Drug-Induced Compulsive Gambling Losses Aren't Deductible Casualty Losses

(Parker Tax Publishing March 2019)

The Tax Court held that a taxpayer, who incurred losses from compulsive gambling brought on by the use of a prescription drug, could not deduct the losses as casualty losses under Code Sec. 165(c)(3) because no property of the taxpayer suffered physical damage as is required for a deductible casualty loss. In rejecting the taxpayer's argument that IRS Publication 547, Casualties, Disasters, and Thefts, implies that physical damage to property is not required for a deductible casualty loss, the court noted that IRS publications cannot be relied on as binding precedent. Mancini v. Comm'r, T.C. Memo. 2019-16.

Background

Marc Mancini was diagnosed with Parkinson's disease in 2004. He was treated by a prominent neurologist and professor at the USC School of Medicine, Dr. Mark Lew. In 2006, Dr. Lew prescribed Pramipexole, a drug Dr. Lew had given patients in clinical trials even before it had received Food and Drug Administration (FDA) approval. Dr. Lew initially prescribed a low dose for Mancini but gradually increased the dose. Mancini's symptoms improved significantly as a result of the medicine.

However, in 2008 Mancini began doing odd things. He became compulsive about cleanliness, obsessed over which mattress to buy, started falling asleep suddenly while driving, had suicidal thoughts, and began gambling compulsively. Over the next two years, Mancini's online gambling wiped out all of his bank accounts and most of his retirement savings. In 2009, he started selling real estate he owned for less than fair market value and used the proceeds to pay his gambling debts. In 2010, Dr. Lew took Mancini off of Pramipexole and the compulsive behaviors stopped. Mancini continued to gamble occasionally, but only to the limited extent he did before he started taking Pramipexole.

Pramipexole is a dopamine agonist, meaning that it activates dopamine receptors in the brain. The drug helps Parkinson's patients control their movements, but it can also distort a patient's risk/reward assessments. Beginning in the early 2000s, there were reports of users developing impulse control disorders (ICDs), which makes sufferers unable to control their behavior despite negative consequences. The most common ICDs associated with Pramipexole include compulsive eating, shopping, and gambling. ICDs tend not to occur until the dosage hits a certain level, and they generally go away once the patients stop taking Pramipexole.

Mancini filed his 2008 tax return in October 2009 with the help of a tax return preparer. He reported $149,000 in gambling winnings, deducted $149,000 for gambling losses, and claimed no casualty losses. On his 2009 return, also filed with a preparer's help, Mancini reported $107,000 in gambling winnings, deducted $107,000 in gambling losses, and reported no casualty losses. Mancini prepared his 2010 return himself using TurboTax. He reported $45,000 in gambling winnings, deducted $45,000 for gambling losses, and claimed a $603,000 casualty loss for "Investment Portfolio and Home." Mancini's casualty loss deduction triggered an IRS audit.

In December 2012, Mancini filed self-prepared amended returns for 2008 and 2009 directly with the IRS Appeals Office. On the amended 2008 return he claimed a $1 million casualty loss for "Investment Portfolio" reducing his taxable income from $360,000 to ($640,000). On his amended 2009 return, he claimed a $1.8 million casualty loss for "Investment Portfolio" which reduced his taxable income from $1.1 million to ($700,000).

In 2013, the IRS issued Mancini a notice of deficiency for 2010, disallowing the original $603,000 casualty loss and asserting a 20 percent penalty under Code Sec. 6662(a). Mancini took his case to the Tax Court. He later gave the IRS Appeals Office an amended return for 2010, which his attorney prepared. On it, he increased his 2010 casualty loss from $603,000 to $678,000. He also carried forward and deducted the $1.4 million excess casualty losses he claimed for 2008 and 2009. The IRS did not accept or process this return.

Analysis

Code Sec. 165(c)(3) allows a deduction for nonbusiness losses that arise from fire, storm, shipwreck, or other casualty, or from theft. The term "other casualty" is not defined in the Code or regulations, but courts have consistently held that the term means something like the specific terms that precede it (fire, storm, and shipwreck). As a result, "other casualty" is a loss arising from something sudden, unexpected, or unusual.

