A New York Doctor/Gambler Hits Three Lemons

The TaxProf Blog alerted me to an interesting Tax Court case decided earlier this week. Once again the Court looked at whether or not an individual can be a professional gambler when that individual specializes in video poker.

In video poker, you play against a machine and attempt to try to get the best payout possible. Because the payouts are shown on the machine you can calculate your exact expected value by playing any machine.

The petitioners in todays case were a successful New York City physician and his wife. The doctor decided that he wanted to start playing video poker, and he went to the nearby Mohegan Sun casino. He looked at the paytables of various video poker machines and only played progressive machines with big payouts.

To be a professional gambler an individual needs to keep good records. I recommend to everyone they keep a gambling log: a pocket notebook where you record your wins and losses. But the petitioner in today’s case decided to rely on the casino for his records:

Petitioners were misguided to assume that Dr. Merkin’s Players Club card would keep a complete business record of his activities at a casino and that this record would absolve them of the duty to maintain business records. See sec. 6001. It is the taxpayer’s duty, and not that of the casino, to maintain such records. Sec. 6001. In short, his lack of records and accountability for his activities illustrates to us that Dr. Merkin did not carry on his video poker playing in a businesslike manner.

The Court didn’t like that his Club card was his only record: “In fact, the only credible evidence in the record with respect to Dr. Merkin’s time spent playing video poker in 2003 was a Player’s Club statement generated by Mohegan Sun and provided by petitioners at trial.”

That was strike one.

Next, it helps to be profitable. One of the tests to see if an individual is conducting a business or a hobby is whether he makes money. The petitioner was losing money, so did he change his system?

Despite Dr. Merkin’s playing time (whether it was 319 or 1,128 hours), he did not testify that he spent any time honing or adjusting his system when it became clear to him that he was not on track to make a profit playing video poker in 2003. See sec. 1.183-2(b)(2) and (3), Income Tax Regs. Dr. Merkin did testify that he read video poker magazines and kept abreast of the machines and their respective payout histories at the casino, but he did not prove that he used this knowledge to adjust his system in the light of his overall losses. We view Dr. Merkin’s failure to spend any time adjusting and/or improving his system as a factor weighing against his gambling activity’s being a trade or business.

He didn’t, and that was strike two.

Next, the petitioners argued that if you included the value of the gifts they received with their Club card they would be profitable. But there’s a problem with that, and the Court saw it quite easily:

The items he earned through redemption of his Player’s Club points were items that he essentially paid for with the amounts that he bet. Put another way, if petitioners were to have purchased all of the items they received through the redemption of their Player’s Club points in 2003, it is highly improbable that the value of those items would equal the amount of money wagered by Dr. Merkin in 2003.

Moreover, and with respect to the items for which Dr. Merkin redeemed his Player’s Club points in 2003, we note that petitioners failed to report as income the value of any car, airfare, or travel that they acquired from the casino in 2003…However, if Dr. Merkin received any items of that type in redemption of his Player’s Club points, we could not permit him to have it both ways; that is, by taking the value of those items into account to determine whether his gambling activity was engaged in with the actual intent of making a profit while not including the value of those items in income.

That’s three strikes, but the Court found a fourth strike. The test to be a professional gambler includes that you use the income for your livelihood. However, the petitioner in this case is a successful physician who “…had ample disposable income as a result of Dr. Merkin’s practice to cover the expenses associated with two residences as well as Dr. Merkin’s spending while at Mohegan Sun.”

It doesn’t help when the petitioner admits that his gambling wasn’t making money. “Dr. Merkin conceded this reality when he admitted at trial that his system did not work.” Indeed, the physician has given up video poker.

But losing this case won’t be the end of the story for the doctor. He will soon be hearing from the New York Tax Department. Why? Because once your income reaches a certain level—and given the petitioner’s successful medical practice, it’s a certainty he’s well beyond that level—New York only allows 50% of itemized deductions. Thus, while the petitioner owed $21,000 in additional tax to the IRS, he will face a substantial tax bill from New York on his gambling…and he was an overall loser. At least he gets to deduct 50% of the losses; had he resided in Connecticut he would get none of the losses.

Case: Merkin v. Commissioner, T.C. Memo 2008-146

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