T .C . Summary opinion 2010-55
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T .C . Summary opinion 2010-55
UNITED STATES TAX COUR T
-HOYT M : AND HELEN J . ORR, Petitioners v .
COMMISSIONER OF INTERNAL REVENUE, Responden t
Docket No . 11017-07S .
Filed
April
26,
2010 .
Hoyt M . and Helen J . Orr, pro sese .
Horace Crump , for respondent .
MORRISON,
Judge : This case was heard pursuant to the
provisions of section 7463 of the Internal Revenue Code in effect
when the petition was filed .' Pursuant to section 7463(b), th e
.decision to be entered is not reviewable by any other court, an d
'All section references are to the Internal Revenue Code
(Code) in effect for the year in issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated .
SERVED AM" 2 6 2010
_
2
this opinion shall not be treated as'precedent'for any other
case .
Respondent Commissioner of Internal Revenue (i .e ., the IRS )
determined a deficiency in the Orrs'2004 federal income tax .o f
$16,653 and a section 6662(a) accuracy-related penalty of $3,331' .
Petitioners Helen J ., Orr (Orr) and Hoyt J . Orr (Orr's husband) ,
disagree . with the IRS's determination . The issues for decision
are
(1)
whether the Orrs are entitled to a deduction for Orr's
net gambling loss because she was a professional gambler rather
than a casual gambler, ', (2) whether they are liable : ,for, an '
accuracy-related penalty for aysubstantial understatement o f
income tax for erroneously claiming the gambling-loss deduction
and omitting certain retirement benefits, and (3) the extent to ,
which the Orrs omitted certain retirement benefits from their .
return . We conclude that section 165(d) prohibits the Orrs from
deducting the net gambling loss even though Orr was
a
professional gambler . We further conclude that the Orrs are not
liable for the penalty because they acted in good faith'an d
44
because (a) Orr's husband's disabling illness, (b) Orr' s
diminished mental capacity associated with severe depression, and
(c) Orr's efforts to prepare .the return together constitute '
reasonable cause for the errors . We will direct that the partie s
address the issue of whether the retirement benefits the Orrs did
report on their return are a portionxof the amount the 'IRS says
3 they omitted : (which may mean that their .taxable income and
deficiency are lower than the IRS claims) or are a separate
amount through a Rule 155 . computational proceeding .
Background
Orr suffered from depression in and about 2004, the year in
issue . (The record before the Court does not describe Orr's
mental condition precisely . We follow her in calling_it simply
"depression" .) Her condition is associated with diminished
mental capacity to address even moderately complex
responsibilities .
.Her boss at the railroad for which she worked
"saw [she] was more than a little disturbed",'and sent her to a .
psychologist, who sent her to a psychiatrist . The psychiatrist
put her on medication and directed that she take a leave of
absence . Later, in 1999, the railroad granted her early
retirement on account of permanent disability .2,3
.
2The record reflects that the Orrs received payments from
the Railroad Retirement Board, but it does not reflect that they
received any payments from a particular railroad . It seems
possible, therefore, that Orr's employer did not itself grant her
permanent disability benefits but .instead helped her to apply for .
Railroad Retirement Board disability benefits . We infer that
either organization would have required proof of disability .
3On brief, the IRS suggested that we should not believe
Orr's trial testimony thus describing her diagnosis 'of severe
depression on the ground that the testimony lacks corroboration .
But the IRS did not question the substance of or basis for the
testimony at trial or argue that it did not then have sufficient
notice of the issue of Orr's depression and diminished mental
capacity . We observe that the testimony is congruous with Orr's
undisputed overall explanation for becoming a professiona l
(continued . . .)
Orr's-depression appears-to have arisen, at least-in part ,
from .a'series of unfortunate circumstances that would have been,a .
severe emotional drain for almost anyone .` In ..1994,,Orr.'s husband :,
was diagnosed with an illness-,believed to be terminal . Some tim e
later, . Orr's elderly, . ill mother came °to .live with the Orrs .
2000, Orr's mother died . In furtherm .explaining .why she was ,
depressed , O=also'noted that she lost two brothers- in one year .
(about the time :her mother died, .' we- infer, although she did not, . ,
say which year )
'Orr's husband was present at trial but,did not-participate ,
except to identify himself . . He appears not to ;have .had any ,
significant economic activity 'during °2004 (Some -of the ;
retirement benefits at issue appear-to have been his,, and som e
the interest and dividends-the Orrs received and some of the . ,
shares they sold during2004 may . have belonged-to him on the,Orrs
jointly .) We infer that he relied on Orr to prepare_the .Orrs''
joint return, which both 'he and she signed . "We find `that hi s
illness was reasonable cause for him .to rely on'Orr to prepare
the return correctly .4 Moreover,'nothing before the-Cour t
3( . . .continued )
gambler and otherwise apparently credible, and,we reject-the IRS '
challenge on this point .
4Each spouse•is generally responsible for ensuring that a ,
joint return the-couple files is,timely and correct . See, LaBell e
v . Commissioner , T .C . Memo . 1984-69 .
suggests that he did not act in good faith .
Substantially all of
the issues in this case thus relate solely , to Orr .
Orr's mental ability, was, as she testified , "very,•very
limited "
in 2004 . 5
Orr's economic-activities for 2004 basically consisted of
losing money to gambling and to scams .
retirement benefits ,
The Orrs also received
dividends and interest ,
and sold some
shares .
Orr decided to take up gambling as a business around the end
of 2003 . The parties agree that she gambled professionally
throughout 2004 .6 it appears that all
of-her gambling for the
year was part of her gambling business .
5She also testified , and we accept ; that to . some extent her
mental abilities were still diminished even at the time of trial .
6For tax purposes , the term "professional gambler" refers to
a gambler who gambles as a "trade or business " -( or simply a }
"business ", as there appears not to be any distinction between a
"trade" and a "business " for tax purposes) . See, e .g ., Hochman
v . Commissioner , T .C . Memo . 1986 - 24 . To be engaged in an
activity as a business, one must be engaged in that activity (1)
with regularity and continuity and (2 ) primarily for the purpose
of profit .
Commissioner v . Groetzinger , 480 U .S . 23,35 (1987) .
There need not actually be a profit or even a reasonable
Dreicer v . Commissioner , . 78 .T .C . 642,
expectation of-'profit .
affd
.
without
published opinion 702 F .2d 1205,
644-645 ( 1982 ),
Consequently, our
1983 U .S . App . LEXIS 30334 ( D .C . Cir . 1983 ) .
use of the term "professional gambler" does not imply
sophistication .
6' Orr, had previously been a casual gambler .' She apparentl y
began to gamble heavily around
the time her mother came to live
with the . Orrs .e Her , metamorphosis into a professional gamble r
was likely inspired by winning a $1 .2 million jackpot at a'casino
in 2003 ., Even though,- as she explained, Orr,still had a "l'ot of
money" at the end,of 2003, "it never registered on ,[her]" . . Sh e
thought-she " needed a ,job", but that nobody would hire her .
Therefore ; after consulting three other gamblers who said the y
made their'living through gambling :,,,S'he decided to take, .-up :
gambling as a business . She explained that her, professional ,
gambling .- activity- differed from her earlier casual gamblin g
activity in that she made a greater of-fort to learn to gambl e
profitably .
Although Orr became a professional gambler "to try to wi n
some money", she now realizes that "it was not a smart decision .
Orr found that she could not make money at blackjack or poker ,
games in which a skilled player may in some- . circumstance s
reasonably expect to profit over time . Nor could she make mone y
at craps, a game in which it is generally accepted that on e
playing'under typical casino rules cannot reasonably expec t
profit over time . She then focused on"slot machines .
7A casual gambler is a gambler who is not a professiona l
gambler .-
Hochman v . Commissioner ,,_ supra . .
'Orr explained that-her mother enjoyed being taken . t o
casino regularly .
7 Slot machines are devices that allow the player to engage in
simple games of chance . It is generally accepted that a slotmachine player cannot reasonably expect to profit over time . Orr
tried various misguided "strategies" in her attempt to make money
playing slot machines . Not surprisingly, they failed . As
discussed in more detail later ; Orr had an overall loss of about
$200,000 from gambling in 2004 .
Orr had two other ventures during 2004 .9 These appear to
have been scams of which she was a victim . She described one as
"some kind of a program for grants and setting up a web site, and
they talked about how you could get grants to--for different
things . They concentrated on low-income housing and housing
prospects ." The promoters' high-pressure tactics would have
warned most people to stay away : . Orr had to agree up front to
pay for the . program for 39 months, and the program was promoted
to her through a seminar at which she "had to sign up then or not
sign up ." She signed up, and had expenses of $1,360 for the Web
site business for 2004 but "was mentally unable to do anything
with it" and never received any money through it .
