimate a minimum amount of losses. Without the Casino player card reports, Mr. Bright would have a much worse result.
Comment — A New Idea of Session? I quite like Judge Buch’s per-Casino approach because it uses a concept of “session” that permits annual netting. But it’s not just netting everything against everything, like the Shollenbergers wanted to do. It instead creates different sessions for different establishments. That does not render §165(d) useless because you still have a set of gains from wagering transactions where you are a net winner at one establishment, and you have losses from wagering transactions at other establishments. Thus, rather than tying the concept of session to an arbitrary 24-hour time period, this concept uses the statutory time period of the tax year. Under this method you take your net losses for the year at an establishment and add to that any gains to come to a total loss figure which you can then apply against wagering gains.
I recognize Judge Buch is using this approach to guestimate wagering losses, but I think it would work equally well for establishing wagering gains, at least when using Casino player cards. As I explain in my Taxation of Electronic Gaming article, all amounts within a Casino player account are best viewed as “play money.” Literally they are numbers that simply track the amount of play the taxpayer enjoys. They are not actual dollars until such time as the taxpayer cashes out. Lucky or skillful taxpayers get more play for their initial deposits, but that does not make it income. It is just more consumption at the same cost. At the end of the year they should not have to report any wagering gains if all they have done it put money into their player account during the year, and they end the year with less in that account than what they had at the start. If, however, they are like the Shollenbergers and they cash out their player account after any given Casino trip, then to the extent they cash out for more than they put in year-to-date, they have a wagering gain to report as income. And if they end the year with a surplus in their player account over what they put in, then the constructive receipt doctrine would require them to report that as income. Thus, as applied to this case, I would use that idea to argue over the proper amount of Mr. Bright’s wagering gains rather than over the proper amount of his wagering losses. To me, the 24 W-2Gs did not reflect wagering gains. They reflected payments, sure. But whether they were wagering gains depends on the relevant session calculation. And with a player card account, you can figure that out from the Casino records. As usual, I welcome comments on this idea from folks who actually represent gamblers.
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Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law. He invites readers to return each Monday (or Tuesday if Monday is a federal holiday) to TaxProf Blog for another Lesson From The Tax Court.
