As reported in my April 7, 2016, October 3, 2016 and October 27, 2016 blog posts, former U.S. Tax Court Judge Diane L. Kroupa and her then husband, Robert E. Fackler, were indicted on charges of tax fraud. Specifically, they were each charged with one count of conspiracy to defraud the United States, two counts of tax evasion, two counts of making and subscribing a false tax return, and one count of obstruction of an IRS audit. The indictment was the result of an investigation conducted by the Criminal Investigation Division of the Internal Revenue Service and the United States Postal Inspection Service.
As previously reported, former U.S. Tax Court judge Diane L. Kroupa and her now estranged husband, Robert E. Fackler, were indicted on charges of conspiracy to defraud the United States, tax evasion, making and subscribing a false tax return, and obstruction of an Internal Revenue Service audit. On September 23, 2016, Mr. Fackler pleaded guilty to attempting to evade more than $400,000 in federal taxes. He also signed a plea agreement wherein he sets out in some detail a long-term scheme, which he proclaims was masterminded by Ms. Kroupa to evade taxes.
Effective October 1, 2016, the Internal Revenue Service (“IRS”) changed its approach to conducting appeals conferences. The changes were likely adopted by the government under the guise of efficiency and cost savings. With that said, the changes probably will result in increased negative taxpayer perception of the IRS administrative process, and a significant reduction in prompt and fair resolution of matters at the conference level.
In a nutshell, the major change adopted by the IRS, subject to limited exceptions, is that the government will conduct all appeals conferences by telephone (or a virtual conference, if available). IRM § 220.127.116.11.1. An in-person conference generally will only be allowed if the appeals conferee (i.e., the “Appeals Technical Employee” or “ATE”) and the Appeals Team Manager (“ATM”) concur that it is appropriate and reasonable. As such, they must agree:
Is a full time gambler in the trade or business of gambling? If the answer is yes, two results follow (one result which is good and one result which is not so good): (1) the gambler is able to deduct under Section 162 of the Code all of the ordinary, necessary and reasonable expenses incurred in carrying on the business; and (2) the net income of the gambler, if any, is subject to self-employment tax under Section 1401 of the Code.
In 1987, the United States Supreme Court was presented with the issue of whether a full time gambler was engaged in the trade or business of gambling. Commissioner v. Groetzinger, 480 US 23 (1987). Justice Blackmun issued the court’s opinion. The Supreme Court thoroughly reviewed the history of the phrase “trade or business” in the context of the Internal Revenue Code. The court stated: “[T]o be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income profit. A sporadic activity, a hobby, or an amusement diversion does not qualify.” Whether a taxpayer is engaged in a trade or business is a question of facts and circumstances.
In Groetzinger, evidence revealed the taxpayer spent substantial amounts of time preparing for and actually gambling. He had been gambling for a long period of time; the activity was not sporadic. It was continuous. Mr. Groetzinger had no other “profession or type of employment.” He engaged in gambling with the intent to make a profit. The court ultimately concluded, gambling may constitute a trade or business, and based upon the facts presented, Mr. Groetzinger was engaged in the trade or business of gambling.
Mr. Groetzinger won the battle in that his victory allowed him to deduct is ordinary, necessary and reasonable expenses associated with his gambling activities. He lost the war in part because his net income (if any) would now be subjected to self employment taxes. The result was likely unsuspected by the taxpayer.
Another interesting twist to the decision in Groetzinger -- what happens if the expenses of a gambling trade or business generate a net operating loss for the tax year? Does Section 165(d) of the Code disallow the loss?
Section 165(d) provides:
“Losses from wagering transactions shall be allowed only to the extent of gains from such transactions.”
Groetzinger did not specifically address this issue. The issue, however, has been encountered over the years since Groetzinger was decided by the courts and the Service. Unfortunately, the position taken by the Service and the opinions of the courts have not always been consistent. Taxpayers were left with uncertainty when dealing with this issue. In 2011, however, the IRS ended the uncertainty when it concluded, while gambling losses alone cannot generate a deductible loss, expenses relating to the activity (provided it rises to a trade or business), may generate a deductible loss. See Chief Counsel Memorandum AM 2008-013. See also Reichert, Wagering Losses Not Deductible, Gambling Business Expenses Deductible, Journal of Accountancy (May 2011).
The US Tax Court will soon be presented with another saga involving a gambler. On November 29, 2013, Randy Binning, a resident of Nevada and a full time gambler, filed a petition with the tax court. Based upon his petition, the case involves a deficiency of taxes, interest and penalties exceeding $2,500,000. Mr. Binning was stopped by an Arizona police officer for a traffic violation while driving through the state. The officer discovered over $400,000 in cash in the automobile. Mr. Binning informed the police that the cash came from gambling activities. The Arizona authorities notified the IRS for further investigation. After concluding its exam, the Service issued a jeopardy assessment, followed by a Notice of Deficiency, based upon its conclusion the taxpayer failed to properly report his gambling income. Mr. Binning asserts the income, considering reasonable, ordinary and necessary business expenses, was properly reported. Stay tuned! Based upon the petition, this case should turn out to be an interesting battle.
If you have an interest in reading about the history of the phrase “trade or business,” see Brant, The Evolution of the Phrase Trade or Business: Flint v. Stone Trace Company to Commissioner v. Groetzinger – An Analysis with Respect to the Full-Time Gambler and the Investor, 23 Gonzaga Law Review 513 (1987/1988).
Larry J. Brant is a Shareholder in Garvey Schubert Barer, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; New York, New York; Washington, D.C.; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "Planning Using IRC Section 1031 Exchanges," Oregon Society of Certified Public Accountants (OSCPA) Forest Products ConferenceEugene, OR, 6.22.18
- "Evaluating the Built-in Gains Tax for C to S Conversions After TCJA," New York University Summer Institute in Taxation – Advanced Conference on Subchapter SNew York, NY, 7.26.18-7.27.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationNew York, NY, 10.21.18-10.26.18
- "The Tax Cuts and Jobs Act – What It May Mean to Your Clients," Estate Planning Council of Portland Mini-SeminarPortland, OR, 11.7.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationSan Diego, CA, 11.11.18-11.16.18