Tax Week in a Nutshell - 10.26.20
What’s Up in Washington, D.C.
A Senate vote advanced the President’s third Supreme Court nomination on Sunday, setting up a final vote for Amy Coney Barrett to be held Monday. If Barrett is confirmed, the Court would have a 6-3 conservative majority. Important tax impacts, including the fate of the individual mandate, premium tax credit, and net investment income tax will be of interest to taxpayers should the Affordable Care Act be ruled unconstitutional. There are a number of potential outcomes, however, and most legal experts do not anticipate the entire ACA to be overturned. ACA case arguments begin on November 10th and the Court is expected to finalize the matter before its term ends in June of 2021.
An attempt to pass a slimmed down relief bill in the Senate failed last week, gaining only 51 of the 60 votes needed. Meanwhile, House leader Pelosi and Treasury Secretary Mnuchin continued to negotiate a larger stimulus, but ultimately there was no real movement. Main sticking points remain state aid, and liability protection.
Watch for new “Loan Necessity Questionnaire” forms to be released, one for-profit and the other non-profit. Out of millions of PPP borrowers, the SBA estimates only 52,000 will complete the loan necessity questionnaire forms in total; which borrowers they deem required to complete the form will be interesting.
Partnership Tax Basis Capital Accounts
Draft Form 1065 instructions were released along with an IRS notice on partner tax basis capital reporting. The requirement to report partner capital on a tax basis to partners on Schedule K-1 for 2020 remains; however, the revised instructions provide a different approach than prior guidance.
The notice states, “Partnerships filing Form 1065 for tax year 2020 are to calculate partner capital accounts using the transactional approach for the tax basis method. Under the tax basis method outlined in the instructions, partnerships report partner contributions, the partner's share of partnership net income or loss, withdrawals and distributions, and other increases or decreases using tax basis principles as opposed to reporting using other methods such as GAAP.”
A look at the draft 1065 instructions provides greater computational detail, including using the methods outlined in Notice 2020-43 to arrive at a beginning tax basis balance if one has not previously been computed. If tax basis was used in 2019, the taxpayer will keep using that transactional method (business as usual for many). Perhaps most importantly, the IRS stated that a notice is forthcoming granting penalty relief on errors in computing beginning tax basis reporting for the 2020 transition.
Draft Form 1040 instructions were released. Key changes were made apparent when the draft Form 1040 itself came out earlier, such as CARES and FFCRA related additions, and the new placement of the virtual currency transaction question from Schedule 1 to the very top of page 1. Form instructions do explain that merely holding virtual currency in a wallet or account does not constitute a “transaction” requiring a taxpayer to answer “yes” to having a virtual currency transaction during the year. The instructions also remind that the stimulus payments are not taxable income to recipients, rather they are an advance credit that reduce a recovery rebate credit. The recovery rebate credit is calculated the same as in figuring the stimulus payment, except that amounts are based on tax year 2020, rather than 2019 or 2018.
The IRS created a coronavirus toolkit for small businesses that details relevant credits and compliance.
A stricter, second time-limited settlement is available for certain taxpayers under audit who had participated in abusive micro-captive insurance transactions. Settlement offers are being sent soon.
Certain balance due IRS notices will soon be sent again to taxpayers. Series 500 notices, including CP501, CP503, and CP504 were on hold as the agency dealt with a massive physical mail backlog but will soon resume their normal mailings to affected taxpayers.
Case of the Mondays
Not All Was Lost - A Gambler’s Win over the IRS
A compulsive gambler wins in substantiating gambling losses in excess of $350,241 using financial records, trial testimony, and an expert witness where complete records were unavailable.
The taxpayer had enjoyed casual gambling for most of his life, but after retiring from his job as an insurance agent, his gambling increased so much that it adversely affected his finances and family.
Casinos have a requirement to issue Form W-2G on slot machine jackpots of $1,200 or more. During 2014, the taxpayer received $350,241 of gambling winnings, almost exclusively on slot machines, reported to him on 160 Forms W-2G from four casinos. Neither the casinos nor the taxpayer, however, kept complete records of all of his gambling transactions, other than when the taxpayer used casino-issued rewards cards at two of the casinos. The taxpayer used the rewards cards often, but not always. Net winnings reported for 2014 on those rewards cards totaled $54,305.
The taxpayer claimed he gambled on at least 193 days during 2014. He claimed he would gamble for 8 to 10 hours a day on a regular basis, sometimes staying overnight at the casino, and made $2-3k withdraws from his bank account on many gambling days. Financial records show his cash advances and withdrawals on casino premises during 2014 totaled $240,113.
Financial accounts of the taxpayer did not reveal any net worth increase that could be traced to gambling winnings; in fact his bank accounts were extremely low at the beginning and end of the year and his credit card balance remained largely unchanged despite his over $70k of other income and substantial insurance settlement proceeds.
During the trial, testimony was provided by the taxpayer, his wife, his adult daughter who lived at home, and an expert witness specializing in mathematics, the casino gaming industry, and casino gaming slot machines. Mr. Nicely, the expert witness, concluded the taxpayer had overall net gambling losses of at least $151,690 during 2014 and “opined that the odds against petitioner’s having enjoyed even $1 of net gambling profit, for the entirety of 2014, were at least 140 million to 1.”
Mr. Nicely explained that “in a game with odds that disfavor the gambler, the law of large numbers means that a gambler who plays long enough is virtually guaranteed to have net losses. And there is no doubt that the petitioner played long enough.”
A 2014 tax return had not been filed by the taxpayer, but in response to an IRS notice and substitute return, the taxpayer prepared a pro-forma 2014 return showing gambling losses in the amount of $350,241 (the amount of his gambling winnings). The IRS did not agree with the taxpayer’s deduction.
IRC §165(d) provides that taxpayers who do not engage in gambling as a trade or business are allowed losses from wagering transactions, to the extent of wagering gains, as an itemized deduction. Professional gamblers, those who are engaged in a trade or business of gambling, may deduct gambling losses against their gambling winnings as a business expenses arriving at AGI under §62(a)(1). The taxpayer did not claim to be a professional gambler in 2014.
Taxpayers must identify and substantiate their expenses [§6001], but in practice, not all gamblers keep track of their wins and losses. Cohan v. Commissioner is sometimes used to allow estimates of an expense, but there must be a basis upon which an estimate can be made. Prior cases have used casino ATM receipts, cancelled checks to casinos, credit card statements proving cash advances at the casino, bank statements, lifestyle, overall financial position, and expert testimony to substantiate gambling losses.
After considering the taxpayers considerable cash withdrawals, his moderate lifestyle, financial records showing several depleted accounts, casino activity reports, and expert testimony stating the rare chance he had any net winnings, the Court found the taxpayer had provided sufficient evidence to support his proposed deduction for the full amount of his gambling winnings.
Coleman v. Commissioner, T.C. Memo. 2020-146
Information provided is for educational purposes only and not to be used as tax advice.