The Tax Court looked today at the case of a professional gambler who lost money both on his wagers and his expenses in 2001. The petitioner tried to deduct his gambling losses in excess of his wins and his business expenses.

Section 165(d) of the Internal Revenue Code limits gambling losses to the amount of winnings. The Tax Court held in Tschetschot v. Commissioner that Section 165(d) holds for both amateur and professional gamblers. The Tax Court hasn’t changed its view.

…[E]ven though the gambling losses of a professional gambler fall under both the section 162(a) allowance of deductions for trade or business expenses and the section 165(d) limitation on the deduction of losses from wagering, it is a well-settled principle that section 165(d), as the more specific statute, trumps the more general provisions of section 162(a). The former provision operates as a limitation on deductions otherwise allowable under the latter.

The Tax Court in the decision gives the history of the inclusion of Section 165(d) into the Tax Code.

The Tax Court then looked at whether or not the petitioner could deduct his business expenses. In Offutt v. Commissioner (16 T.C. 1214, 1215 (1951)), the Tax Court considered business expenses like gambling losses: They could only be deducted to the extent of gambling winnings.

The Tax Court rejected Offutt. The Court looked at what “gains from wagering transactions” means. It first examined Boyd v. United States (762 F.2d 1369 (9th Cir. 1985) at 1373):

The IRS argues that the phrase means gain from a wagering transaction entered into by the taxpayer. Boyd argues that it means gain flowing to the taxpayer from a wagering transaction, whether as a participant or as the house taking a table rental. While there is no controlling authority, the IRS position is more persuasive.

In Williams v. Commissioner (T.C. Memo. 1980-494), the Court held that a blackjack player’s toke bets are not gambling wagers.

In sum, to the extent this Court and the Courts of Appeals have considered the question, they have generally held that “gains” from “wagering transactions” within the meaning of section 165(d) must be the actual product of wagers entered by the taxpayer. Generally, it is not sufficient that the gain arise merely in connection with the conduct of wagering activities; the gain must be the direct result of a wager entered by the taxpayer… The narrower interpretation that has been applied to gains from wagering transactions, requiring that they be the result of a wager entered by the taxpayer, more closely reflects the ordinary meaning of the words used in the statute, which is the applicable standard.

The Tax Court then looked at a case dealing with the expenses of an illegal bookmaker, Commissioner v. Sullivan, 356 U.S. 27 (1958). In that case, the Court (and this case went to the US Supreme Court) had to determine whether a bookmaker could deduct his rent.

The amounts paid as wages to employees and to the landlord as rent are ‘ordinary and necessary expenses’ in the accepted meaning of the words. That is enough to permit the deduction , unless it is clear that the allowance is a device to avoid the consequence of violations of a law * * * or otherwise contravenes the federal policy expressed in a statute or regulation * * * . [Id. at 29; emphasis added.]

The Court went back to Boyd and noted that the Appeals Court implied that business expenses are separate from poker losses:

In his claim, Boyd stated that he “incurred losses from participating in the [casino] poker games” and that “[t]his expense” was deductible under section 162(a). “This expense” plainly refers to the poker losses, and nowhere does the claim mention tipping or take-off fees. Taken at its face value, Boyd’s claim directed the IRS’ attention to losses incurred betting on poker hands, and nothing else. Moreover, the wording of Boyd’s alternative theory strengthens this impression. It refers to section 165(d), which provides that wagering losses may be deducted only up to the amount of wagering gains, reinforcing by implication the claim’s express statement that the losses for which deduction was sought were actual wagering losses, not other unspecified expenses incidental to gambling which would not be subject to the section 165(d) deduction limit. [Id.; fn. ref. omitted; emphasis added.]

The Tax Court then noted that the Commissioner would no longer follow Offutt and that the IRS Chief Counsel Attorney Memorandum AM2008-013 strongly suggested that deducting expenses (that are ordinary and necessary) should be allowed. The Court, thus, holds that the petitioner can deduct his ordinary and necessary business expenses.

This is a big victory for professional gamblers. First, this is a full decision of the Tax Court, so it is serves as precedent. (All of the Tax Court judges agreed with this portion of the opinion.) Second, given that gamblers can have losses, you can now take a Net Operating Loss based on those expenses without much fear of reprisal from the IRS. (While the IRS could appeal the decision, given that Chief Counsel Attorney Memorandum it is unlikely they will do so.)

Case: Mayo v. Commissioner, 136 T.C. No. 4