T.C. Memo. 2007-57
UNITED STATES TAX COURT
JOSE CALVAO, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7287-05. Filed March 8, 2007.
Timothy J. Burke, for petitioner.
Luanne S. Di Mauro, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined a deficiency in
petitioner’s 2002 Federal income tax of $17,096 and an accuracy-
related penalty under section 6662(a) of $3,419.1 The issues for
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended. All amounts are rounded
to the nearest dollar.
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decision are whether petitioner was in the trade or business of
gambling during 2002, and whether petitioner is liable for an
accuracy-related penalty under section 6662(a).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. At the time he filed his
petition, petitioner resided in Tiverton, Rhode Island.
Prior to 1993, petitioner was an operations manager for a
textile firm called Prim/Dritz Corporation. In 1993, petitioner
started Caltex Corporation (Caltex), an S corporation. Caltex is
a textile firm which sells embroidered T-shirts, caps, and other
similar products.
Sometime before 1999, Caltex hired petitioner’s brother with
the goal that, once petitioner’s brother learned about the
textile business, petitioner could reduce his involvement in
Caltex. In 1999, petitioner’s brother took over the day-to-day
operations of Caltex.
During 2002, petitioner was the president and 100-percent
owner of Caltex and worked at Caltex 20 to 25 hours per week
providing “consulting services”. In 2002, petitioner received a
salary of $42,000 and a distribution of income of $99,790 from
Caltex.
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During 2002, petitioner played the slot machines at several
casinos throughout the United States.2 Petitioner spent most of
his time at Foxwoods Resort and Casino in Connecticut, which was
approximately 100 miles from his home. The casinos issued
petitioner Forms W-2G, Certain Gambling Winnings, for 2002,
reflecting gross winnings of $132,800. Prior to filing his 2002
Federal income tax return, petitioner prepared a summary of his
gambling activity (the gambling summary). The gambling summary
reflected that petitioner gambled on 24 separate occasions, won a
total of $132,800, and lost a total of $180,300.
Petitioner timely filed his 2002 Federal income tax return.3
Petitioner reported the following sources of income: (1) Wage
income from Caltex of $42,000; (2) taxable interest of $7,676;
(3) ordinary dividends of $3,176; (4) taxable State income tax
refund of $3,224; and (5) income from rental real estate, S
corporations, and trusts of $109,403.4 On an attached Schedule
C, Profit or Loss From Business, petitioner reported that his
2
Petitioner occasionally played Carribean stud poker, but
the slot machine was his preferred game.
3
Petitioner’s return was prepared by Norman R. Beauregard
(Mr. Beauregard), who identified himself on the return as a
certified public accountant. There is nothing else in the record
regarding Mr. Beauregard’s experience or qualifications.
4
The income from rental real estate, S corporations, and
trusts included a total rental real estate loss of $6,047, a
passthrough of income from Caltex of $99,790, and trust income of
$15,660.
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principal business or profession was professional gambling.
Petitioner reported gross receipts of $132,800, cost of goods
sold of $180,300, and deducted $3,150 in travel expenses, for a
net Schedule C loss of $50,650. After deducting the Schedule C
loss and a net operating loss carryover of $1,106, petitioner
reported total income of $113,723. Petitioner claimed itemized
deductions of $14,077 and a personal exemption of $3,000,
resulting in taxable income of $96,646 and total tax of $23,303.
On March 21, 2005, respondent issued petitioner a notice of
deficiency. Respondent determined petitioner was not engaged in
the trade or business of gambling during 2002 and therefore could
not deduct his gambling losses on Schedule C. Instead,
respondent determined petitioner could deduct the gambling losses
as an itemized deduction, but only to the extent of his gambling
winnings.5 Based on the above, respondent determined the amount
of tax required to be shown on petitioner’s 2002 return was
$40,399, resulting in a deficiency of $17,096. Respondent also
determined petitioner was liable for an accuracy-related penalty
under section 6662(a) of $3,419.
In response to the notice of deficiency, petitioner filed
his petition with this Court on April 18, 2005.
