T.C. Memo. 2010-48
UNITED STATES TAX COURT
JOHN F. & ESTHER K. CHOW, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18774-08. Filed March 18, 2010.
John F. and Esther K. Chow, pro sese.
Sarah A. Herson, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined deficiencies of
$9,580.40 and $47,944.76 in petitioners’ Federal income taxes for
2004 and 2005, respectively. For 2004, respondent determined an
addition to tax of $2,089.35 under section 6651(a)(1) and an
amount to be determined under section 6651(a)(2). Respondent
also determined accuracy-related penalties of $1,916 and
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$7,493.59 under section 6662 for 2004 and 2005, respectively.
All section references are to the Internal Revenue Code in effect
for the years in issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
After concessions, the issues for decision are whether
petitioners are entitled to reduce rental income and capital
gains by amounts not conceded by respondent; whether petitioner
Esther K. Chow was a professional gambler, entitling her to
deduct fully her gambling losses against gambling income on
Schedule C, Profit or Loss From Business, as business losses or
whether those losses are deductible only on Schedule A, Itemized
Deductions, as itemized deductions; whether petitioners are
liable for additions to tax under section 6651(a) for late filing
of their 2004 Federal income tax return; and whether petitioners
are liable for penalties under section 6662(a) with respect to
their 2004 and 2005 returns.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts are incorporated in our findings by this reference.
Petitioners resided in San Gabriel, California, at the time that
they filed their petition.
Petitioner John F. Chow (Dr. Chow) is a retired physician.
Petitioner Esther K. Chow (petitioner) studied as a medical
laboratory technician. From 1974 through 1994, petitioners
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operated a medical practice. They built a medical office and
pharmacy on property on Del Mar Avenue in Rosemead, California.
In 2004 and 2005, petitioners’ income consisted of rental income,
gains from sales of real property, and Social Security benefits.
Petitioners’ rental property included residential property
on Lilac Place in Los Angeles and, before its sale in 2005, the
Del Mar Avenue property. They incurred various expenses,
including legal expenses, relating to the rental property.
During 2005, they incurred expenses of $25 paid to the Department
of Water and Power and $70.20 paid to the Department of Building
and Safety with respect to the Lilac Place property.
The Del Mar Avenue property was sold in 2005 for $970,000.
At that time, petitioners paid $51,760 to secure release of a
lien recorded against the property by their former attorney,
Kenneth Hopp. Hopp had represented petitioners in relation to a
civil rights action against San Bernardino County, California.
The lien was filed after Hopp secured a judgment against
petitioners.
Also at the time the Del Mar Avenue property was sold,
petitioners paid $25,000 to Dr. Chow’s sister and her husband in
repayment of a loan.
About 1987, petitioner began gambling. After Dr. Chow
underwent surgery in 2003, petitioner began playing slot machines
extensively and exclusively at the Morongo Casino in Cabazon,
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California. She gambled on 124 days in 2004 and 176 days in
2005.
In 2004, petitioner won 15 jackpots of $2,000 or more, and
in 2005 she won 98 jackpots of $2,000 or more. In 2005, she won
two $10,000 jackpots; two $15,000 jackpots; and single jackpots
of $13,500, $13,530, $18,750, $19,200, $25,000, and $32,000. In
all, she had gambling winnings of $283,072 and gambling losses of
$339,832 in 2004. She had gambling winnings of $1,079,292 and
gambling losses of $1,232,005 in 2005. If the winnings and
losses are calculated on a net basis for each slot machine
session in which she played over a period of time and did not
take more than a 3-hour break, she had total gambling income of
$36,216 and losses of $93,862 in 2004 and income of $231,836 and
losses of $383,507 in 2005.
Petitioners did not use a professional preparer to prepare
their Federal income tax returns. The first Form 1040, U.S.
Individual Income Tax Return, for 2004 received by the Internal
Revenue Service (IRS) was signed on October 31, 2006, and
received on November 1, 2006. It was labeled “Amended Return”
but was not on a Form 1040X, Amended U.S. Individual Income Tax
Return, prescribed for amended returns. On that return,
petitioners deducted on Schedule A $60,350 as gambling losses,
which they included in the amount of itemized deductions used to
offset their adjusted gross income. They reported no taxable
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income and no tax due. Copies of 31 Forms W-2G, Certain Gambling
Winnings, were attached to the return.
