IRS Practice and Procedure News Briefs for October 2020

TAXING GAMBLING WINS AND LOSSES – Coleman v. Commissioner, T.C. Memo. 2020-146 (2020)

Why this Case is Important:  With new forms of gambling being legalized throughout the country and more people gambling, it is important that gamblers understand how their wins and losses are taxed.

Facts:  In Coleman, the taxpayer, a compulsive gambler, received 160 separate Forms W-2G from four different casinos reporting gambling winnings of $350,241 in 2014. Because he did not file an income tax return for 2014, the IRS prepared a substitute return, and on that return taxed the full amount of winnings reported on the Forms W-2G. This resulted in a tax deficiency of $128,886 plus penalties of $46,025. The taxpayer filed a Tax Court petition contesting this substitute return, and in doing so submitted what he considered to be a corrected tax return. On that return, he included a tax deduction of $350,241 in gambling losses to offset the income reported on his Forms W-2G.

Law and Conclusion:  The general rule of the Internal Revenue Code is that all revenue, including gambling winnings, is taxed. A taxpayer who does not gamble as a trade or business is permitted to take gambling losses as an itemized deduction, but only to the extent of his or her gross gambling winnings; a deduction in excess of those winnings is not permitted. The issue that often arises is that taxpayers are unable to substantiate their claimed losses because they do not maintain complete records of their gambling activities. In those cases, if the taxpayer can at least prove that there were some losses, the Tax Court is willing to estimate the total losses and allow that amount as a deduction. While the taxpayer did not keep a complete diary of his wins and losses in 2014 and the casinos he gambled at did not have a full record of his gambling, at trial he presented other financial information from that year, such as credit card and bank statements, to show that there was no increase to his wealth over the course of the year, in support of his argument that he did not profit from gambling. In addition, he presented testimony from a mathematics expert that, based on his gambling habits in 2014, including his time spent gambling and the types of games he played (generally slot machines), it was almost statistically impossible for him to have profited from gambling in 2014. Based on this evidence, the Court accepted the Taxpayer’s position that he had no net gambling winnings in 2014 and found in his favor.

FEDERAL TAX LIENS AND BANKRUPTCY – Webb v. IRS, No. 1:17-cv-00058 (S.D. Ind. 2020)

Why this Case is Important:  Individuals in bankruptcy often misunderstand the effect that a bankruptcy discharge will have on any federal tax liens filed against them, and the tax liabilities that are the subject of those liens. 

Facts:  In Webb, the IRS filed notices of federal tax lien against the taxpayers in 2010. In 2013, the taxpayers filed a Chapter 7 bankruptcy petition, listing their home as exempt from bankruptcy. The bankruptcy court granted a discharge in 2013. Apparently, unbeknownst to the taxpayers, that discharge did not extend to the tax liabilities covered by the IRS liens. The IRS, believing that the taxpayers’ liabilities had been discharged by the bankruptcy, abated the liabilities and released its tax liens in 2014. In 2016, realizing that the liabilities had not been discharged, the IRS reversed its abatement and filed revocations of its releases of the tax liens. The IRS then filed suit against the taxpayers demanding payment of the taxes. As part of that lawsuit, the IRS filed a motion for summary judgment, requesting that the Court determine that, following the revocation of the lien releases, the tax liens were valid and attached to all property owned by the taxpayers as of the date of their bankruptcy filing, including their home. The taxpayers argued that they were entitled to summary judgment on the issue based on their tax liabilities having been discharged in bankruptcy and abated by the IRS and the IRS having released the tax liens.

Law and Conclusion:  Under Section 6321 of the Internal Revenue Code, a federal tax lien arises when a taxpayer fails to pay taxes due. When a tax liability is assessed, a lien automatically arises and attaches to all property and property rights owned by the taxpayer during the life of the lien. Tax liens survive bankruptcy even following a discharge. Section 522 of the Bankruptcy Code makes clear that the debt secured by a tax lien filed against bankruptcy-exempt property, such as a residence, is not subject to discharge. The Court disagreed with the taxpayers’ argument that the IRS could not reinstate the tax liens because, while the taxpayers argued that the underlying taxes had been discharged, in reality they had not. While a bankruptcy discharge may eliminate personal debt, a creditor’s lien, such as a federal tax lien, if validly established prior to the bankruptcy filing, will survive the bankruptcy discharge. In this case, because the tax liens were established prior to the taxpayers’ bankruptcy filing, the bankruptcy did not invalidate the liens. Furthermore, the fact that the liens survived the bankruptcy meant that the tax liabilities covered by the liens were not discharged - as the Court stated, where liabilities are secured by a lien that survives bankruptcy, those liabilities are not discharged as a result of the bankruptcy, and no law prevents the IRS from reversing its mistaken abatement of tax liabilities. Finally, based on Section 6325(f) of the Internal Revenue Code, which allows the IRS to revoke a release of a tax lien if the release was issued “erroneously or improvidently,” the Court held that the IRS validly revoked its release of the tax liens, such that the liens were valid as if they had never been revoked. Having found in favor of the IRS on each of these issues, the Court granted summary judgment in favor of the IRS.

If you would like more details about these cases, please contact me at 312-888-4113 or jnesser@lavellelaw.com.