Another, for which Orr received $1,920 in 2004 (which she
reported as gross income) but "never even got my original money
back" (suggesting that she had over time "invested" a greate r
9The IRS does not dispute that these activities were
businesses for tax purposes .
amount) ., was an arrangement that would supposedly "multiply" her
investment every 90 days . . She now thinks that it 'was-just fe d
by people coming in and paying, .*
to begin with", meaning :tha t
it was _ a Ponzi,scheme . We-infer-that she was correct . 1°
Orr prepared the Orrs' 2004 joint return (the "return")
herself ., She'used the tax-preparation,,software TurboTax to
prepare the return . She used the program because she wanted to' .`
avoid computational errors ., not because she wanted, the program to
tell her the appropriate tax treatment of the-gambling ;business(or any other item) . , As she recalls n . (and as we find .for -purposes
of deciding this case), TurboTax did not-give her .any warning
that the amount of gambling losses she claimed . might not b e
deductible . 11
;The Orrsrreported-the tax consequences of the three .,
businesses on three :, respective : Schedules C, .Profit-or Loss from,
..
Business .(Sole .Proprietorship), attached to the return . These
Schedules Care simple, and apparently . required little accountin g
100rr did not mention this business in her petition ; nothing
suggests that the IRS had even .informal notice that it would be
addressed at trial, and the parties address it only briefly in ;
the . course of a general explanation of the entries on the', .Orrs'
return . Consequently, we`conclude that it is not appropriate to`
redetermine the Orrs' gross income from that .business, or to
determine that they suffered any loss from it .
"We understand that Orr did not receive a warning to review
her entries for the gambling business either on the ground'tYat'"
the deductibility of gambling losses is limited or .,on°a : less
specific ground such as that the'amounts were unusually large .
work to prepare . (Orr kept track of her winnings and losses for
the gambling business by using a "player's club card" issued by a ,
casino . Apparently, she gambled only at one casino, or perhaps
one group of related casinos, during 2004 .12) . The IRS does not
question the accuracy of the Schedules C except in arguing tha t
the net gambling loss is nondeductible .
The Schedule C for the gambling business identified,the
business as "Gambling" . It listed "Other income" of $909,058 (a n
amount, the parties have stipulated, consisting entirel y
"gross winnings") ;13 travel expenses of' $10,780 on the designated
line ; and "Other expenses" ; described specifically .as "gambling
losses", of $1,113,766 . It stated on the designated line that
the net loss for the business was $215,488 . Of this amount, the
IRS challenges the deductibility of $204,708, which is the excess
of the amounts Orr bet over her proceeds . from the bets . We refer
to this excess as the "net gambling loss" .--
12We understand that a "player ' s club card " is a card
resembling a credit card by means of which a gambler enables a
casino to automatically track the gambler's winnings and losses .
See, e . g ., Merkin . v . Commissioner , T .C . Memo . 2008-146 .
It appears that the Orrs may have reported their gross
receipts from gambling (including, for instance , all coins paid
out of slot . machines ) as gross income, and their gross
expenditures on bets (including , for instance , all coins inserted
into slot machines ) as losses .
As discussed later, this practice
may not have been technically correct, but the IRS does not
challenge the practice ' s correctness , and the use of the practice
probably does not in itself prevent the correct determination of
their tax liability .
The Schedule C- for her- Web .site business. , ( described as .
"computer web site and affordable homes for rent," )
listed five .
items' of°expenses , each apparently a sum, of . monthly fees =that she- ,
paid :to the promoter of the . business, for Web . site maintenance ; '
or for banking or,similar services, which°totaled,toythe°-y$1,36 0
loss she reported for the business . The Schedule ..C,fbr he r
business which now .seems to have been'a Poinzi .scheme describe d
the business as` ."reading advertisements"'and listed the $1,920,-ini ,
payments she received as both gross receipts .and gross -income-.
The Orrs reported $16,470 :onthe'return's line entitle d
"Pensionsand annuities", and, of this-, $9 .,529 on-the return' s
next line,-entitled,"Taxable amount"- . `(of,,'the," Pensions,an d
annuities") . . As we explain later,, itis® .not•clear whether thes e
entries-reflect some-portion of the Railroad Retirement .Board'and
Social Security benefits : the couple received,` which would,mean ,
that the remainder of those . amounts . may contribute to a, .4.
deficiency ; or whether the entries reflect other income, whic h
The Orrs reported several thousand-dollars' in interest anddividend income and about $100',000`in capital gains (from "a sal e
of shares of Norfolk Southern stock ;-as one `-line i n the short-
term'capitalgain and loss schedule and'another' i
schedule` indicate,
sales of
"various
the, long=term
11 infer probably means mutual-fund shares ; and capital-gain
distributions, probably from the mutual funds) on the return .14
These entries were not complex, and the IRS did not questio n
them .
The Orrs did not report any further items on the return
other than the standard deduction, personal exemptions, and
credits for a small amount of tax already paid .
Orr deducted the entire net loss of $215,488 from the
gambling business against all of the Orrs' other income for the
year in computing the taxable income to be reported on the
return . The result was a reduction of taxable income to zero .
We now turn to Orr's attempts to determine how to properly
report her gambling business . She focused on the deductibility
of gambling losses .
In filing the Orrs' return for 2003, a"year in which she was
a casual gambler, Orr had limited the Orrs' gambling-loss
deduction to their gambling winnings . In response to a question
by counsel for the IRS at trial, she explained that she filed
this way not because-of section 165(d) (a provision that she did
not seem to fully understand even by then), but because an IRS
publication explained that she should do so . She believed tha t
"Nothing before the Court suggests that receiving these
gains reflected, special skill or judgment .
12
the guidance in the IRS ; publication did not, apply for 2004 ;°
because't°she had become°a professional gambler .
Orr did not inquire .as systematically or,thoroughly as .a . .
sophisticated tax practitioner might . She did not .examine the
Code, tax, regulations, or a treatise on,tax law But sh e
satisfied ; herself that ; (1) she was a professional gambler,•(whic h
is correct) and (2) therefore her gambling losses could offse t
her other income in theisame manner as most other business losse s
would ( which, as discussed later, is incorrect) .
Orr made,limited .attempts to seek advice .from tax
professionals and from other professional gamblers ." She did no t
have a regular ..,tax ;, adviser =at the- time .
Orr- visited .an ..IRS office,in,Chattanooga, Tennessee . .-,On e
IRS employee there, who appeared to be new, expressed doubt that
she could claim the ,. deduction ;,while another, . in the, next . cubicl e
said ,
as Orr, recalls : " I've seen , it-done ;_ I don't know how; the y
do it but-I know that it's been done . "
Orr, did legal research . She.went to the main,library,,at .- a
courthouse in Trenton, Georgia . -The,librarian there was unable .
to help Orr except ;to-suggest that .she go„to the courthouse's ta x
15These people were not called as witnesses . Given Orr' s
overall situation, it seems possible, ; that she may not have fully
understood their advice . We find, however, .,that she testifie d
honestly, and that an honest misunderstanding of their advic e
(which we would accept in the light of her situation) . woul d
similarly inform our consideration of whether there wa s
reasonable cause for the errors on her return .
13 library . There was no librarian or anyone else at the tax
library to help her . On her own, Orr found the case of
Commissioner v . Groetzinger , .480 U .S .'23 (1987), which we discuss,
later . She believed (as she continued to believe throughout the
proceedings in this case) that . it meant that a professional
gambler can deduct gambling losses in the same manner that one .
engaged in a business can generally deduct losses . She did not
find any other materials there that she understood to be
relevant .
Orr went to a lawyer whom someone had recommended to her .
The lawyer explained that he was not a tax practitioner, but
recommended an accountant, Ben Hill .
Orr asked Hill whether she could claim the deduction . She
recalls that Hill responded : "I'm not saying it can't be done,
but I don't know . "
Orr also approached another accountant . This second
accountant had in the past filed returns for another gambler .
But she would not tell Orr about the tax treatment of gambling
losses because she wanted a fee and Orr did not want to pay her .
The other professional gamblers that Orr knew would not discuss
their tax affairs with her .
14 .
Orr relied in part on-her past experience as,a tax preparer .
She had " done business taxes" 16 and understood that "you deduc t
business losses"-(a .proposition .that is correct generally,_bu t
subject-to numerous .exceptions-wand limitations) . She "used to be
familiar with,taxes" and had worked as .a tax preparer at the
mass-market tax-preparation company .H&R Block . . . Attrial,-counsel-for the IRS did not ask Orr-about her,work at H&R Bl-ock,'and the
record before the Court reveals very little about it . . We do not
know when she worked there, how long she worked there, what-kinds
of tax . work she did there ; or what kinds . of skills they-involved . .
We infer =that she worked there, well before 2004 because her . early °w.
retirement for permanent disability was granted by the railroad,''
not H&R Block, .. and because she was unable-to find any .job after
beginning to receive-benefits .'' We also do-not know-what further .
tax experience she may have had . Her legal research ;,and analysis
leading to this case, and the form and content of her argument s
in it, indicate that her_understanding-of tax law is limited ..