5
Respondent also disallowed the claimed personal exemption
deduction because petitioner’s adjusted gross income exceeded the
allowable amount for such a deduction. Petitioner does not
dispute this determination.
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OPINION
I. Petitioner’s Gambling Activity
Respondent determined petitioner was not in the trade or
business of gambling during 2002 and thus could not claim his
gambling losses as a Schedule C deduction. Petitioner argues he
was in the trade or business of gambling because he pursued the
activity full time, in good faith, with regularity, and for the
production of income.6
Section 162(a) allows deductions for all ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business. If a taxpayer were engaged in
the trade or business of gambling, losses would be deductible
from gross income in arriving at the adjusted gross income. See
sec. 62. However, if the taxpayer were not in the trade or
business of gambling, his losses would be deductible as an
itemized deduction in arriving at taxable income. See sec.
63(a). Regardless of whether the gambling activity constituted a
trade or business, section 165(d) provides: “Losses from
wagering transactions shall be allowed only to the extent of the
6
The resolution of this issue does not impact the amount
of the allowable gambling loss deduction. See sec. 165(d).
However, the resolution of this issue does impact the amount of
the deficiency. If the gambling loss deduction were shifted from
Schedule C to Schedule A, Itemized Deductions, it would increase
petitioner’s adjusted gross income, thus limiting under sec. 68
the extent to which itemized deductions other than the gambling
loss are allowable.
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gains from such transactions.” See also sec. 1.165-10, Income
Tax Regs. Although petitioner deducted gambling losses exceeding
his gambling winnings by $50,650, petitioner does not dispute
that section 165(d) limits his gambling loss deduction to the
amount of his gambling winnings.
To be engaged in a trade or business within the meaning of
section 162(a), an individual taxpayer must be involved in the
activity with continuity, regularity, and with the primary
purpose of deriving income and profit. Commissioner v.
Groetzinger, 480 U.S. 23, 35 (1987). Whether the taxpayer is
carrying on a trade or business requires an examination of all
the facts in each case. Id. at 36; Higgins v. Commissioner, 312
U.S. 212, 217 (1941).
In Groetzinger, the Supreme Court addressed the issue of
whether a taxpayer’s gambling activity was a trade or business
within the meaning of section 162(a). The taxpayer devoted 60 to
80 hours each week for 48 weeks to parimutuel wagering, primarily
on greyhound races. Commissioner v. Groetzinger, supra at 24.
The taxpayer gambled at racetracks 6 days a week and spent a
substantial amount of time studying racing forms, programs, and
other materials. Id. While the taxpayer received $6,498 in
income from other sources during the year, the taxpayer had no
other profession or type of employment during the 48 weeks he
devoted to gambling. Id. at 24-25. The Supreme Court stated:
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to be engaged in a trade or business, the taxpayer must
be involved in the activity with continuity and
regularity and * * * the taxpayer’s primary purpose for
engaging in the activity must be for income or profit.
A sporadic activity, a hobby, or an amusement diversion
does not qualify. * * *
* * * * * * *
we conclude that if one’s gambling activity is pursued
full time, in good faith, and with regularity, to the
production of income for a livelihood, and is not a
mere hobby, it is a trade or business within the
meaning of the statutes with which we are here
concerned. * * *
Id. at 35-36. The Supreme Court affirmed the judgment of the
Court of Appeals for the Seventh Circuit, finding the taxpayer
was engaged in the trade or business of gambling. Id. at 36.
Petitioner argues the facts of Groetzinger are similar to
the facts of this case, and, like the Supreme Court in
Groetzinger, we should find petitioner was engaged in the trade
or business of gambling. After carefully considering the facts
in this case, we disagree.
Petitioner argues, like the taxpayer in Groetzinger, he
spent a substantial amount of time preparing for his trips to the
casino and developed a strategy for his gambling:
In 2002, the petitioner went to the casino with a plan.
The petitioner would first talk to the casino hosts to
find out which areas of the casino were heavily played
and what slot machines were/were not hitting. Based
upon the information, the petitioner then determined
what slot machines he was going to play and how much
money he would need.
