Can a video poker player qualify as a professional gambler for tax purposes?
The petitioner, Michael Ferguson, was employed full-time as an engineer and earned about $51,000 from his employment during the taxable year. Video poker consumed all of Ferguson's spare time and he spent more than 1,000 hours playing the game during the taxable year. Video poker is a game played against a computer rather than against other players. The computer evaluates the player's hand and issues a payout if the player's hand matches one of the winning hands in the machine's programmed pay schedule. The petitioner testified that he prepared for his gambling activity by spending many hours practicing on a computer and carefully studying how to play the perfect game. In addition, he tried to play only on machines with an expected payout value of 100%. He thought that, if one played a perfect game, it was theoretically possible to make a profit against the casino. He also testified that, despite his diligent preparation, "it didn't work." Although he hit a couple of big jackpots, he lost money overall.
Ferguson then filed a Schedule C, Profit or Loss From Business, for the 2003 taxable year. Contending he was a professional gambler, he claimed $1,311,200 in gross income from gambling, and a corresponding gambling loss of $1,311,200. His professional tax preparer opined that he was a professional gambler because he spent more than 20 hours per week gambling. The petitioner did not keep a record of his gambling activity and relied on the casinos' tracking of his activity. The IRS decided that his gambling winnings should have been reported on line 21 of Form 1040 as other income. As a consequence, his losses should have been claimed on Schedule A, Itemized Deductions, rather than on Schedule C.
The critical question is whether the petitioner's gambling activity constituted a trade or business under IRC section 162. If Ferguson is a professional gambler engaged in a trade or business, his video poker losses would properly be deducted in computing his adjusted gross income. If he is not a professional gambler, his losses would be deductible as an itemized deduction in the computation of taxable income [Gajewski v. Comm'r, 84 T.C. 980 (1985)]. Unfortunately, the term "trade or business" is not well defined in the IRC or Treasury Regulations. Generally, however, for an activity to constitute a trade or business for the purposes of IRC section 162, the activity must be carried on with "continuity and regularity" and the taxpayer's primary purpose for engaging in the activity must be for "income or profit" [Comm'r v. Groetzinger, 480 U.S. 23 (1987)]. In Groetzinger, the taxpayer's employment was terminated in January and he gambled on dogs for the rest of the taxable year. The Supreme Court decided he was a professional gambler because the primary purpose of wagering on the dogs was to maintain his livelihood.
Ferguson testified that video poker consumed all of his free time and cost him a lot of money. In response, the Tax Court said that merely spending one's free time on an activity does not necessarily mean that the activity is a trade or business. The most important part of the trade or business analysis is the taxpayer's actual or honest objective of making a profit [Keanini v. Comm'r, 94 T.C. 41 (1990)]. Any gambler would certainly contend that the careful preparation and diligent devotion to playing the game is a compelling indication that he had an honest and actual motive to make a profit--surely, few people gamble with the intent of losing money. The court was not impressed by this argument from Ferguson. Its response was that whether the taxpayer has an actual and honest profit objective is a question of fact to be decided from all the relevant facts and circumstances of the case [Treasury Regulations section 1.183-2(a)]. Despite Ferguson's statement of his intent, it is well settled that the taxpayer has the burden of proof to establish that he had the required profit motive [Keanini v. Comm'r].
The regulations set out several factors that may be considered in deciding whether the required profit motive exists. Among them are the following:
* The manner in which the taxpayer carries on the activity;
* The time and effort expended by the taxpayer in carrying on the activity;
* The taxpayer's history of income or losses with respect to the activity; and
* The financial status of the taxpayer.
The Tax Court examined the totality of Ferguson's activity and decided that under the facts and circumstances his video gambling activities were not a trade or business for the following reasons:
* The petitioner did not carry out his gambling activities in a businesslike manner. The court was concerned that Ferguson did not maintain his own books and records, but relied on the casinos to keep up with his wins and losses.
* Despite his considerable expenditure of time and effort to master the gambling game, Ferguson did not seek additional assistance or adjust his gambling strategy when it became apparent that he was not winning.
* Perhaps the key factor was that the court was not convinced Ferguson could have any reasonable expectation of making a profit when he gambled against machines programmed by the casino to make a profit. Gambling against a machine that a casino has programmed to make income for the casino has been characterized by the Supreme Court as merely a sporadic activity, hobby, or amusement diversion (Groetzinger). In contrast to Ferguson's case, in Groetzinger the Supreme Court found that the petitioner was a professional gambler engaged in a trade or business because when he ended his employment in January, he spent the balance of the taxable year engaged in parimutuel wagering on dogs and looked to wagering for his livelihood. In Ferguson, the petitioner was employed full-time as an engineer and did not look to his video wagering for his entire livelihood.
* Finally, for some individuals, gambling against a programmed machine may become a habit or an addiction. Neither, of course, is compelling evidence of a business or profit motive.
The court was convinced that the totality of the circumstances compelled a determination that the petitioner, despite his intense preparation, was merely engaged in a sporadic activity, hobby, or amusement.
A Valuable Resource
Despite the taxpayer's loss in this case, Ferguson is a valuable resource for two reasons:
First, it informs accountants and tax preparers of the criteria for determining whether gambling is ever considered a trade or business for tax purposes. It takes more than an individual devoting 20 hours per week to a gambling activity to be considered a professional.
Second, Ferguson sets out a blueprint for how an individual might qualify as participating in a trade or business for the purpose of the tax code. First, individuals should keep their own business records. The court in this case did not opine on why records kept by the casino are less persuasive than the petitioner's personal records. One can assume that casinos have a business need to keep accurate records for their own use. It can be assumed that the court believed that taxpayers truly in business in the ordinary sense would want to rely on their own records. Next, if individuals are consistently losing, they might seek assistance from gambling experts or try strategies that have a better probability of winning. Otherwise, it appears that their gambling activities are incidental to earning a living. Finally, a gambler might choose a game of chance or sport that is not computer-programmed to favor the casino, or participate in games of skill against other persons, such as those who participate in popular professional poker matches.
All of these activities point toward individuals engaged in a trade or business for their livelihood. There is still a danger in all gambling endeavors in which the odds are set by the casino to ensure that the casino makes a profit. But whatever the strategy, if gambling does not represent the player's primary means of livelihood, there is a reasonable likelihood that the player is not a professional gambler for tax purposes.
Pamela Spikes, PhD, CPA, is a professor of accounting; Roy Whitehead, JD, LLM, is a professor of business law; and Patricia Mounce, PhD, CPA, is the interim chair of the department of accounting and an associate professor of accounting, all at the University of Central Arkansas, Conway, Ark.
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|Title Annotation:||federal taxation|
|Author:||Spikes, Pamela; Whitehead, Roy; Mounce, Patricia|
|Publication:||The CPA Journal|
|Date:||Sep 1, 2007|
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