See Kees v . Commissioner , T .C . Memo . 1999-41 .
After filing the return, in•preparing for this case (or the
administrative proceedings which led .:to it) Orr-obtained,a, cop y
16We do not know . what kind of "business taxes" these were .
She could have, for instance, merely :°prepared simple Schedules C
to IRS Forms 1040, U .S . Individual Income Tax Return, to report
individuals' business activities .
17We do not know what Orr's job at the railroad was, but the
record does not indicate that it was tax related .
15 of Commissioner v . Groetzinger ,
supra , from -legal-research
provider Westlaw . The parties attached this copy-to the
stipulation . She also read the Web site "Professional Gambler
Status", at www .professionalgamblerstatus .com, and attached an
excerpt from its "Case Law" page, to the Orrs' pretrial,
memorandum . The Web site discusses various differences in the
tax treatment of casual and professional gamblers and-reproduces
several gambling-related Tax Court` opinions .
The Web°site "Professional Gambler Status" repeatedly and
consistently states-that net gambling losses are not deductible,
for professional as well as casual gamblers, and explains what
section 165(d) is and what it means . But since the Web site is
fairly large and complex, we infer . that one . suffering from
diminished mental capacity might well fail to recognize the
significance of the Web site's material about net gambling
losses' being nondeductible for professional as well as casual
gamblers . The Court asked Orr whether she had seen parts of the
Web site that referred to section 165(d), which by that point in
the trial had been repeatedly described to her as the section o f
the Code that, in the IRS' view, would generally disallow net
gambling losses . She said she had, but that she had understood
other parts of the .site to be more important . We accept this
explanation .
The IRS` issued a notice of-deficiency to the Orrs ;for :.200 4
The explanatory material . accompanying . the notice showed that th e
deficiency and penalty on`the notice resulted from the followin g
determinations . One determination appears to-be that the Orrs ,
received the ..$30,391 in now-stipulated retirement benefit s
discussed earlier, .==that the'now-stipulated . taxable portion of ,
those°benefits .,.was $25 ,'832, , and that .this entire taxable. portion .
was to be added to their income because none of it had'been shownon the return .18 Another determination was-that'no deduction wa s
allowed for-'the°-net gambling loss . A°third determination .wa s
18The IRS Notice CP2000 accompanying the notice o f
deficiency , asserts as :follows that the Orrs failed to report .any .
of the stipulated ; retirement benefits :
Amount
Issue
Account
Information
Received From
Social US Railroad SSN [for Orr]
Amount
Reported Included
to IRS by on You r
Others
Return . - Differenc e
$ 17,784 '
Security/ Retirement Board
Railroa d
Retirement
2
Social, , . Social Security SSN [for Orr's $ 12,607
Security/ Administration husband] F
Railroad
Retirement
Form
1099-SSA
Social Security/Railroad Retirement $ 30,391 $ - $ Total-[ Fn . ..ref . omitted . ]
In another table, it asserts that-the taxable amount o f
these benefits is $25,832 :
Changes to Your Reported to
Income and Deductions Shown on Return or as
Social
Security/Railroad
Retirement
IRS ,
Corrected
$
Differenc e
25,832
$25,832
17 that a section 6662 accuracy-related penalty was imposed for the
substantial understatement of income tax due to these alleged
errors .
The record before the Court does not indicate that Orr had
notice before she filed the 2004 return that she was incapable of
complying with her tax obligations on her own . For example, it
does not indicate that any tax-return errors for previous years
had been revealed by an audit .
The Orrs timely filed a petition for redetermination of
their deficiency in which they "request[ed] that professional
gambler status be'granted ." The IRS agrees that Orr's gambling
activity was a business in 2004 . Thus, the contention in the
petition is moot . Even so, the main issues actually relevant to
the Orrs' tax liability for 2004--the omission of certain
retirement benefits, the deductibility of net gambling losses,
and the existence of reasonable cause to except the Orrs from an
accuracy-related penalty for errors on their return--are properly
before the Court because the IRS presented them in its pretrial
memorandum19 and addressed them without objection at trial and in
its posttrial brief .2 0
19We appreciate the IRS' introduction of these issues, which
are genuine issues that the Orrs appear not to have grasped on
their own . It likely helped them to more fully present their
case to the Court .
20Since the Orrs have the burden of proof on these' issues
(continued . . .)
18 Discussio n
I.
Deductibility : of Net Gambling Los s
The Orrs present several theories why they are entitled .to
deduct their net gambling loss (i .e ; .,,the $204,708 excess of_the
amounts Orr_ betty over her proceeds from bets), . 21 The, IRS argue s
that section 165 . (d),
which provides .that " [1],osses from wagering
transactions,shall'be allowed .only,to .the extent of .the gains :
from such transactions", makes the loss nondeductible, notin g
that we held in Valenti v . .,Commissioner , T .C . : Memo . 1994-483,'
that section 165,(d) denies professional gamblers deductions- .for .
their net gambling losses . 22 we agree with ,the, IRS ., and. w e
21( . . .continued).
under Rule 142(a)(1), they benefit from our decision to',cons~ide r
the issues at all .
21Since the Orrs are representing themselves, we have
construed ; their' arguments liberally .' Cf ., e .g ., ` Erickson' v . ,
Pardus, 551 U .S .,89, 94 (2007) . Some of the Orrs' theories of
why their net gambling loss should be deductible are procedurally"
improper because the Orrs .raised the theories only in their reply
brief . since we can determine on our own that these theories area
not correct, we'need not consider whether to reject them as
untimely or give the IRS an opportunity to respond to' .'theni .
22The IRS does not dispute that Orr's gambling-related
travel expenses are deductible . Courts have disagreed on whether
the sec . 165(d) limitation applies only to net losses from bets
themselves (for instance, an excess of money paid into a slot
machine over money paid out from the slot machine) or,also to,
other expenses (such as travel expenses) that constitute part of
an overall, loss froma gambling activity . A recent IRS .internal
memorandum, AM20 .08-013,' summarizes precedent on eachside .of the,.,
issue and concludes that because the statute refers to wagering
"transactions", which the memorandum . asserts to be a narrowerterm than "activity or others used in comparable provisions ,
(continued . ., .)
- 19
explain our reasoning in the course of addressing the Orrs '
various arguments .
The Orrs argue that the status of Orr's gambling as a
business made the net gambling . loss deductible . In support of
this argument, they present Commissioner v . Groetzinger , 480 U .S .
at 35,
Clemons v . Commissioner , T .C . Summary Opinion 2005-109,
3
and Panages v . Commissioner , T .C . Summary Opinion 20,05-3 .2
However,
Groetzinger ,
Clemons and Panages do not focus on
whether a net gambling loss arising in a gambling business is
deductible .24
22 (
Groetzinger held that gambling losses to the exten t
. . . continued )
sec . 165(d) addresses only net losses from bets themselves as
described above, which we discuss as "net gambling losses" . For
this case, we accept the parties' agreement that the Orrs'
gambling-related travel expenses are not limited by sec . 165(d)
because this position has a,reasonable basis in law . (An
internal memorandum does not normally bind the IRS, but it may
cite law and contain reasoning that can inform our consideration
of a case . )
23Although sec . 7463(b) prohibits us from treating Clemons
v . Commissioner , T .C . Summary Opinion 2005-109, and Panages V .
Commissioner , T .C . Summary Opinion 2005-3, as precedent, meaning
that we cannot base our decision in this case on having made a
similar decision on comparable facts in those cases, we consider
the law they address and the reasoning they contain in deciding
whether the Orrs' treatment of their net gambling loss was
correct .
,24We understand, however, how Orr ., who suffers from
diminished mental capacity, might infer from them that net
Commissioner v . Groetzinger , 480
gambling losses are deductible .
U .S . 23 (1987), discusses the status of . a gambler as a
professional and a deduction for gambling losses ; Clemons and
Panages discuss the status of gamblers as casual gamblers and
unavailability of certain tax benefits . The Web sit e
(continued . . .)
20 of gambling winnings are-deductible in computing alternative
minimum taxable income (under the significantly different
alternative minimum=tax rules, in effect for ., 1978), and discussed
more generally what kinds of,activities constitute a business for,
tax .purposes . F Clemons and Panages both concluded that a .casua l
gambler must include gambling winnings in gross income :,and .may
deduct gambling losses that do . not exceed winnings as an itemized
deduction .25 As discussed later ., treatment of a deduction as ,` . . .
"above-the-line ,or "itemized" affects various other tax, items .
24 ( . continued )
"Professional Gambler Status", from whose "Case Law" page Orr
printed excerpts from Clemons and Panages , uses bold text for
parts of the„cases about status .of gambling activities as=a
business and about gambling losses being deducted on Schedule-A,
Itemized Deductions,gor Schedule C of Form 1040 .
