The Tax Court held that a taxpayer engaged in the trade or business of gambling could not deduct wagering losses in excess of his wagering gains but could deduct ordinary, nonwagering business expenses incurred while pursuing his gambling business.
Section 165(d) limits losses from wagering transactions to the amount of wagering gains. Section 162(a) generally allows a taxpayer to deduct any ordinary and necessary expenses related to a trade or business.
In 2001, Ronald Mayo, while engaged in the business of gambling on horse races, placed bets on them totaling $131,760, winning $120,463. During that year, he incurred expenses of $10,968 related to operating his business, which included amounts paid for transportation, travel, meals, entertainment, handicapping data and subscriptions. On his joint tax return, Mayo subtracted both his total wagers and expenses from his winnings, resulting in a Schedule C net loss of $22,265. The IRS disallowed $11,297 ($131,760 − $120,463) of the wagering losses and all of his ordinary business expenses due to the limitation of section 165(d). The taxpayer petitioned the Tax Court for relief.
The taxpayers argued that since the Supreme Court decision of Commissioner v. Groetzinger, 480 U.S. 23 (1987), section 165(d) no longer applies to the losses of a professional gambler, since section 165(d) does not apply to any other business. The court rejected that argument, stating Groetzinger considered only whether a gambling activity was a trade or business for the purpose of treating a gambling loss as a tax preference item for the alternative minimum tax. In addition, numerous cases after Groetzinger have held that section 165(d) does apply to a gambling business, since the more specific section 165(d) trumps the more general section 162, according to the court.
Furthermore, the Tax Court had historically applied to such cases its 1951 holding in Offutt v. Commissioner, 16 TC 1214, that “losses from wagering transactions” limited by section 165(d) include expenses paid or incurred in connection with conducting the activity, even those not directly resulting from wagering. However, subsequent cases cast doubt on that conclusion, and the IRS had applied this holding from Offutt inconsistently, the court said. In December 2008, the Service said in Chief Counsel Memo AM2008-013 it would no longer follow Offutt. The Tax Court said it would follow suit to discourage “further administrative inconsistency.”
Therefore, while it limited Mayo’s wagering losses to the amount of his winnings, the court held that his nonwagering ordinary expenses related to his gambling business were deductible, despite the fact they generated a loss.
- Ronald Andrew Mayo and Leslie Archer Mayo v. Commissioner , 136 TC no. 4
By Charles J. Reichert, CPA, professor of accounting, University of Wisconsin–Superior.
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