Professional Gambler Can't Deduct Track's Takeout in Calculating Gambling Losses

(Parker Tax Publishing June 2018)

The Ninth Circuit affirmed a Tax Court decision which held that an accountant, who was also a professional gambler, could not deduct from his ordinary income that portion of his losing wagers representing the track's "takeout" - the percentage of all monies wagered on a horse race that the track retains to offset its business costs. The court rejected the taxpayer's argument that the takeout was an expense to him separate and apart from the wager itself and was therefore deductible as an ordinary and necessary expense from non-gambling income under Code Sec. 162(a). Lakhani v. Comm'r, 2018 PTC 135 (9th Cir. 2018).

Observation: The Tax Cuts and Jobs Act of 2017 (TCJA) clarified the scope of the term "losses from wagering transactions" as that term is used in Code Sec. 165(d). The clarification provides that this term includes any deduction otherwise allowable in carrying on any wagering transaction. The TCJA provision thus reversed the result reached by the Tax Court in Mayo and is effective after December 31, 2017, and before December 31, 2025.

For 2005-2009, Shiraz Lakhani was a CPA who operated an accounting practice in California that included the preparation of tax returns. During those years, Lakhani was also a professional gambler whose gambling activities were limited to parimutuel wagering on horse races. Lakhani, who placed bets on races occurring both at California racetracks and at racetracks in other states, reported his gambling winnings and losses on a separate Schedule C for each of the years at issue.

On each of the gambling Schedules C, he reported the gross amount he received on winning bets as "Gross receipts or sales," and he reported the amounts he bet as "Cost of goods sold," subtracting the latter from the former, to determine his gross income or loss from gambling. He also reported and deducted miscellaneous other expenses associated with his gambling activities and reported the sum of his gambling winnings, losses, and miscellaneous other expenses as his income or loss (net gambling income or loss, respectively) from gambling for the year. He then combined his net gambling income or loss with his accounting practice income for the year and reported the sum as his total net "Business income or (loss)" for the year.

For each of 2005, 2006, 2008, and 2009 (gambling loss years), Lakhani's net gambling loss exceeded his accounting practice income, so that Line 12 of each Form 1040 reported a business loss. For 2007, in which he reported a net gambling gain, and for 2009, Lakhani claimed net operating loss carryover deductions, which arose out of unused net gambling losses incurred in prior years.

Upon auditing Shiraz's tax returns, the IRS adjusted each of the gambling loss years by disallowing Shiraz's deduction for his net gambling losses on the basis of Code Sec. 165(d), which provides that gambling losses are allowed only to the extent of the gains from such transactions. The IRS also disallowed the net operating loss carryovers to 2007 and 2009.

For the years at issue, Code Sec. 165(d) provided that taxpayers could not deduct gambling losses in excess of winnings. However, the limitation in Code Sec. 165(d) did not limit deductions for expenses incurred to engage in the trade or business of gambling. In Mayo v. Comm'r, 136 T.C. 81 (2011), the Tax Court held that a gambler's business expenses were not "losses from wagering transactions" subject to the Code Sec. 165 deduction limitation. Such business expenses, the Tax Court concluded, were deductible under Code Sec. 162. In AOD-2011-06, the IRS acquiesced to that decision. For the years at issue, the limitation in Code Sec. 165(d) thus did not limit deductions for expenses incurred to engage in the trade or business of gambling.

In parimutuel wagering, the entire amount wagered on horse races is referred to as the betting pool or "handle." The pool can be managed to ensure that the event manager (i.e., the track) receives a share (or a percentage) of the betting pool regardless of who wins a particular event or race. That share is referred to as the "takeout," and the percentage, set by state law, varies from state to state, generally ranging from 15 percent to 25 percent and often depending upon the type of bet, e.g., "straight" or "conventional" win, place, or show wagers or "exotic" (multiple horse or multiple race) wagers, with the latter usually resulting in higher takeout percentages. The takeout is used to defray the track's expenses, including purse money for the horse owners, taxes, license fees, and other state-mandated amounts. What remains from the takeout after those expenses are paid is the track's profits.

Lakhani argued that, in extracting takeout from the betting pools, the tracks are acting in the capacity of a fiduciary because they are collecting taxes and fees that they are then sending to the different state and local tax authorities. He likened the process to that of an employer collecting payroll taxes from employees and sending the payroll taxes to the IRS and state agencies. According to Lakhani, his pro rata share of the takeout was a business expense and, as such, was not a loss from gambling subject to disallowance under Code Sec. 165(d). In making this argument, Lakhani cited the Tax Court's opinion in Mayo.

The IRS argued that, even if a deduction for takeout were available to Lakhani, his failure to furnish the factual information necessary to make a reasonable determination of the takeout percentage applicable to his losing bets (e.g., the extent to which those bets were attributable to the various parimutuel pools with varying takeout percentages at tracks in various states) was sufficient to bar Lakhani's right to a passthrough deduction for takeout expenses.

The Tax Court agreed with the IRS and held that Lakhani's attempt to analogize the track's retention and disbursement of takeout to an employer's payroll tax obligations with respect to its employees was misguided. First and foremost, the court observed, none of the payments the track makes from the "handle" (i.e., betting pool) discharge any obligation of any bettor. And while reduction of the parimutuel pool by the amount of the takeout reduces the amount in the pool available to pay winning wagers, none of the takeout can be said to come from a winning bettor's wager, which in all events must be returned to him in full with at least a small profit. Because the takeout is not an obligation or expense of the bettor, the court said, it cannot qualify as the bettor's deductible nongambling business expense under Mayo. Thus, the court held that Lakhani was not entitled to a passthrough deduction of such expenses. Lakhani appealed to the Ninth Circuit.

The Ninth Circuit affirmed the Tax Court after concluding that Lakhani's position was not sound. The court noted that the track's takeout, as mandated by California law, came from all of the money wagered, so it was not an expense to the taxpayer separate and apart from the wager. Furthermore, the Ninth Circuit agreed with the Tax Court's assessment that the takeout cannot be said to add to the loss of a losing bettor, who loses the same amount whether the takeout is 15 percent or nothing at all.

The Ninth Circuit also found that the Tax Court's decision was consistent with its decision in Mayo, recognizing a distinction between deductions for wagering losses limited to gains, and the deductions available for non-wagering gambling expenses that could be deducted from other income. In Mayo, the Ninth Circuit noted, the Tax Court allowed the taxpayer to deduct, among other expenses, car, office, travel, telephone, internet, admission, and ATM fees. Thus, the court concluded, since the IRS did not contest Lakhani's deductions for similar fees, the Tax Court's decision was consistent with Mayo, because Mayo did not involve, as Lakhani's case did, the house takeout.

For a discussion of the rules with respect to reporting gambling income or losses, see Parker Tax ¶85,120.

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.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com