25 Commissioner v . Groetzinger , supra at 32, brief ly,,dnd,,,
indirectly discusses sec . 165(d)'s limitation on net gambling
losses, stating-in dicta :
the confinement of gambling-loss deductions to the
.amount of gambling•gains, a provision brought into,th e
income tax, law as § 123 (g) _ of the Revenue Act of ; 1934,,
48 Stat . 689, and carried forward into §,165(d) of the
1954 Code, closed the .door•on suspected abuse s
* * * but served partially to differentiate genuine- .
1 11
.gambling losses from many other ; types of .adverse=`
financial consequences sustained during the tax year .
* * *
Note 3 in Panages v .,Commissioner , supra , states that "If :
petitioner qualified as a professional gambler for purposes of,, :,,.
sec .-162, . she still could claim her losses only to the extent she .
had gains . Sec . 165(d) ; Praytor v . Commissioner , T .C .-Memo .
2000-282 ."We infer that Orr did not-understand the significance . of the
foregoing passages .
- 21
In their posttrial brief, the Orrs noted that there is no
mention of section 165(d) .-in section 162 (subsection . (a) of whic h
provides that "There shall be allowed .as a deduction all the
ordinary and necessary expenses paid or incurred during the
taxable year in carrying on any-trade or business") . Their
argument, we infer, is that section 165(d) does not limit the
scope of section 162 .26 . Although an explicit . cross-reference
might make the law easier to understand, we reject this
argument . 2 '
Sections165(d) provides that "Losses from wagering
transactions shall be allowed only to the extent of gains from
such'transactions .i28 The word "wagering" is synonymous with
"gambling" .
Tschetschot v . Commissioner , T, .C . Memo .
.2007-38
(generally, and in the federal tax .context) .
26The brief states in relevant part : "In the case of a
taxpayer not engaged in the trade or business of gambling, losses
are allowable as a miscellaneous itemized deduction, but only to
the extent of gains . Professional gamblers have qualified as
being eligible to file as a business according to tax code
162(a) . . NO WHERE in irc code 162 does it mention 165(d) . "
27 It appears that, at least untilrtrial, Orr did not merely
draw an incorrect conclusion from the absence of a crossreference to sec . 165(d) but failed more generally :to understand
the significance of that section and its relation to other tax
rules . Consequently, we need•notfocus on the absence of a
cross-reference in deciding whether Orr's misunderstanding of law
is consistent with the reasonable-cause exception to the
accuracy-related penalty .
28Sec . 1 .165-10, Income Tax Regs ., provides that this
limitation of-wagering losses to wagering gains applies on a
year-by-year basis rather than over a!shor`ter period .
-
Section -165 (d) 'denies a deduction for -a net . gambling .loss
even if the .1oss is .also described as a kind of generall y
deductible item ,
such as a section . 162(a )
business expense,-
section 165(a) loss from a transaction : entered into for profit, or,,
a section 212 expense
for the production of income . Thisbroad 4
interpretation .of section 165(d)°is•supported by its history, th e
plain language of . :-the Code, and,,as discussed earlier,- judicial .;
preceden t
Congress first enacted the language now reflected in-Sectio n
165 (d) as section 23 (g .) .,.,of the Revenue Act of 1934, (1934 Act)j, c .h .
277, 48 Stat . 689 . According to committee reports, Congres s
wished to reverse caselaw that allowed,legalr gamblers to deduct?their gambling losses against nongambling income :29
Under the interpretation .of the courts, illegal gamblin g
losses can only be taken to the extent of the gains o n
-such .transactions . A similar limitation on losses,,fro m
legalized gambling is provided for in the bill . Under
the present law many taxpayers take deductions fo r
gambling losses but fail to report gambling gains . Thi s
limitation will force taxpayers to report their gamblin g
gains if they desire to deduct their gambling°lossesH . Rept . '704, '73di Cong . ,
2d Sess . 22
'(1534), 1939-1 C .B.
554, 570, and S .Rept . 558,-73d Cong .°, 2d Sess .25
(Part 2 )
(1934),'i939 .- 1
C .B .'(Part 2)=586, 605'(following the House committee's .' language ,
except in referring to-.the bill as .the-"House bill") Thus, th e
29See Beaumont v .-Commissioner,
affd . 73 F .2d 110 (D .C . Cir .-1934),
taxation before the 1934 Act .
25 B .T .A . 474, 482 (1932) ,
for adiscussion of gambling .
- 23 committee reports provide no support for an argument that Congress
intended to express any distinction between professional and
casual gambling in enacting section 23(g) of the-1934 Act .
Neither does any other authority of which we are aware .
Section 23 of the 1934 Act is entitled "Deductions from Gross
Income" . Its flush language is simply "In computing net income
there shall be allowed as deductions :" . It set forth most of the
deductions allowable against gross income in computing net (i .e .,
taxable) income .30 These included,among-others, business expenses
(section 23(a) of the 1934 Act, ch . 277, 48 Stat . 688) and losses
on transactions entered into for profit (sections 23(e)(1) and (2)
of the 1934 Act, ch . 277, 48 Stat . 689) .
The location of section 23(g) of the 1934 Act alongside the
other subsections of section-23, which in turn set forth most of
the deductions allowed by .the Code (including the deduction for
business expenses), confirms what we believe to be the mos t
logical reading of section 23(g) : section 23(g) limited all net
gambling losses, even those that could also be described as
another kind of generally deductible item, such as busines s
30The deductions not addressed in sec . 23 of the Revenue Act
of 1934 (the "1,934 Act") were generally limited to special
classes of taxpayers, such as trusts and estates, and lack
relevance to gambling transactions as"such (addressing instead,
See sec .
for example, distributions by trusts and estates) .
.
728
.
162(b) of the 1934 Act, ch . 277, 48 Stat
24
"
expenses .31 The 1934 Act did not contain a, provision similar, t o
current section 7806 (b) --which provides ''that "No inference,
implication, or„ presumption . of legislative construction shall be ;
drawn or made by reason of the location,or grouping of any .
.
mm
particular section .or provision or portion of this title" . }
Section 23 (g) of the 1934 Act-came into .; the, Internal Revenue .,
Code of 1939 .as subsection (h) of section 23 : Ch .
2,-.53 Stat . 13 ._
Section 23 of . the 1939'Code ;was .still ;entitled,"Deductions from :
Gross Income" and still contained most of the deductions allowed,
under the income-tax law .
The Internal Revenue, Code of 1954,•ch . 736, 68A Stat .w ;49,
brought what is now section 165(d) to°its present location within . ,
section 165, a section that addresses
" Losses." ., The 1954 Code,
like ., the . currently effective Internal Revenue Code of 1986,,I, place d
section 165 in part VI= of subchapter : B of chapter 1,,-a' part
entitled "Itemized, Deductions for Individuals and Corporations" :.,
The 1954 .Code placed . some other kinds, of deductions that might ,
31It is a longstanding maxim of statutory construction that
if two statutes overlap, the later enacted statute prevails over
the earlier to the extent of the inconsistency .
Posadas v .
National City Bank , 296 U .S . 497, 503 (1936) .
Business losses as
such had long been deductible at the time the 1934 Act introduced
(Until 1939, Congress '
disallowance of net gambling losses .
regular practice was to enact a comprehensive tax statute
including incremental changes from the prior version rather than
to enact a statute containing only the incremental changes to a
longstanding code . Even so, the maxim is .relevant because .it,
reflects,, among other considerations, the - legislature's ability,
to consider an older rule and take .care in-drafting the newer
rule to overlap it or not .)_
- 25 address gambling losses, such as section 162'business expenses, . in
other sections of part VI . But other kinds of deductions that
might also address gambling losses, such as the section 212
deduction for expenses for the production of income, were placed
in part VII of subchapter B of chapter 1, a part that was entitled
"Additional Itemized Deductions for Individuals" .3 2
Viewed in isolation, the 1954 Code's rearrangement of the
1939 Code's deduction-related . provisions may appear to indicate a
significant change in the relationship of those provisions to each
other . The designation of section 165(d)
as a subsection o f
section 165 (which, unlike section 23 of the 1934 Act and 1939
Code, contains only a few of the kinds of deductions the incometax law allows) might suggest that section 165(d) does not limit
deductions allowable under other sections of the Code (such as
section 162) . Similarly, the location of section 165(d) within
part VI of subchapter B of chapter I might suggest that it doe s
32Valenti v . Commissioner , T .C . Memo . 1994-483, describes
the history of what is now sec . 165(d) :
Moreover, the provisions in section 165(d)-first
appeared in our revenue law as section 23(g) of the
Revenue Act of 1934, ch . 277, tit . . I, 48 Stat . 689 . 4
4The provisions were redesignated section 23(h) in
the Revenue Act of 1938, ch . 298, 52 Stat . .447, 461,
and continued as such in the 1939 Code until they
became the current section 165(d) as enacted in the
1954 Code .
26 not limit deductions allowable under .other "parts" of .the .Cod e
(such as part VII, . which contains section 212) .