In 2002, the petitioner set a limit for his losses each
day that he went to the casino. The petitioner also
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set a limit on his games/winnings such that he left the
casino once he made a twenty (20%) percent return on
his money.
Petitioner also argues that he bought a slot machine, spent a
significant amount of time studying how the “chips” and cycles of
slot machines worked, subscribed to a gambling magazine, and read
“probably about 20” books on playing the slot machines.
Petitioner’s efforts and strategy are consistent with the
desire to win money playing the slot machines. However, we find
petitioner’s desire to win money and his strategy for doing so is
also consistent with gambling purely for its entertainment or
recreational aspects. The time petitioner spent and the strategy
he developed, by themselves, do not establish petitioner was
engaged in the trade or business of gambling.
Petitioner testified he maintained daily records of his
gambling activity and argues on brief his record keeping is
indicative of a trade or business. Petitioner did not provide
respondent with these records, nor did he introduce the records
into evidence. Given the lack of evidence, we do not find that
petitioner maintained daily records of his gambling activity.
Petitioner argues that he spent “approximately 2,206.5
hours” gambling at various casinos, “where he focused primarily
on slot machines such as the ‘Double Diamond’”, and that the
amount of time devoted to his gambling activity is indicative of
a trade or business. Petitioner relies on a schedule of gambling
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wins and losses to establish the hours spent gambling. The
schedule of gambling wins and losses reflects petitioner’s
attempt to reconstruct the dates he gambled, the amount of money
won or lost, and the amount of time spent gambling each day.
However, the schedule was not provided to respondent until
January 4, 2006, and there is no evidence in the record
indicating when the schedule was prepared. This evidence was not
contemporaneously maintained, and it is inaccurate and
unreliable.7 Petitioner did not provide his purported daily
records, nor did he provide other evidence corroborating the
amount of time he devoted to gambling during 2002. Given the
lack of reliable evidence, we cannot determine how much time
petitioner devoted to gambling during 2002.
Unlike the taxpayer in Groetzinger, petitioner spent
approximately 20 to 25 hours per week working for Caltex.
Additionally, petitioner’s livelihood did not depend on playing
the slot machines. His primary income came from his salary of
$42,000 and the passthrough of income of $99,790 from Caltex, of
which he was president and 100-percent owner during 2002. By
7
For example, the schedule of gambling wins and losses
indicates petitioner spent 18 days gambling during March 2002,
during which he won $9,700 and lost $27,900. However, the
gambling summary prepared by petitioner for use in filing his
2002 return indicates petitioner gambled on only 2 days during
March 2002, during which time he won $9,700 but lost $31,300.
Additionally, the Forms W-2G issued to petitioner for payouts
made during March 2002 indicate petitioner won only $8,100.
Similar discrepancies appear in other months.
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themselves, these facts do not preclude petitioner from being
engaged in the trade or business of gambling. However, such
factors were considered by the Supreme Court in Groetzinger and
are relevant to our determination. See Commissioner v.
Groetzinger, 480 U.S. at 24-25, 35-36. We find that these facts
weigh against petitioner’s being engaged in the trade or business
of gambling. See Jones v. Commissioner, T.C. Memo. 1988-393.
Taking into consideration all of the above, we find
petitioner was not engaged in the trade or business of gambling
in 2002. Therefore, petitioner is not entitled to report his
gambling activity on Schedule C. Instead, petitioner must claim
his gambling losses as an itemized deduction on Schedule A, as
determined by respondent. We sustain respondent’s determination
that the amount of tax required to be shown on petitioner’s 2002
Federal income tax return was $40,399, resulting in a deficiency
of $17,096.
II. Accuracy-Related Penalty Under Section 6662(a)
Respondent determined petitioner is liable for an accuracy-
related penalty under section 6662(a) for 2002 of $3,419.
Petitioner argues he is not liable for an accuracy-related
penalty because he reasonably relied upon the advice of his
accountant.