On January 22, 2007, petitioners signed and sent to the IRS
a Form 1040X for 2004. They again included $60,350 as gambling
losses on Schedule A and deducted them against adjusted gross
income. They reported no taxable income and no tax due.
On February 5, 2007, petitioners signed and sent to the IRS
another Form 1040X for 2004. On this Form 1040X, petitioner was
identified as a “professional gambler since 1987”. On a Schedule
C, petitioners reported gambling income of $60,360 (the amounts
shown on the attached copies of Forms W-2G) and deducted “cash
capital used” of $88,650, showing a Schedule C loss of $28,540.
Although the manner of computation is unclear from this Form
1040X, the reported adjusted gross income was reduced by amounts
that included the claimed gambling losses. Petitioners reported
no taxable income and no tax due.
Petitioners’ Form 1040 for 2005 was signed by petitioners
and sent to the IRS on April 17, 2006. Both petitioners were
shown as “retired”. On that return, they reported a $607,133
gain from sale of the Del Mar Avenue property. They deducted
from adjusted gross income $334,217.90 as gambling losses based
on a detailed “Gambling Statement For 2005” attached to the
return, but they did not include a Schedule C. Among the
deductions claimed on Schedule A as miscellaneous deductions were
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“loans reimbursements ($25,000 + $53,000)” totaling $78,000.
Again petitioners reported no taxable income and no tax due.
On August 28, 2006, petitioners signed and sent to the IRS a
Form 1040 marked “Amended Return 2005”. Their occupations were
shown as “retired”. On Schedule A, petitioners claimed as
miscellaneous deductions “GAMBLING LOSSES: Capital used:
$1,054,170 WG forms: $710,543” and included $710,543 in the
total itemized deductions claimed. They also deducted $710,543
from adjusted gross income on the first page of the Form 1040 and
reported no taxable income and no tax due.
On February 5, 2007, petitioners signed and sent to the IRS
a Form 1040X for 2005. On this Form 1040X, petitioner was shown
as a “professional gambler since 1987 to present”. A Schedule C
was attached and reported a loss of $347,591, which was claimed
to reduce adjusted gross income. Petitioners reported $35,764 as
taxable income and $4,636 tax due.
Sometime before the Forms 1040X were submitted to the IRS in
February 2007, petitioner met with an IRS representative
concerning the proper method of reporting petitioners’ income and
losses. The use of Schedule C was commenced after discussions
with the IRS representative. Sometime before August 3, 2008,
(the date of the statutory notice), petitioners’ returns were
examined by the IRS. During the course of the examination, bank
records, including canceled checks, were delivered to the
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examining agent. The records were subsequently misplaced and
were not available by the time of trial in July 2009.
OPINION
Unfortunately, the parties have expended much effort during
the process of this case disputing matters that have no effect on
the decision to be entered. Petitioners have from the beginning
and through their posttrial briefs chosen to make spurious
attacks on respondent’s agents and counsel and to file motions
and requests for relief that have no reasonable basis in fact or
in law. Their claims range from deliberate destruction and
falsification of records to “elder abuse”. We will not detail or
address those claims in this opinion because they have no
colorable merit and do not affect the resolution of issues
properly before the Court.
Notwithstanding the difficulties created by petitioners’
approach to this case, the parties were able to settle
substantial issues and to enter into stipulations of many of the
controlling facts. Respondent has conceded charitable
contribution deductions and some rental expenses that had been
disallowed in the statutory notice. Other claimed rental
expenses and basis adjustments relating to petitioners’ sale of
the Del Mar Avenue property remain in dispute as personal
expenses or are unsubstantiated. The most significant issue is
classification of petitioner’s gambling losses as business losses
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of a professional gambler or losses in an activity not engaged in
for profit. If the former, the losses may fully offset the gains
reportable on Schedule C. If the losses are only reportable as
itemized deductions on Schedule A, the itemized deductions (other
than the gambling losses) are subject to reduction pursuant to
section 68. The addition to tax for late filing of petitioners’
2004 return and the accuracy-related penalty for both years also
remain in dispute.