However, . the House and Senate reports on`therl954',Code state d
that "Rules for the treatment of losses contained in variou s
subsections of section 23 of the 1939,,Code .have been brough t
together in [section 165 ]
this rearrangement ."
*
No substantive change is ..made,b y
H . .Rept . 1337,
83d Cong ; .,
(1954-) ; S . Rept . 1622, 83d'Cong ., 2d Sess .
2d Sess . ~ A46 •
198,,(1954) .-.
In
addition, . the : 19.54 Code .,introduced section 7806-(b) (inference ,
legislative construction not to be - drawn .from .'location ore,groupin g
of provisions of Code) in its presentform carrying„forwar d
similar, .language from section 6 of the introductory "enactin g
clause of the statute . containing, the, 1939 Code,(ch . 2, 5 3Stat .
1) . Section 7806-(b.) , confirms that the designation of section . ;
165(d)
as a . subsection of a section addressing only a particular.
kind of deduction (the deduction for, certain "losses") , .does not ~in-
itself prevent section 165(d) from applying to other .kinds o f
deductions . ;3 3
33Sec'. 165( d)'s use of . sec . 165's term " losses" , rather"than.
the sec . 162 and 2121 term "expenses ", ; might also in isolation
suggest that the-sec .- 165(d) limitation does not extend t o
deductions described .in the latter sections . But we and other
courts have consistently held that net gambling losses incurred
in a business are nondeductible under sec . 165(d) and it s
predecessors . See, e .g ., Nitzberg v . Commissioner , 580 F .2d 357, .
358 (9th Cir . 1978) ; Valenti v . Commissioner , supra ; Skeelesav .
United States , 118 Ct . Cl . 362, 371-372, 95 F . Supp . 242, 246-247
(1951) . Although gambling losses may be-described as,,fo r
(continued . . . )
- 27 II .
Applicability of Section 165(d) to Orr's Gambling
The Orrs make a comment in their posttrial brief that we
construe as an argument that section 165(d) should not be-applie d
to Orr' s gambling activity because no meaningful distinction ca n
be .drawn between her gambling activity and other activities whos e
net losses are undisputedly deductible . The brief says :
When Mr . Eric Evans, of the IRS office in Birmingham,
interviewed us for our preliminary court case, [343 we
mentioned losing a lot of money in the stock market E3_13
and Mr . Evans said "another form of gambling" and so it
is, yet, these losses are deductible . Webster's defines
gamble as to play a game for money, to take risks in the
hope of getting better results than by some safer means ;
to stake one's money . Any business anywhere in the
world is a risk, i .e ., gamble . If you can name one that
is not a risk, I and many others would like to
participate in that business .
Conway Twitty (Harold Jenkins) started a restaurant
(Twitty. Burgers) with 75 of his friends investing in the
business . The business went under in 1971 and Mr .
Twitty reimbursed his friends for their losses an d
33( . . .continued)
instance, "ordinary and necessary expenditures directly connected
with or pertaining to the taxpayer's trade or business" (sec .
1 .162-1, Income Tax Regs ., describing sec . "162 busines s
expenses), nothing suggests that they thereby cease to be
"losses" .
34At trial, Orr testified that "Eric in the Appeals court"
gave her the copy of Commissioner v . Groetzinger , 480 U .S . 23
(1987), which the parties attached to their transcript . We infe r
that Eric Evans was an officer in the IRS Office of Appeals,
which offers taxpayers an opportunity to attempt to resolve their
disputes with the IRS in a relatively informal setting .
"Nothing else in the record addresses these losses . We
infer they may have occurred in years other than the one in
issue .
claimed and'- was allowed= the_' reimbursements' .asp business,.
expenses
. [36 ]
We reject this argument .
if it is difficult to defin e
the outer reaches of the term "gambling" ,
what Orr did was gambling . To hold that playing a .slot-machine is
not gambling would be an absurd interpretation of the word
"wagering" in section 165(d )
be tantamount to, saying that there :is•.no activity .that qualifie s
gambling, which would render.: section 165 ( d) .-surplus languag e
See Calafati v . , Commissioner ; 127 T . C . 21,9, 229 (2006 )
36The Court characterized the reimbursements as expenses o f
preserving the famous country singer's reputation, which,we foun d
.to be essential to his country music,, .business .
Had Conway not repaid the investors
His career would have been under cloud,
Under the unique facts of°this'case
Held : The deductions are allowed .
Excerpt from " Ode to Conway Twitty",
Memo . 1983-667 n .14 .
Jenkins v .`"Commissioner . -T .C :
37The Orrs appear,to argue that .defining gambling to includ e
slot-machine playing would require the . equally absurd result-tha t
every business is "gambling" . It does not, ., Courts- interpretin g
"gambling" for tax purposes have followed common understandings,, '
of the term which do not include most businesses . For instance ,
betting,on horse races '.( Schoole.r v . Commissioner , . 68 T .U . ` 867,
867-868-(1977),), bookmaking F (Winkler : v . United States ,' 230 F .2d, ,
766 (-1st Cir . ;1956)) ,' playing poker ' .( Tschetschot v . . Commissioner , ;
T .C . Memo ..,, .2007-38),, 'and,,,playing slot machines ( Chow v- .`
Commissioner,, T .C . . .Memo . 2010-48 ;, LaPlante v . Commissioner" , T .C .
Memo . 2009-226) ,.are all "gambling" . ., But speculating in,jun k
Jasinski v . Commissioner , T .C . Memo .
bonds is not "gambling" .
1978-1 See also Skeeles v .-Commissioner , supra at 365-136719 5
F . Supp . at 242-243 (betting . on sports, cards ., and dice i s
gambling) .
29 parts of a statute, if at all possible, are to be given effect"
(quoting Weinberger v . Hynson, Westcott-& Dunning, Inc . , 412 U .S .
609,633 (1973))) ;
Schoneberger v . Commissioner , 74 T .C . 1016,•
1024 (1980) .III .
Does Section 165(d) Unconstitutionally Discriminate Against
Gambling Businesses ?
The Orrs ask in their brief :
How can a business (professional gambler) be
subject to self employment tax and-yet be unable to
claim business deductions as any other business . It is
the only business the IRS places the restriction that
can't show a loss . What part of the law makes that
distinction and is that constitutional? . We understand
our laws are created by Congress,,` but shouldn't the
rules made by°the IRS be governed by someone ?
As'we have discussed, section 165(d) contains-the gambling
loss limitation relevant to this case . Section 165(d) -is a part
of the Internal Revenue Code, a statute enacted and amended from
time to time by Congress . Through . section 7 805 and other more
specific delegations of authority,' Congress has authorized the
Department of the Treasury, of which the IRS is a part, to issue
official interpretations of the Code . But we do not base our
decision that a professional gambler is not entitled to deduct
gambling losses in excess of gambling gains upon an-IRS
interpretation . We base it on the language and history of the_
Code and a longstanding principle of statutory construction .
We acknowledge that the Internal Revenue Code treats gambling
less favorably than most other businesses . But we have previously
30 rejected the argument that the Constitution does not permit
Congress to single out the"business of gambling for unfavorable ,
tax treatment . See . Valenti V .
Commissioner ,
supra ; cf ., Gordon v .
Commissioner , 63 T .C . 51, 80-81 (1974) (addressing unfavorable
treatment of-gambling income . under "income averaging" provisions'of .prior law), revd . in part on other grounds . 572 F .2d 193,(9t h
Cir . 1977) .
In Valenti ,
we noted that
" the due process clause o f
the Fifth Amendment has been construed .as'imposing an equal .
.protection requirement in respect-of classification" by the
,federal government, but that the Supreme .Court has recognize d
legislatures to have wide powers,to .distinguish .between even,,
closely, related businesses'in the exercise of their taxing powers .
We cited the extensive history of gambling set forth ;in Skeeles'v .
United States , 118 Ct . Cl . 362, 365-368,``95 F ; Supp . 242,'242-244
(1951) in observing that "Plainly,,a classification that
differentiates the business of gambling .•from other'business,[may
be justified in that it] has `a rational basis, and when subjecte d
to judicial scrutiny
* must be presumed to rest on that basi s
if there is any conceivable state of,facts which, would, support
it .'"
Valenti v . Commissioner ,
Coal & ,Coke Co
supra
(quoting Carmichael v . S .
, 301 U .S . 495, 509"(1937))
- 31 IV .
Deductibility of the Net Gambling Loss "Above the . Line "
A.
The Classification of the Orrs' Net Gambling Loss as an
"Above-the-Line Deduction" Does Not Affect the Section
165(d) Limitation
The Orrs claimed their gambling losses on Schedule C, a
standard preprinted attachment to an individual income tax return
(IRS Form 1040) . The instructions for Form 1040 and Schedule C
provide for deductions listed on Schedule C to be claimed "abov e
the-line", which means that the deductions are subtracted in
computing adjusted gross income . As we explain later, the Code
does provide for a professional gambler to deduct allowable
gambling losses "above the line" .