A casualty loss is deductible only if the taxpayer's property suffered physical damage as a result of the casualty. In Citizens Bank of Weston v. Comm'r, 28 T.C. 717 (1957), the Tax Court denied a bank's deduction for records kept in a basement that flooded because the flood neither damaged the building nor caused the taxpayer to abandon it. The Tax Court explained that whatever loss was suffered was due only to the fluctuation in the value of the building, which was not a casualty loss. The Ninth Circuit applied the same reasoning in Pulvers v. Comm'r, 407 F.2d 838 (9th Cir. 2002), holding that reductions in property value resulting from mudslides which did not physically damage the properties, but did raise fears of future mudslides, were not deductible as casualty losses because the mudslides did not physically damage the properties. In Furer v. Comm'r, 33 F.3d (9th Cir. 1994), the Ninth Circuit held that financial losses suffered as a result of a stock market crash were not casualty losses because they were the result of market fluctuations and not of any physical injury to the taxpayer's property.

Mancini argued that the ICD his Pramipexole caused fit the definition of "other casualty." He contended that it was "sudden" because it manifested abruptly once his dosage reached a certain level, it was unexpected because neither he nor Dr. Lew anticipated it, and it was unusual, even for Pramipexole takers. He argued that physical damage to property was not required because the Code does not limit the definition of "property" to just physical assets. Mancini cited no cases to support his argument. However, he did cite IRS Publication 547, Casualties, Disasters, and Thefts (2017), which says that a taxpayer can deduct as a casualty the loss on deposits when a bank, credit union, or other financial institution becomes insolvent or bankrupt. With regard to the penalty, Mancini argued that he should not be held liable because substantial authority supported his return position. Specifically, he contended that the IRS "approved" his amended 2008 and 2009 tax returns that he gave to the IRS Appeals Office during the audit of his 2010 return, and that he should therefore be able to treat as substantial authority the position he took on them.

The Tax Court found that it was more than likely that Mancini's compulsive gambling was a side effect of Pramipexole, but held that Mancini's gambling losses were not deductible as casualty losses because there was no physical damage to Mancini's property. The court observed that, like revenue rulings, IRS publications are not binding precedent but may be treated as concessions, and the court said that it was "tempted" to do the same with IRS Publication 547. However, the court explained that even if it did, the publication says only that taxpayers can claim as a casualty the "type of loss" that occurs when a bank becomes insolvent or goes bankrupt. In the court's view, the publication did not authorize casualty loss deductions for decreases in bank accounts generally. The court therefore said that it was not inclined to let Publication 547 upset decades of caselaw from both the Tax Court and the Ninth Circuit.

Observation: IRS publications and forms instructions constitute indispensable guidance on which practitioners rely, but courts do not accept them as authority. However, it is widely understood that publications do count as de facto authority when dealing with the IRS, and practitioners expect the IRS to honor the guidance they contain.

The court also found that, because of the way casualty losses are calculated, the kind of losses Mancini suffered did not qualify as deductible casualty losses. The court noted that, under Reg. Sec. 1.165-7(a)(2), the amount of a casualty loss is the fair market value of the property immediately before the casualty minus its fair market value immediately after, reduced by any compensation received from insurance. The court reasoned that, if the date of Mancini's onset of ICD was the "immediately before" date, then the date he went off Pramipexole would be the "immediately after" date, even though it was three years later. The court found that a three-year long casualty is not "sudden." The court concluded that Mancini's losses were simply not what the Code considers a casualty because they progressed over three years and there was no physical damage to any of his property.

With respect to the Code Sec. 6662(a) penalty, the Tax Court rejected Mancini's argument that his own amended returns constituted substantial authority for how he reported his tax liability. However, because the IRS introduced no evidence that the penalty determination had been personally approved in writing by the immediate supervisor of the individual assessing the penalty, the court concluded that Mancini was not liable for the penalty.

For a discussion of casualty and theft losses, see Parker Tax ¶84,500.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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