Where A Deduction Is Claimed Can Be As Important As How Much Is Claimed…

An accountant who had her own accounting and consulting business also visited local casinos quite often—in fact often enough to have reported winnings of $151,162 in 2003 and $445,738 in 2004. The accountant claimed that she undertook the gambling activity as a trade or business entered into for a profit, and as such she was able to deduct the expenses related to the gambling activity on Schedule C, which allowed expenses to offset her gambling winnings in the computation of adjusted gross income. She claimed expenses that exactly offset the gambling winnings for the year.

The IRS contended that, in fact, the gambling was not being conducted as a trade or business activity and that, as such, the expenses were allowed only as itemized deductions. In this case that was important because moving the deductions down there caused the couple’s adjusted gross income to soar into levels where the §68 reduction of itemized deductions applied, creating a tax liability for the years in question.

The Tax Court looked at the methods and the way that Ms. Hastings carried on her gambling activities, applying the tests found in §1.183-2(a) regarding whether or not an activity is conducted as a trade or business under the hobby loss rules and found the accountant falling short on most counts. She did not produce a detailed ledger of her activities at trial, though she claimed she kept one. The Court rejected her alternative contention that the W3-Gs and player card statements constituted adequate records, noting that they were incomplete.

The Court also found that she had very limited expertise in the area, finding her methods of “research” (observing the casino and talking to casino employees) was not a sufficient way to gather expertise in the business. Most of her time was spent managing the accounting business, and it found that the activity had elements of personal entertainment or recreation, as her husband would accompany her on some visits to the casino even though he was not directly involved in the “business”.

It likely did not help the taxpayers case that she was an accountant who advised clients, the court noted, “advised ACP’s clients to keep their own set of business and accounting records rather than relying on bank statements or other yearly summaries from third parties to substantiate their business transactions.” The accountant failing to follow her own advice certainly makes this activity seem not to rise to the same level as the “real” businesses of her clients.

Note, as well, that the accountant did not claim a loss from the gambling activity and, in the end, the IRS did not disallow any claimed expense. But the requirement to move those expenses down below the line had a significant impact on the tax calculation and, in fact, for the second year the Tax Court sustained the finding that the accountant was subject to accuracy related penalty under §6662(a).

Merely “zeroing out” a Schedule C is not the same as properly reporting an activity that is not carried on for a profit, where the income does enter into the calculation of adjusted gross income but the deductions are itemized deductions limited to the income from the business. Ms. Hastings did limit the deductions to the income from the business, but still had a tax understatement for the two years of over $15,000 simply based on where she reported the deductions.

Hastings v. Commissioner, TC Memo 2009-69

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