The Orrs stated in their pretrial memorandum that they
believed the issue in this case is whether "To allow or disallo w
gambling losses above the line ."' It is not . The IRS did not
dispute that the Orrs could deduct the allowable losses "above the
line" . The Orrs did not explain at trial or in their posttrial
briefs why they thought the IRS disagreed with an above-the-line
deduction for their gambling losses .
We infer that the Orrs believed that deducting the losses
"above the line" would except the losses from the limitation of
section 165(d) . Such a belief would not be correct . It is well
established that section 165(d) applies both to professiona l
gamblers, who, as discussed later, deduct their allowable gambling
losses above the line, and to casual gamblers, who deduct their
-32
-
allowable gambling .losses below the line . See, .e .g .,
Tschetschot ,
v . Commissioner , T .C . Memo . 2007-38 n .7,(citing Boyd v . United
States , 762 F .2d 1369 (9th Cir . 1985),
T .C . 1214 (19,51),
Offutt v . Commissioner , 1 6
and Heidelberg v . Commissioner ,' TLL.C . .Memo, . .
1977-133) .
B ., :
Consequences of :Deducting Business -Related Gamblin g
Losses Above the Lin e
A deduction which is subtracted from gross income t o
determine .adjusted gross income (AGI) is known as an "above-theline"-deduction because it is taken into account above a
conspicuous line at the end of the section of Form 1040 relatin g
to AGI . Section 62(a) lists-the kinds of .deductions . that'ar e
claimed "above the line ." One set of above-the-line deductions i s
"The deductions allowed by this chapter (other than by part VII o f
this chapter) [381 which are attributable to a trade or busines s
carried on by the taxpayer, if such trade or business does no t
consist of the performance of services by the` taxpaye .r as an .
employee ." Sec . . 62 ( a) (1) Therefore ,
a professional gamble r
38The Code'isY-divided into -"subtitles "chapters "
(Sec .
:"subchapters "
"parts", "subparts", and " sections "
7806(b), discussed earlier, explains, .that this classificatio n
does not in . itself have any legal effect .) The subchapter t o
which the quoted passage refers is entitled "Computation o f
Taxable Income" (containing, as of the year at issue, secs . 61291),"and the "part" whose deductions it excludes is'entitled
"Additional Itemized Deductions for Individuals" (secs . 211-224) .
33 -
claims allowable gambling losses and expenses as deductions abov e
the line . 3 9
Deductions other than (1) above-the-line deductions or (2)
the section 151 deduction for personal exemptions are known a s
"itemized deductions" . Sec . 63(d) . (An individual may claim
",itemized deductions" only if he or she does not claim th e
"standard deduction" . Sec . 63(e) .) Therefore, a casual gambler' s
gambling losses and expenses are normally itemized (i .e .,
the-line") deductions . See sec . 62(a) ;
;"below-
Hochman v . Commissioner ,
T .C . Memo . 1986-24 .
Above-the-line deductions and itemized deductions both
generally reduce taxable income dollar-for-dollar . But an abovethe-line deduction for a gambling loss is sometimes more valuable
than an itemized deduction because (a),, a taxpayer is entitled to
claim an above-the-line deduction even' if the standard deduction
is also claimed and (b) an above-the-line deduction reduces AGI ,
"Since sec . 62(a)(1) requires merely that the deductions be
attributable to a trade or business, not that they be deductible
under sec . 162, "Trade or Business Expenses", this result does
not depend on whether the professional gambler's deduction for
gambling losses (1) arises under sec . 162(a)-and is limited by
sec . 165(d), see Valenti v . Commissioner , supra , or (2) both
arises under and is limited by sec . 165(d), see Humphrey v .
Commissioner , 162 F .2d•853, 855-856 (5th Cir . 1947) (holding that
sec . 23(h) of the 1939 Code, a predecessor to sec . 165(d), both
allowed gambling losses without'regarcl to profit motive and
limited them to gambling gains), affg . in part and revg . in part
a memorandum Opinion of this Court .
and AGI is- used ,to limit certain .tax benefits . e°,.: .See Calvao v .
Commissioner , T .C . Memo . 2007-57 n .6 (discussing reduction .of `
certain itemized deductions by reference to'adjusted gross,,income
under' section 68 .) ; cf . e . g' ; , sec . 170 (b) (1) (A),, (B)
.(F)
(relating to the deduction for charitable 'contributions )
We noted earlier that°Orr .may have reported the Orrs' gros s
receipts from gambling as ., gross income and their gross
expenditures on bets as losses, and that even, if, technically
incorrect this practice probably does : not in itself ..affect their
tax liability . This follows in part from the fact-that Orr, . as,; a
professional gambler, deducts allowable gambling, losses . above, th e
line : We°and other courts :have,from--time totime'held that a
gambler's : gross income is properly determined by,reducing . .gross
receipts from a particular bet, and,-,in the case o .f,a professional '
gambler., a series .of related bets,-by the amount wagered ,on those
bets ; . (Any,net loss would : still,'be subject to section, 165 (d) . )
See Winkler v . United States , 230 F .2d 766, 770-776 ('1st Cir .
1956) (offsetting costs of related winning and losing bets b y
professional gamblers against their proceeds from those relate d
40ltemized deductions generally are disallowed to'the exten t
of 3 percent -.of AGI . over a threshold amount for- a taxpayer .whos e
income exceeds that amount, sec . . 68(a),-and 'certain itemized
deductions , classified as "miscellaneous , '-itemized deductions"are disall-owed,to the extent they do not exceed 2 percent of
total AGI, sec . 67 ( a) : But these disallowance rules do not appl y
68 (c)(3 ) ;, .,H .R . Conf .,,,.
to gambling losses . See secs . _ 67 (b) (3 )
Rep . 99-841 (Vol . . II), at .II-34 ( 198 .6 ),= 1986 - 3 C .B . (Vol . 4),-1,
34 ; Whitten v . Commissioner , T .C .,Memo . 1 '995-508 .
.
35 bets in determining gross income) ;
B .T .A . 326, 332-333 (1925) ;
McKenna v . Commissioner , 1
Hochman v . Commissioner ,
supra
(offsetting the cost of each of a casual gambler's winning bets
against his proceeds from that . bet indetermining his gross
income) . These cases suggest that the Orrs may have overstated
their gross income and gambling losses by equal amounts by
treating the gross proceeds of winning bets as gross income and
treating the cost of making those bets as losses . Equal
overstatements of gambling gross income and losses would not
change the net gambling loss . disallowed under section 165(d), and
would increase the deductible gambling loss dollar-for-dollar with
the overstatements . Since even an itemized deduction for net
gambling losses is not limited by sections 67(b)(3) and 68(c)(3),
such overstatements would not change taxable income .' Since a
professional gambler's allowable gambling-loss deduction is
claimed above the line, the overstatements would not change AGI .41
We thus lose nothing by accepting the'statement on the Orrs'
return that they had $909,058 in "gambling winnings",-the same
amount of gross income,
:and $1,113,766 in gambling losses from
their gambling business .
41Nothing suggests that the Orrs have any tax item whose
treatment would be affected by the amount of their gross income
as such . The extent to which the Orrs would be taxable on their
Railroad Retirement Board and Social Security benefits may depend
in part on their "modified adjusted gross income", which, like
AGI, would not be affected by equal overstatements of gambling
gross income and losses .
36 V.
Substantial Understatement Penalt y
Section 6662(a) generally imposes a 20-percent : penalty,
described in the section's title as the "accuracy-related
penalty on underpayments . of tax attributable to certain`i
circumstances, including,:under:section 66 .62(b)(2), a "substantial,
understatement,of income tax ." Section 6664(a) defines an, .
"underpayment" for relevant purposes not=simply as a lack of=, payment but,,in'relevant part, . as an excess of the correct tax
over the sum of-(A) the amount shown as tax on :the return and (B)-'
amounts not shown as tax on the return .but previously assessed or ._
collected . Since the Orrs paid only a-smallamount of tax before
filing the return and reported on the return that no tax was due,
the-majority of their correct tax liability for , the year was an
"underpayment" under section, 666 .4 (a) . (This, .,is true regardless-: of, .
the precise amount of their omitted retirement benefits, .which,as :
we discuss-later, remains to be determined° .) Section . ,6.662 (d), - ..
provides that a + substantial . understatement of income tax . is,,.,with exceptions .-not relevant here, the excess of'the correct tax
required . to be shown on the return over the tax shown :on~the - .
return, but only if that excess is greater than the greater o f
$ 5 , 0 0 0 and (2) 10 percent of the correct tax . 42 ---Since .the- Orrs t
,'42Sec .
6662(d) .(2) (B) provides .that a portion of an,
understatement-attributable to a position-which, although
ultimately determined . to be erroneous , is ors was supported by
"substantial authority"_, _ or has a " reasonable basis" and :wa s
(continued .. .
