If I was told I could provide to gamblers only one piece of advice when it comes to taxes, I would say this: Keep very good records. If the IRS or a state or city tax agency decides to examine a taxpayer’s reported gambling losses, they will very likely be disallowed if the taxpayer presents insufficient records.

Last week, Clarance W. Jones of Massachusetts learned, courtesy of the Massachusetts Appellate Tax Board, that maintaining detailed records of his gambling activity paid off big time.

Massachusetts is one of the “bad” states for amateur gamblers: The state does not permit a deduction for gambling losses. I’ve already written about cases in New York and Wisconsin; these highlight unfavorable state tax laws with respect to gambling losses. Today we turn to a case addressing the unfavorable tax law in Massachusetts.

Mr. Jones filed as a professional gambler in Massachusetts for his 2001 through 2007 tax years. His returns were selected for audit, and the state took the position that he was not a professional gambler. (Note: Professional gamblers may deduct gambling losses from winnings in Massachusetts.) Accordingly, the state claimed he could not deduct any of his gambling losses from his gambling winnings, and assessed Mr. Jones additional tax due of $33,665, $53,872, $58,446, $77,545, $102,214, and $140,002, for his 2001 through 2006 tax years, respectively. The 2007 tax year deficiency of $13,715,912 was resolved in large part because it was discovered the state misplaced a decimal point. Yes, it happens.

To determine whether Mr. Jones was a professional gambler, the Appellate Tax Board had to consider whether he was engaged in the trade or business of gambling. The board listed the following factors from Directive 03-3 for guidance:

Gambling activities are entered into and carried on in good faith for the purpose of making a profit;

Gambling activities are carried on with regularity;

Gambling activities are pursued on a full-time basis, or to the fullest extent possible if taxpayer is engaged in another trade or business or has employment elsewhere;

Gambling activities are solely for the taxpayer’s own account and the taxpayer does not function as a bookmaker;

Taxpayer maintains adequate records, including accounting of daily wagers, winnings, and losses;

The extent and nature of the taxpayer’s activities which further the development of a gambling enterprise; and

Taxpayer claims deductions associated with the conduct of a trade or business for gambling-related expenses.

Mr. Jones clearly met most of these factors. During the years in question, he attended various horse- and dog-racing tracks, and engaged in live and simulcast betting, casino betting, and lottery ticket betting, from about 11:00AM until midnight, for four to five days a week. He was considered a “regular” at the racetrack, and was able to place bets with window tellers by “surreptitiously giving the teller a hand signal.” This approach enabled Jones to place multiple bets quickly, without having to wait in long lines.

In this case, the only factor challenged by the Massachusetts Department of Revenue was whether Mr. Jones maintained adequate records. As I’ve written before, IRS guidance suggests to maintain a diary containing the following information:

Date and type of gambling activity;

Name and address or location of the gambling establishment;

Names of other persons present with the taxpayer at the establishment; and

Amounts won or lost.

Mr. Jones maintained voluminous records of his gambling activity, including:

[P]ersonal calendars detailing his gambling activities; race track programs, with his losing ticket stubs from the day attached to the program together with a notation of the date, number of tickets and total amount of wagers; “tax organizers” that list his income and expenses and the information from the Forms W-2G; and [his] “tax books” for each year.

Jones had been audited by the state previously, and followed the advice of his accountant after each audit for purposes of maintaining adequate records. For example, his “tax books” included listings of his losses, and the entries in the books corresponded to the receipts that he maintained in storage.

Apparently, the state wouldn’t consider his records. The board exposed the state’s inadequate audit methodology:

[The] auditors performed a limited correspondence audit, during which the auditors sent written requests to [Jones] seeking records which were to be maintained in a certain format or else the auditors would refuse to review them. Yet, nothing in [Directive] 03-3…or any relevant statute, departmental promulgation or case law required [Jones] to keep the records in the precise form demanded by the auditor. … The Commissioner presented no objectively adequate reason why [Jones’] records should have been disbelieved, and in fact, the auditors lacked a firm understanding of what the records contained and how to interpret their notations, and they lacked a willingness to inquire further. The auditors never conducted a field audit to gain a better understanding of how thorough his records of losses were, nor even a desk audit in order to gain first-hand knowledge from [Jones] as to how to interpret his records.

The court found that Jones’ evidence, and not the auditor’s conclusions, was the best available with respect to his deductions for gambling losses. Had Jones failed to maintain these records, he would have been facing a tax bill of over $460,000 for his 2001 through 2006 tax years, plus interest and penalties. Clearly, the efforts he took to do so were more than worth his time.

As a final note, yesterday the Massachusetts Senate approved a casino bill, which authorizes up to three full-scale brick and mortar casinos in the state. The governor could sign the bill into law by the end of the year. Indeed, I suspect most Massachusetts residents are aware of this legislation. What most are probably not aware of, however, is that Massachusetts casino patrons will pay state income tax on “phantom” gambling winnings, since there is no deduction for gambling losses in the state, unless one is a professional gambler. It certainly makes me wonder whether knowledge of this result would keep a significant number of would-be patrons from placing bets in the new casinos.

Case: Jones v. Comm’r of Revenue, ATB 2011-855 (Mass. App. Tax Bd. Oct. 5, 2011).