The Tax Court found that a taxpayer sufficiently substantiated gambling losses of at least as much as his gambling winnings reported for the year.
Facts: John Coleman was a compulsive gambler who admitted that his gambling had negatively impacted his finances and his family life. Although he had substantial earnings through the years as an insurance agent, he had been delinquent in paying multiple bills, including property taxes, because of his gambling habit.
Coleman did not file a tax return in 2014, despite having gambling winnings of $350,241 reported by casinos to the IRS on Forms W-2G, Certain Gambling Winnings, for the year. Thus, the IRS prepared a substitute for return for him and issued a notice of deficiency. Coleman also received nongambling income of $76,784 and a $150,000 nontaxable personal injury insurance settlement during 2014. Coleman gambled at four casinos during 2014, and he did not have complete records of his wins and losses for the year.
Casinos are required to issue a Form W-2G for any slot machine jackpots of at least $1,200 but are not required to report smaller winnings or losses. Two of the casinos tracked Coleman's wins and losses when he was using casino-issued rewards cards, but he did not always use these cards.
Coleman gambled extensively during 2014, predominantly at slot machines. Because he had received the $150,000 insurance settlement, he gambled more during 2014 than he had been able to in other years. Coleman often withdrew cash from his bank account on the way to the casino. If he ran out of money while gambling, he would withdraw money from an on-site ATM, get a cash advance from the casino, or obtain an advance on a debit or credit card. During 2014, he made withdrawals totaling $240,113 while gambling at casinos. Coleman's bank accounts did not reveal any increase in net worth during 2014 that was traceable to net gambling winnings, and his credit cards had closing balances totaling $28,243. In addition, his retirement account had decreased from $75,000 when he had retired in 2004 to $2,725 by the end of 2014, with most of the distributions being used for gambling. Coleman had no significant changes in his lifestyle during 2014.
Besides assessing a deficiency of $128,886 primarily due to the unreported gambling winnings, the IRS added amounts due related to failure to file, failure to pay, and failure to pay estimated tax that totaled $46,025. Coleman requested a redetermination from the Tax Court regarding his gambling losses.
Issues: The primary issue before the Tax Court was whether Coleman could substantiate gambling losses that offset his gambling winnings for the year.
Coleman used testimony from a gaming industry expert in mathematics and slot machines to estimate the likely outcome of his gambling transactions for 2014. The expert applied established statistical techniques to how often Coleman gambled and the expected win percentages at the casinos to determine that the odds against Coleman's having any net gambling profit for the year were at least 140 million to 1. The expert concluded with a 99% level of certainty that Coleman had overall net losses during 2014 of at least $151,690.
For taxpayers who do not gamble as their trade or business, losses from gambling transactions can be deducted as an itemized deduction to the extent of any gambling winnings. To substantiate deductions, the taxpayer must identify and keep records of each transaction and show that the transaction meets other relevant requirements.
However, gamblers typically do not keep complete records of their gambling wins and losses. As established in Cohan, 39 F.2d 540 (2d Cir. 1930), if taxpayers can show that they paid a deductible expense but cannot substantiate the exact amount, the Tax Court may estimate an allowable amount.
The IRS asserted that records maintained by two of the casinos showed that Coleman had net gambling winnings for 2014. Further, the IRS contended that the taxpayer's expert's report was based on "uncertain or flawed assumptions" and its conclusions were unlikely because Coleman could not have sustained such large annual net gambling losses over time.
Holding: The court examined Coleman's financial records, his modest lifestyle, and the expert witness's report as evidence of his gambling losses. The court determined that Coleman provided sufficient evidence to substantiate a deduction for gambling losses of at least his $350,241 in gambling winnings. The court found that credible testimony and financial records indicated that Coleman used account withdrawals and other income for gambling. In addition, the court saw no evidence of an increase in net worth from the winnings or changes in the taxpayer's lifestyle.
The court rejected the IRS's use of records from certain casinos as incomplete and biased toward showing winnings. It also rejected the IRS's assertion that the expert's methodology was inappropriate, noting that the same expert had prepared similar reports in previous court cases and that Coleman's gambling losses in 2014 were unusually large because his income included the $150,000 insurance settlement.
- Coleman, T.C. Memo. 2020-146
— By Beth Howard, CPA, Ph.D., associate professor of accounting at Tennessee Technological University in Cookeville, Tenn.