37 income tax for 2004 as properly determined without the deduction
for net gambling losses exceeds $5,000 (regardless of the precise
amount, of the omitted retirement benefits), and the tax shown on
the return was zero, they have a substantial understatement of
income tax for the year . It is undisputed that the entire
underpayment is attributable to the substantial understatement .
Section 6664(c) provides that no penalty shall be imposed
under section 6662 with respect .to .any portion of an underpayment
if it is shown that there was a reasonable cause for such portion
and that the taxpayer acted in good . faith with respect to such
portion .
The Orrs argue that they had reasonable-cause for omittin g
the retirement benefits because Orr had diminished mental capacit y
on account of her depression . They-further argue that if their
i
deduction of net gambling losses was in error (and it was, as w e
have explained), Orr's diminished mental capacity and unsuccessfu l
attempts to understand the law constitute reasonable cause . As
discussed earlier, Orr's husband was too ill to be expected t o
ensure that the Orrs' joint return was filed correctly . Th e
42( . . .continued)
adequately .disclosed to the IRS, is not taken into account in
determining the existence of a "substantial understatement" .
Neither party argues that this rule is relevant . We need . not
consider it because we decide that the Orrs are excepted from any
substantial-understatement penalty on the ground that they had
reasonable cause for and 'acted in good faith with respect to each
of their errors . See sec . 1 .6662-3(b)(3), Income Tax Regs .
- 38
record' does . not . indicate that anyone : else hada duty to ensure',the
return was correct . : there was . no agent .or guardian, for, example .
Thus, we consider the reasonableness of the-actions taken to,
ensure the. return was correct only in ;;,,the light of Orr's own
.
diminished mental capacity .
The IRS argues that Orr's .attempts to understand the law were
not sufficient, and her mental capacity was not sufficiently .
diminished to . constitute-reasonable cause~ .43 In support, it,..argues
that she was "able to carry out . her gambling trade or°businessff
.
during 2004 and that one :. would .generally be expected to b e
familiar with the tax laws relating to one's business . It furtherargues that Orr's mental state was sufficient that she "could"
adequately carry on her ' personal affairs", . "take care of her
ailing mother and husband", and "keep accurate business .records,
her gambling' enterprise as_well,as two other busines s
enterprises and that Orr's implicit' contention . that she was anovice in-tax law research was undermined by`her work-for .H&R . .
Block and . her "familiarity with" TurboTa x
43 The IRS has the burden of production,with respect,to .the
penalty, which has been met . See sec . . 7491(c) . Because we
.
affirmatively find that Orr suffered from diminished mental
.capacity that constituted reasonable : causef or the errors, we ,
express no view on which party had the burden of proof .
.
- 39 The IRS did not contend that Orr acted in-bad faith separate
from the argument that she did not have reasonable cause .," . The
kinds of activities Orr conducted in connection with filing th e
return--doing legal research .and discussing her situation with the
IRS, tax advisers, and colleagues--tend to indicate that she was
honestly attempting to file it correctly .' Her transactions ar e
consistent with a good-faith mistake : she simply claimed,a
deduction for an actual business . . loss, which, were it not for a
special rule, normally would be deductible . . She described the
transactions on her return clearly, as a business of "gambling" i n
which she incurred "gambling losses", making no attempt to hid e
the tax issue, and enabling the IRS to,easily determine . whether an
examination would be appropriate . Moreover, Orr's omission o f
some or all of the Orrs' retirement benefits appears to be
essentially an "isolated computational or transcriptional error"
that "generally is not inconsistent with reasonable cause and goodfaith ." Sec . 1 .6664-4(b)(1), Income Tax Regs . Consequently, we
infer that if Orr's mental capacity was sufficiently diminishe d
that she would have-honestly understood her objectively flawe d
44The IRS concludes the section of its brief addressing the
accuracy-related penalty by stating that "petitioners in bad
faith and without reasonable cause tried to circumvent the,
limitations of § 165(d)" but does not specifically explain why it
believes they acted in bad faith . . . . IfrOrr's .mentalcapacity was
not sufficiently diminished for her to have believed that she had
done enough to ensure her return was correct, it would follow
that she did not act in good faith . But'if that were the case,
she would not have reasonable cause for her errors, either .
- 40 -
efforts .. to file. a` correct return' to be adequat e
address later), she acted in good faith .
Section 1 .6664-4 (b) ,(,1Y,- Income' Tax Regs ., interprets- .
"reasonable cause" .for `purposes of section 6664 .in relevant part-
as follows :
. -The .determination of'whether a taxpayer acted with ;
reasonable cause and in good faith is made on a .
.case-by-case .basis, •taking,into~account all pertinent, ;,` .
facts and circumstances . * * *Generally, the mos t
important' factor is the extent- of the : taxpayer's effort ;,, ,
to assess the taxpayer ' s proper tax liability.
Circumstances that may indicate reasonable-cause an d
good faith include an honest misunderstanding of, fact or ,
law.that is reasonable in .light of all . the facts and i
- ;.education of , the4 taxpayer .
°
*
*
*
!;
. tax-compliance failures resulting from .menta l
We-have .found .
illness,including .severe emotional-disturbance, .to be .due to '
reasonable . cause and not' inconsistent with good faith . . In Ruckma n
v . Commissioner , T . .C .- :,Memo .
1998-83 ,-,we .found reasonable cause- . for. .
an-omission of"income from a joint return where the spouse- ;who
handled the couple's finances was undergoing extensive, treatments,, "
for cancer and the :other, ;, who :had long-,relied -on her to handle :their-'-finances, ,wa s
"undoubted [ly] , impact .[ed]b - ;[by] having a spous,e•• ;
battling a life-threatening illness She, similarly to,Orr .,, .
testified that "I didn't "know that°' I wasn' t capable of what " I ` wa s
trying to-do . In 'Gray 'v . Commissioner , T .C .'Memo
1982-3'92, we
found reasonable cause for omissions 'of income from °a joint-retur nr
d"
(some of 'which omissions 'the-taxpayers were 'unable to- explain- as-
41 other than simply accidental) where one spouse became totally
disabled and required hospitalization periodically throughout the
year, placing a "significant emotional drain" on the other, who
read various publications in the course of taking what she
described as "great care" to file the return . See also Kees v .
Commissioner , T .C . Memo . 1999-41 . (Some of the foregoing cases
address former section 6653, Additions to Tax for Negligence and
Fraud, a precursor to the current accuracy-related and fraud
penalties that was also subject to a reasonable-cause exception . )
We are satisfied that Orr suffered from-diminished mental
capacity that impaired her ability to file a correct tax return,
and that she was not sufficiently-aware of this diminution for us}
to find bad faith from her failure to do something more than she
did (such as her failure to hire a tax adviser) . Orr gave
undisputed testimony that her employer had granted her early . .
retirement for permanent disability on account of her depression .
She also stated, and we accept, that the fact of her disability
was certified by a doctor . Her mother, for whom she had been
caring, had recently died ; two of her brothers also had recently
died ; and her husband had an illness, believed to be terminal,
which continued to require her care . Her conduct of her
"businesses", discussed later, corroborates that she did not
understand how far her mental capacity had diminished . We have in
the past accepted evidence less extensive than what Orr presented
- 42 to establish diminished mental ability as reasonable-cause fo r
.penalty purposes . See` Ruckman v . Commissioner , ., supra
(in .which we
excused the couple from a penalty in part on thebasis ..of th e
"undoubted . impact" upon the spouse who prepared the .returnao f
having'a spouse battling a life-threatening illness) ;-, Gray
Commissioner ,' supra .
We noted earlier that . in her- pretrial memorandum . .Orr asserted ,
that the issue .in this case was whether "To allow or disallo w
gambling .. losses above the line", and that Orr believed that an "IR S
publication 's statement that•a net gambling loss was not ,
deductible did not-apply to a professional ,gambler . . Informal IR S
guidance is not itself law, but a reasonable,misunderstanding o f
its-,discussions of lawe,can be relevant to whether a taxpayer
should be excused froma penalty .45 ° See Gray v . Commissioner ,
supra . Because Orr did not=explain which publication she used or ,
how it contributed to her error. and because other . . evidenc e
suffices to establish reasonable cause, we do not consider her-us e
of the IRS publication .
451t is well established that an' ambiguity or error in
informal . guidance, such as IRS form instructions and informal
publications, "cannot affect the .operation of'the tax statutes o r
* * *,[a taxpayer's] obligations thereunder ." See Weiss v .
Commissioner , 129 T .C . .175, 177 '(2007) . We have also'held'more
broadly that interpretations of tax law in these informal
materials are not authoritative . See Green v'. Commissioner , 59
T .C . .456, 458 (1972) .
- 43 The IRS' argument that Orr's handling of her businesses
indicates that her mental ability was not so diminished as to
prevent her from filing a correct tax return is misplaced . None
of Orr's businesses had a reasonable potential for profit . The
fact that she thought they did tends to show that her mental
capacity was diminished, and the fact .that_she persisted in them
tends to show that she did not know how far her mental capacit y
had diminished .