As a general rule, taxpayers have the burden of proving that
they are entitled to the deductions that they claim. Rule
142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934); Rockwell v. Commissioner, 512 F.2d 882, 886 (9th Cir.
1975), affg. T.C. Memo. 1972-133. Under section 7491(a), the
burden of proof shifts to respondent if petitioners complied with
requirements to substantiate an item, maintained all required
records, and presented credible evidence as to a factual issue.
Rental Expenses
Petitioners claim expenses in 2004 and 2005 relating to
their Lilac Place rental property beyond the amounts allowed in
the statutory notice or conceded by respondent. The disputed
items for 2004 relate to lawsuits involving petitioners, a real
estate broker, and others. Although petitioners have presented
partial documents from several lawsuits, they have not presented
credible evidence or corroborating evidence that they paid in
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2004 the amounts that they claim for that year. They are not
entitled to any additional rental deductions for 2004.
For 2005, petitioners presented copies of two money orders
for $25 and $70.20 dated in 2005. The money orders appear to be
for public services relating to the Lilac Place property.
Petitioners are entitled to an additional deduction of $95.20 on
Schedule E, Supplemental Income and Loss.
Del Mar Avenue Property Adjustments
Petitioners seek to reduce their taxable gain on the sale of
the Del Mar Avenue property in 2005 by the amounts used to pay
off a judgment obtained by their former attorney and to pay back
a loan from relatives. Petitioners originally reported these
items as miscellaneous expenses on Schedule A. Respondent
contends that the origin of the judgment, i.e., attorney’s fees
incurred in civil rights litigation, was personal.
Petitioners contend that removal of the judgment lien was
necessary to “clear title” to the Del Mar Avenue property and
that Hopp’s fees were deductible attorney’s fees. However,
respondent is correct that paying a judgment having a personal
origin does not increase petitioners’ basis in the property sold
and that attorney’s fees incurred in personal litigation are not
otherwise deductible. See generally United States v. Gilmore,
372 U.S. 39, 49 (1963) (holding that the origin and character of
the claim with respect to which the expense was incurred, not its
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consequence to the taxpayer, is controlling in the determination
of whether the expense is business or personal). The litigation
with petitioners’ former attorney had no relationship to
operating, acquiring, or defending title to the Del Mar Avenue
property. Payment of the judgment obtained by the attorney was a
nondeductible personal expense under section 262 and did not
increase petitioners’ basis in the Del Mar Avenue property under
section 1016. See Heger v. Commissioner, T.C. Memo. 1993-408,
affd. without published opinion 35 F.3d 561 (5th Cir. 1994).
Petitioners claim that they borrowed $25,000 from relatives
and repaid the loan at the time the Del Mar Avenue property was
sold. On their original Federal income tax return for 2005, they
deducted this amount as “loans reimbursements” on Schedule A. It
was not separately itemized on the schedules attached to the
amended returns for 2005. Petitioners have not presented
credible evidence that $25,000 was spent on amounts properly
added to the basis of the property. They have failed to satisfy
their burden of proof or to shift the burden of proof to
respondent with respect to this item.
Petitioner’s Gambling Activities
The parties have stipulated petitioner’s winnings and losses
as reflected in the records maintained by the Morongo Casino.
Respondent has calculated the losses using a “session-based
analysis”, i.e., by netting wins and losses per slot machine
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session, as described in LaPlante v. Commissioner, T.C. Memo.
2009-226. Regardless of the methodology, petitioner’s losses
exceeded her winnings in each year. She is not, however,
entitled to deduct those losses against other income, even if we
conclude that she is a professional gambler. See sec. 165(d);
Boyd v. United States, 762 F.2d 1369, 1372-1373 (9th Cir. 1985);
Kochevar v. Commissioner, T.C. Memo. 1995-607.
Petitioners rely on Commissioner v. Groetzinger, 480 U.S. 23
(1987), as similar to petitioner’s situation and the standard by
which she should be determined to be a professional gambler. In
Commissioner v. Groetzinger, supra at 35, the Supreme Court held
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”.
The Supreme Court did not hold, as petitioners contend, that all
gamblers are in the trade or business of gambling and that
classifying gamblers is improper discrimination. Respondent
asserts that the facts of Groetzinger are not similar to those of
this case.
