Tax Lawyer's Blog

Donald and Denise Hastings v. Commissioner of Internal Revenue – Gambling for most taxpayers is considered to be a hobby and, therefore, losses can be claimed only to the extent of winnings. 

This case shows the kinds of analyses that must be made to determine whether or not a taxpayer’s gambling activies rise to the level of a trade or business.

In his opinion Judge Stephen Swift stated the general rule:

To be carrying on a trade or business within the meaning of section 162(a), an individual taxpayer must be involved in the activity with continuity and regularity and with the objective of making a profit. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987); sec. 1.183-2(a), Income Tax Regs.

Determining whether a taxpayer is carrying on a trade or business requires an examination of all of the facts in each case.

He then analyzed the facts of this case using seven factors described in Treasury Regulation § 1.183-2(a) to determine whether the Hastings’ were in the trade or business of gambling or were merely pursuing a hobby:

1. Manner in Which Activity is Carried On – Is the business carried on a businesslike manner. For example, is there a written business plan, a separate bank account, regular and consistent business activities, and an organized record-keeping system?
2. Expertise – Does the taxpayer have special expertise in the business. If so, it indicates that he or she had a reasonable expectation of making a profit?
3. Time and Effort Expended – How much time does the taxpayer spend in furthering the business? If the activity is truly a for-profit enterprise, the IRS and the courts expect to see a substantial amount of time and effort put into it.
4. Success in Carrying on Other Activities – If the taxpayer has succeeded in other business ventures it indicates that he or she might, eventually, turn a profit in this one as well.
5. History of Income or Loss With Respect to the Activity – This is huge. If you say you are performing an activity for the purpose of making a profit and you don’t make a profit for a significant period of time, the IRS expects you to abandon the business. That is, unless, you were just doing it for fun.
6. Amount of Occasional Profits – If the taxpayer has had some income from the business, it indicates that he or she has a reasonable expectation of profits.
7. Elements of Personal Recreation or Entertainment- The more fun you are having, the less likely it is that the activity is a trade or business. At least thats what the regulations imply.

I guess that last one means Hugh Heffner’s screwed.

The Judge ruled against the taxpayers concluding that factors 1, 2, 3, 5 and 6 weighed against them and factors 4 and 7 were neutral:

Of the factors present in this case, five weigh against petitioner and two are neutral.

We conclude that for 2003 and 2004 petitioner has not shown that she had a profit objective in carrying on her slot machine gambling activity and therefore that petitioner in 2003 and 2004 was not in the trade or business of gambling.

Our Advice: If you consider yourself to be a professional gambler, do the following to increase your chances of being found so by the IRS:

1. Set up and use a separate bank account for your gambling activities;
2. Prepare a written business plan outlining your strategy for making a profit from your gambling activities. Be sure to include many self-serving statements in the plan like “I really, really hope I win and make a profit at this business because it’s not a hobby.” This way the IRS will know you aren’t in it to lose money;
3. Keep a detailed log of the time you spend on gambling and related activities. Do not include an entry for your visit to the Chicken Ranch;
4. Limit or eliminate all incidental, recreational aspects of your gambling activities. We recommend that you web-cam yourself being bored and miserable;
5. Choose a gambling activity that involves (or at least appears to involve) some element of skill. The courts seem more willing to believe the existence of a profit motive for Texas Hold ‘Em players than they are for slot machine players. Must be those really cool and serious hats; and, finally,
6. Win. If you do the first 5 but consistently lose money it will be difficult to prove that you are truly in it for profit.

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