We reject the IRS'- .argument that'Orr's ability to kee p
financial records for her businesses indicates a high degree of
sophistication . As discussed earlier,, all of these records were
very simple . The records indicate Orr's ability to accurately
report the amounts of what she understands to be her income and
deductions--which, generally, she did . ; But they do not .-indicate
an ability to adequately address the legal issue of whether a
professional gambler may deduct net gambling losses .
We reject the IRS' argument that Orr's care for her ailing
mother and husband, or her ability to "carry on her personal
affairs" meant that she did not have reasonable cause for the
errors on the return . Nothing suggests that Orr's care .for her
mother and husband reflected a degree of sophistication relevant
to tax return preparation rather than simply-hard work . He r
ability to care for them suggests at most that she may have ha d
the ability to perform periodic tasks, such as filing a tax return
- 44 -
every year, which she did . As discussed earlier, Orr's_handlin g
of her affairs did not reflect any degree of ;sophistication . He r
employer had found her unable,to do her job . Her "businesses "
were illogical . ( The parties . did not . elaborateion the Orrs' sales .
of shares, :. but, as discussed earlier, . these appear not .to reflec t
any particular skill or judgment .)
Tamberella v . Commissioner ,,.
139 Fed . . Appx . 319, 323 (2d Cir . 2005) :, affg .T .C . ;Memo .'2004-47,,.
which the IRS cites for the proposition that carrying,, .on-.one'spersonal affairs indicates a lack, of reasonable' cause ;? i
distinguishable' . In Tamberella , we held and the Court of Appeal s
for the Second Circuit affirmed that=a taxpayer did not hav e
j3
reasonable cause, .for an omission of income from°-his return on•th e
ground' of .mental 'incapacity . We found' that he had-beenhospitalized for mental illness on two ., occasions--10 days,near,,th e
beginning of the year before the year at
issue $ and .5 weeks. a few
years after the year at ...,issue- but that there was no :evidence :that ,
.he suffered from any mentalr incapacity in the interim . We ;, als o
found that during-the tax year at issue-he had represented himsel f
in an arbitration proceeding, . and settlement negotiations-, .throug h
which . her obtained a large :employment-related award .„ Menta l
incapacity- did not actually prevent that .. taxpayer :from complyin g
with his .-tax obligations . : He was just trying . to use mental,
incapacity from an .irrelevant period as an excuse for no t
complying .-
45 i
The fact that Orr once prepared tax returns at H&R Block doe s
suggest that she had more relevant knowledge and experience than
the average taxpayer . But we infer that her skills deteriorate d
with time and with her overall mental : ; capacity . By the time she
prepared her 2004 return, she was neither able to determine the,
correct treatment-herself nor recognize that she was unable to do
so . We note, moreover, that Orr's way, of addressing an issue sh e
found difficult would have been very r1oughly correct even for a •
tax expert : she consulted others in her industry, IRS employees,
accountants, a lawyer, and a law librarian,-and considered these
people's advice in the light of-her own experience, research,•and
analysis. Orr should have made a greater effort to find- .someone
able-to help her with her particular tax issue, but we find her
diminished mental capacity to be reasonable=cause for this
omission .
-- We reject the IRS' argument that' ;lOrr's :"familiarity with
TurboTax" "undermines her contention that she is a'novice in tax
law research ." Nothing about Orr's use of TurboTax -suggest s
special knowledge of tax law br tax law research .
We have found before that taxpayers with substantial tax an d
financial experience can become unable to prepare their return s
correctly . In Gray v .
Commissioner , T .C .
Memo . 1982 - 392, the
spouse who prepared the return had for many years prepared return s
f
reporting the taxpayers' farming activities . In Ruckman v .
46 Commissioner , . T .C. . Memo . 199 .8-83, theL .spouse who prepared they
return had for many years maintained-financial-records for and
consulted with .anmaccountant for the preparation of returns .r
:
reporting_the ..taxpayers'`trucking activities. . --'(While thosetaxpayers apparently had .not-prepared .tax returns professionally-,
the limited record before us does not show, .Orr's experience to be,,
much greater than theirs .)- We .accepted the distress Gray suffered
as a- result of her husband's becoming totally disabled andrequiring hospitalization from time to time throughout the . tax
year, .and the distress Ruckman•suffered,as a result of undergoing
extensive cancer treatments,' as being-reasonable cause for their
tax compliance problems . . We similarly acceptas .reasonable cause
for Orr'-s significant : but'apparently~isolated compliance problem
= sherdimn talcpiysoatedwhprsionc
made her unable to work, her gambling problem, her recent loss .;.of .
multiple family members, and her responsibility of caring for he r
ailing -husband .. VI .
Computation of Retirement Benefit s
The stipulation of-facts that the parties submitted jointly
at-,trial stipulated, that the . .Orrs received and ..reported Railroad
Retirement Board : and Social Security .-benefits totalin.g ; $30+, 39h 'n .
(the stipulated,_retirement benefits) :
4 . During the, 2004 taxable, year,, the petitioners
received retirement benefits of $17,784 .00 from the U .S .
Railroad Retirement Board and $12,60 .7 .00 from the Social
Security Administration .
.P
- 4 :7
5 . The petitioners failed to report any of the
retirement benefits on their 2004 federal income tax
return .
In the Orrs' reply brief,, however, 'Orr argues that :
I know retirement funds are taxable and I .don't know why
I did not include them ; Ithought I had everything
listed . I have enclosed a copy of Form 1040 showing I
DID report $16,470 of which $9,529 was considered
taxable ." [ 46 )
The Orrs had reported $16 ;470 on the return's line entitled
"Pensions and annuities", and, of this, $9,529 on the return's
next line, entitled "Taxable amount" (of the ."Pensions and
annuities") . Social Security and certain Railroad Retirement
Board benefits should have been entered on a different line,
entitled "Social security benefits" (with a corresponding line for
"Taxable amount"), on which the Orrs did not . enter any amount .
2004 1040 Instructions at 24 . It seems possible, however, that
the Orrs mistakenly entered their Social Security and Railroad
Retirement Board benefits on the line for "Pensions and
annuities" : these benefits are a kind of pension, in the generic
sense, and, like certain other pensions, they are only partiall y
46We consider the partial copy of ; the Orrs' return enclosed
with their reply brief merely an informal reference to the copy
of the return which the parties had earlier submitted as a joint
.
exhibit and stipulated .to be authentic .
Orr should not have waited until filing her reply brief to .
introduce the retirement-benefits issue . But we consider it
because we conduct proceedings in sec . 7463 "small tax cases"
informally and because the IRS will have a full opportunity to
address the issue in a Rule 155 computational proceeding .
- 48- -
taxable .
See, e .g :, secs .
72
(annuities, including-certai n
pensions), 86 (Social Security and Railroad Retirement . Board ;,
benefits) . Since .'the record beforethe Court does not specify th e
source 'of the amounts they listed on the relevant . lines , 47 .;we do
not know whether the',$16,470 of "pensions and annuities',the y
reported were a part of the $30,391 of stipulated retiremen t
benefits or .. are a separate amount-of income . .
If the Orrs reported'some of the stipulated retirement .
benefit s'on the return,-only a part of the stipulated retiremen t
benefits --,(and only a part of their taxable portion ) . : would properly .,
be added to the- figures they had1 listed fore "pens .ions an d
annuities- in determining the .Orrs' taxable . income, .and tax,, .for, .4
the year . Alternately, : the .Orrs may 'simply have reported . on the ,
,return "pensions and . annuities" .. other .than the amounts :-.-to which '
the stipulation refers .
We decline to adopt paragraph 5 .,of the, stipulation- as .• a
finding of fact` . We may, permit a party to "contradict= a
stipulation "where justice requires",,,and "We are-not boundb y
stipulations of fact that'appear contrary to the facts disclosedby the record ." Rule 91( e) ;
T .C . 135, 137
n .4 (2000) ;
Estate of Eddy v . Commissioner -, 11 5
see also° Jasionowski v . Commissioner`, 66
jr
T .C .. 312, 318 (1976) . The record before the-Court calls~paragraph _
1 11
47Any relevant :information returns or,payee statements that
theOrrs may have filed with the,return, such as IRS,Forms 1099,, .
are not before the Court .
I t
- 49 5 into doubt, and we observe that Orr's diminished mental capacity
makes her more likely than a typical litigant to have failed to
notice--despite exercising care reasonable in her circumstances-that she had already reported an amount on her return . Therefore,
we will leave (1) the portion of the Orrs' "pensions and
annuities", if any, that is separate from the stipulated
retirement benefits and (2) the portion of the stipulate d
retirement benefits that is taxable for the parties to compute
under Rule 155 .
To reflect the foregoing,
. Decision will be entere d
under Rule 155 .
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