Consistent with other cases using the Groetzinger standard,
the parties analyze petitioner’s gambling activities with regard
to regulations promulgated under section 183 to identify
activities not engaged in for profit. See, e.g., Hastings v.
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Commissioner, T.C. Memo. 2009-69; Merkin v. Commissioner, T.C.
Memo. 2008-146.
Whether the taxpayer engages in an activity with the primary
purpose of making a profit is a question of fact to be resolved
based on all the facts and circumstances in a particular case.
Golanty v. Commissioner, 72 T.C. 411, 426 (1979), affd. without
published opinion 647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(a),
Income Tax Regs. While the test for whether a taxpayer engaged
in an activity with the intention of making a profit takes into
account the subjective intention of the taxpayer, greater weight
is given to the objective facts than is given to the taxpayer’s
mere statement of intent. See sec. 1.183-2(a), Income Tax Regs.
Section 1.183-2(b), Income Tax Regs., provides a
nonexclusive list of relevant factors to be weighed when
considering whether a taxpayer is engaged in an activity for
profit. The relevant factors are: (1) The manner in which the
taxpayer carried on the activity; (2) the expertise of the
taxpayer or his advisers; (3) the time and effort expended by the
taxpayer in carrying on the activity; (4) the expectation that
the assets used in the activity may appreciate in value; (5) the
success of the taxpayer in carrying on other activities for
profit; (6) the taxpayer’s history of income or losses with
respect to the activity; (7) the amount of occasional profits, if
any, that are earned from the activity; (8) the financial status
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of the taxpayer; and (9) whether elements of personal pleasure or
recreation are involved in the activity. No one factor is
determinative of whether an activity is engaged in for profit.
Brannen v. Commissioner, 722 F.2d 695, 704 (11th Cir. 1984),
affg. 78 T.C. 471 (1982); Golanty v. Commissioner, supra at 426;
sec. 1.183-2(b), Income Tax Regs. Some of the factors do not
apply or are neutral here.
Respondent asserts that petitioner had no business plan, did
not seek or follow expert advice, and did not adhere to her
alleged pattern of strategic times to gamble. Thus respondent
argues that petitioner did not carry on her activities in a
businesslike manner and did not use the skills involved in her
prior successful activity of managing Dr. Chow’s medical
practice.
Petitioner testified that she had “on the job” training as a
professional gambler beginning in 1987; that she read a couple of
books about slot machine strategy; and that she had reasons for
gambling on particular days and during particular hours. The
nature of gambling or other high-risk activities makes comparison
to businesslike conduct of more traditional businesses difficult.
There seem to be no recognizable standards for a businesslike
approach to slot machine gambling. Therefore these factors are
not conclusive.
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The record contains information about petitioner’s history
of profits and losses only for the 2 years in issue. Petitioner
received substantial jackpots, but she continued to play until
the overall results, whether on a session-by-session basis or an
annual basis, were substantial losses. Her gambling and her
losses increased from 2004 to 2005, when the substantial proceeds
of the sale of the Del Mar Avenue property permitted her to
increase the “capital” she claims to have invested in the
gambling activity. Petitioners, however, were retired, and the
record suggests that sale of the Del Mar Avenue property
eliminated a substantial source of rental income. Petitioners’
other income would not permit petitioner to sustain such losses
indefinitely in the future. Petitioners’ situation is
distinguishable from cases respondent cites in which other
sources of income allowed a taxpayer to pursue an activity as a
hobby, without expectation of profit.
The parties dispute whether petitioner maintained
appropriate records of her gambling activities. Petitioners
claim that respondent’s agents are responsible for loss of
certain records and that, therefore, respondent cannot show that
they did not maintain adequate records. Petitioner did not
maintain a logbook, but the casino records of her activities
allowed the parties to reconstruct the stipulated amounts of
winnings and losses. Cf. Estate of Espinoza v. Commissioner,
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T.C. Memo. 2005-239. The schedules and Forms W-2G attached to
petitioners’ returns were detailed as to dates and amounts.
While petitioners’ calculations of deductible losses were
erroneous, they appear to be attributable to a misunderstanding
of the law rather than to insufficient records.
Respondent acknowledges that petitioner engaged in gambling
during 2004 and 2005 with continuity and regularity. It is
unclear from her testimony whether she derived pleasure from it,
but that factor is generally neutral. See, e.g., Strickland v.
