No Gold at the End of the Rainbow

Yesterday, the Tax Court ruled in Au v. Commissioner. The Aus, husband and wife from California, gambled during 2006 but lost money. Indeed, they lost over $40,000. They took those gambling losses as a miscellaneous itemized deduction.

Unfortunately, the Tax Code doesn’t allow that. Section 165(d) of the Tax Code states that gambling losses are deductible as a miscellaneous itemized deduction (not subject to the 2% AGI limitation on miscellaneous itemized deduction) up to the amount of gambling winnings. Since the Aus had no gambling winnings, they couldn’t take any gambling losses.

The Aus, as Joe Kristan notes, contested the accuracy-related penalty they were charged. They relied on the “Turbo Tax” defense: Tax Cut (the software they used to prepare their return) allowed us to do this.

Petitioners contend that they followed the instructions on the tax preparation software that they used in preparing their 2006 tax return, asserting that the software was “approved by the IRS”. They indicate that they were unaware of the provisions of the Code and that they did not consult any Internal Revenue Service (IRS) publications or professional tax advisers before claiming deductions equaling almost half of their reported income in 2006. The software instructions are not in the record, so we cannot determine how the error occurred. We doubt that the instructions, if correctly followed, permitted a result contrary to the express language of the Code. Petitioners may have acted in good faith but made a mistake. In the absence of evidence of a mistake in the instructions or a more thorough effort by petitioners to determine their correct tax liability, we cannot conclude that they have shown reasonable cause for the underpayment of tax on their 2006 return.

The Turbo Tax defense doesn’t work in Tax Court.

The Court also noted that they gave plenty of opportunities for the Aus to negotiate a settlement with the IRS, and/or to consult attorneys regarding their case. They didn’t until the Court was about to render its decision. Had they asked a tax professional or an attorney familiar with tax law about their case, they likely would have been advised to settle and they would be paying less than they’ll have to.

Case: Au v. Commissioner, T.C. Memo. 2010-247

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