In one week, we were contacted by taxpayers in Oklahoma and Wisconsin. They received similar letters from the IRS notifying them that their 2018 income tax returns were selected for audit because of “unreported gambling winnings.” The amount of additional tax, interest and penalties are significant.
However, both of the taxpayers calculated their income using the “gambling session” methodology as described by IRS Chief Counsel Memorandum 2008-011: Reporting of Wagering Gains and Losses.
Even though our sample size only includes two taxpayers so far, some interesting observations can be made.
- The audits involve the 2018 tax year.
- The taxpayers calculated their wagering gains and losses by using the “gambling session” methodology.
- The auditor included accuracy-related penalties of 20.0%. Ouch!
So what is going on?
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Acts (TCJA). This act amended IRC Section 165(d), and applies to the taxable years 2018 to 2025. For individual taxpayers, Congressional intent was to disallow the deduction of wagering losses on IRS Schedule A.
Our guess is that the IRS computers are totaling each taxpayer’s total gambling winnings (reported by the casinos on Form W2-G to the IRS). Next, their computers compare this total with the amount of wagering gains reported by the taxpayer on their income tax return. Finally, if there is a difference between these amounts, then the income tax return is selected for audit, additional tax, penalties, and interest are applied, and the taxpayer is notified.
Basically, the IRS is selecting income tax returns for audit based on the “gross receipts” received by the taxpayers from gambling, and not on their “wagering gains.”
For example, if I buy an asset for $70,000, and later sell that asset for $100,000, then I would realize a gain of $30,000. How much should I report as income? The amount of the gross receipts – $100,000? Or, the amount of the gain – $30,000?
For the asset-owner, the correct answer is $30,000 – the amount of the gain (aka “accession to wealth”). But, for gamblers, the IRS is suggesting that the answer is $100,000 – the total amount of reported gambling winnings (aka “gross receipts”).
In other words, the IRS is suggesting that a gambler’s income is the total amount of their gambling winnings, and not their wagering gains. This is not correct.
The IRS computer is ignoring over a century of well-established tax law.
- On February 3, 1913, Congress ratified the Sixteenth Amendment to the US Constitution which allowed Congress to levy a tax on income from whatever source derived. (IRC Section 61 memorializes the Sixteenth Amendment.)
- In 1918, the U.S. Supreme Court interpreted “income” to mean “gain” and not “gross receipts” in Doyle v. Mitchell Bros. Co., 247 US 179 (1918).
- In 1955, the U.S. Supreme Court in Commissioner vs. Glenshaw Glass Co., 349 U.S. 426 (1955). referred to this gain as an “accession to wealth.”
- For over 45 years, the US Tax Court has repeatedly allowed gamblers to calculate their gains or losses over a series of plays or wagers. Green v. Commissioner, 66 TC 538 (1976), and Szkircsak v. Commissioner, TC Memo 1980-129 (1980).
- In 2008, the IRS in-house lawyers issued their guidance in IRS Chief Counsel Advice Memorandum 2008-011 (IRS CCAM 2008-011) entitled “Reporting of Wagering Gains and Losses” and adopted the “gambling session” methodology for the reporting of “wagering gains and losses.”
To summarize, deductions are a matter of “legislative grace.” Congress can allow or disallow “deductions” as they see fit. For example, in 1982, Congress enacted IRC 280E which disallows all “deductions” and credits for taxpayers involved in the trafficking of controlled substances (e.g. heroin, cocaine, and medical marijuana). But, Congress cannot disallow the “reduction” of gross receipts by the amount of basis of the wager.
Thus, any interpretation of IRC Section 165(d) (including the 2017 revisions) that conflicts with this well-established legal precedent is UNCONSTITUTIONAL!
I encourage you to contact our office if we can assist you with the proper reporting of your wagering gains and losses.