Commissioner, T.C. Memo. 2000-309. Petitioner strongly disputes
a suggestion by respondent’s agent that her gambling was
“compulsive” or “addictive”. Her activities appear similar to
those in other cases not involving professional gamblers, but
there is no evidence from either party sufficient to draw a
conclusion about psychological factors. Cf. Gagliardi v.
Commissioner, T.C. Memo. 2008-10.
Bearing in mind that the expectation of profit is a matter
of subjective intent and need not be reasonable, see sec. 1.183-
2(a), Income Tax Regs., we believe that the preponderance of the
evidence favors petitioner’s claim that during 2004 and 2005 she
pursued gambling with a profit objective. This is a close case,
and petitioners would be prudent to abandon gambling as a
potential source of income. We conclude, however, that
petitioner was a professional gambler during 2004 and 2005 and
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may deduct her gambling losses to the extent of her gambling
winnings on Schedule C. Of course, she may not deduct any excess
losses from petitioners’ adjusted gross income from other
sources.
Late Filing of 2004 Return
Section 6651(a)(1) provides that, in the case of failure to
file a tax return on the date prescribed for filing (including
any extension of time for filing), there shall be added to the
tax required to be shown on the return an amount equal to 5
percent of that tax for each month or fraction thereof that the
failure to file continues, not exceeding 25 percent in the
aggregate, unless it is shown that the failure to file timely is
due to reasonable cause and not due to willful neglect. Under
section 7491(c), respondent has the burden of production and has
produced records showing that petitioners’ 2004 return was not
received by the IRS until November 2006.
Petitioners claim that they filed a Form 1040 for 2004 on
April 10, 2005, and that they always filed their tax returns on
time. The document that petitioners claim was their timely Form
1040 dated April 10, 2005, has attached Schedules C and E that
are identical to those attached to the Form 1040X sent to the IRS
in February 2007; they are not attached to the purported amended
return filed in November 2006. Petitioners claim that the
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attachments were erroneous due to rushing to include the document
as an exhibit to the stipulation.
After reviewing the entire history of petitioners’ filings
and shifting positions, we cannot accept the testimony concerning
a timely filed return for 2004. Because petitioners deny that
the return was late, they have not suggested any reasonable
cause. Therefore, petitioners are liable for an addition to tax
under section 6651(a) on the recomputed deficiency for that year.
Section 6662 Accuracy-Related Penalty
Section 6662(a) and (b)(1) and (2) imposes a 20-percent
accuracy-related penalty on any underpayment of Federal income
tax attributable to a taxpayer’s negligence or disregard of rules
or regulations, or substantial understatement of income tax.
Section 6662(c) defines negligence as including any failure to
make a reasonable attempt to comply with the provisions of the
Internal Revenue Code and defines disregard as any careless,
reckless, or intentional disregard. Disregard of rules or
regulations is careless if the taxpayer does not exercise
reasonable diligence to determine the correctness of a return
position that is contrary to the rule or regulation. Sec.
1.6662-3(b)(2), Income Tax Regs.
On each version of their Forms 1040, petitioners attempted
to deduct wagering losses against other income, directly contrary
to section 165(d). That issue alone justifies application of the
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penalty to the final recomputed deficiency for each year.
Petitioners also claimed deductions that were contrary to section
262 or were not substantiated. They spoke to IRS representatives
but obviously rejected or misinterpreted the advice they
received. There is no indication that they ever sought
independent professional tax return preparation advice or
otherwise exercised reasonable diligence to determine the
correctness of their returns. As in Umstead v. Commissioner,
T.C. Memo. 1982-573, petitioners were negligent in displaying an
unwillingness to understand any explanation of the tax laws other
than their own misguided notions. Their tendency to use self-
help caused problems with their returns and with their conduct of
this case, and they are urged to consult competent tax
professionals before filing their returns or engaging in
litigation in this Court in the future.
Petitioners also claim that there are no penalties due
because they owe no tax, but they are wrong about that. The
section 6662 penalty will apply to the recomputed deficiency for
each year.
We have considered the other arguments of the parties. They
are irrelevant, moot, or without merit. To reflect concessions
and our conclusions stated above,
Decision will be entered
under Rule 155.