Section 6662(a) imposes a penalty in the amount of 20
percent of the portion of the underpayment to which section 6662
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applies. As relevant to this case, the penalty applies to any
portion of the underpayment that is attributable to any
substantial understatement of income tax. Sec. 6662(b)(2).
There is a “substantial understatement of income tax” if the
amount of the understatement exceeds the greater of 10 percent of
the tax required to be shown on the return or $5,000. Sec.
6662(d)(1).
The Commissioner bears the burden of production with respect
to penalties. Sec. 7491(c); Higbee v. Commissioner, 116 T.C.
438, 446-447 (2001). Once the burden of production is met, the
taxpayer must come forward with evidence sufficient to show that
the penalty does not apply. Higbee v. Commissioner, supra at
447.
The tax required to be shown on petitioner’s tax return was
$40,399. Ten percent of that amount is less than $5,000. Thus,
petitioner’s understatement is substantial if it exceeds $5,000.
Petitioner reported an income tax liability of $23,303, resulting
in an understatement of $17,096. Respondent has satisfied his
burden of production by showing that petitioner’s understatement
of tax was substantial.
The accuracy-related penalty is not imposed, however, with
respect to any portion of the understatement if the taxpayer can
establish he acted with reasonable cause and in good faith. Sec.
6664(c)(1). Reliance upon the advice of a professional may
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demonstrate a taxpayer acted with reasonable cause and in good
faith. Neonatology Associates, P.A. v. Commissioner, 115 T.C.
43, 98-99 (2000), affd. 299 F.2d 221 (3d Cir. 2002); Freytag v.
Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th
Cir. 1990), affd. 501 U.S. 868 (1991); see sec. 1.6664-4(c)(1),
Income Tax Regs. However, a taxpayer’s reliance upon the advice
of a professional does not automatically constitute reasonable
cause. Neonatology Associates v. Commissioner, supra at 98-99;
see sec. 1.6664-4(c)(1), Income Tax Regs. For a taxpayer to
reasonably rely on the advice of a professional, the taxpayer
must show: (1) The adviser was a competent professional who had
sufficient expertise to justify reliance; (2) the taxpayer
provided necessary and accurate information to the adviser; and
(3) the taxpayer actually relied in good faith on the adviser’s
judgment. Neonatology Associates v. Commissioner, supra at 98-
99.
Petitioner testified he relied on his accountant, Mr.
Beauregard, to prepare his return, and Mr. Beauregard had
prepared his returns since 1993 without incident. However,
petitioner did not call Mr. Beauregard as a witness, nor did he
introduce evidence which would establish that Mr. Beauregard
possessed the requisite expertise.8 Because petitioner has not
8
Petitioner did not begin his gambling activity until
2002, and his underpayment of tax arose from claimed deductions
(continued...)
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established that Mr. Beauregard was a competent professional who
had sufficient expertise to justify reliance, petitioner has not
shown that he acted with reasonable cause and in good faith. See
sec. 6664(c)(1); Neonatology Associates v. Commissioner, supra at
98-99. Therefore, we find petitioner is liable for an accuracy-
related penalty under section 6662(a) of $3,419.
III. Conclusion
Petitioner was not engaged in the trade or business of
gambling in 2002. For all of the foregoing reasons, we hold
petitioner is liable for a deficiency in his 2002 Federal income
tax of $17,096 and an accuracy-related penalty under section
6662(a) of $3,419.
In reaching our holdings, we have considered all arguments
made, and, to the extent not mentioned, we conclude that they are
moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
for respondent.
8
(...continued)
for that activity. Mr. Beauregard’s preparation of petitioner’s
returns for 1993-2001 does not establish that Mr. Beauregard had
sufficient expertise regarding the tax treatment of petitioner’s
gambling activity. In fact, despite the clear requirement of
sec. 165(d) that gambling losses may be claimed only to the
extent of gambling winnings, petitioner claimed gambling losses
that exceeded his gambling winnings by $50,650. In addition, the
gambling losses were claimed as costs of goods sold. At the
least, this calls into question Mr. Beauregard’s expertise.