People who gamble and win are required to report their winnings as income on their tax returns. Gamblers frequently attempt to offset that income by reporting their gambling losses. The IRS allows filers to report losses up to, but not in excess of, their winnings.
Gamblers sometimes try to offset winnings with losses they can’t easily substantiate. For example, a taxpayer might report $7,000 in winnings from bets placed in casinos. The taxpayer might then claim $7,000 in losses from casino betting. Significant casino winnings are documented in a W-2G form but no comparable tax form is issued to document losses.
The IRS has developed detailed recordkeeping requirements for taxpayers who want to deduct gambling losses. Taxpayers who don’t follow those rules typically learn that the IRS assumes one of two things are true: undocumented losses did not occur or undocumented losses were offset by unreported winnings.
While the IRS usually wins those disputes, a taxpayer recently made use of an expert witness to convince the Tax Court that his gambling losses exceeded his winnings. The case is a reminder that the creative use of expert witnesses can make the difference in difficult cases.
John Coleman’s Gambling
John Coleman retired in 2004. He earned a modest income after retirement from an insurance consulting business.
Coleman was a compulsive gambler. He began gambling on card games in high school. He played slot machines in Atlantic City and gambled closer to home when casinos opened in Maryland. After his retirement, he gambled more frequently.
As is true of most compulsive gamblers, Coleman’s gambling interfered with his life. He became delinquent on property taxes and utility bills. In 2019, he began treatment for a gambling disorder.
During 2014, Coleman gambled away a good bit of a $150,000 insurance settlement he had received. Four casinos gave Coleman W-2G forms that documented about $350,000 in gambling winnings. He won that money by playing slot machines. Casinos must issue a W-2G form when a gambler wins a slot machine jackpot of $1,200 or more.
Two of the casinos made no record of Coleman’s slot machine losses. Nor did those casinos keep track of Coleman’s smaller slot machine winnings that they were not required to report on W-2G forms.
At the other two casinos, Coleman sometimes signed into slot machines using player cards that the casinos issued. Those cards tracked all winnings and losses. However, Coleman did not always use those cards. Sometimes he didn’t have his card with him when he decided to enter the casino. Sometimes he stopped using the card because he thought his luck might change if he didn’t sign into a machine.
Coleman established that he regularly withdrew $2,000 to $3,000 per day from his bank account to fund his gambling. He also established that he made ATM withdrawals and received credit card advances while he was gambling.
Coleman’s Expert Witness
Coleman failed to file a 2014 tax return. After the IRS estimated his income, Coleman challenged the estimate and attempted to file a return that the IRS refused to accept. By the time the case came to tax court, the IRS agreed that Coleman’s reported income and deductions were correct in most respects. The IRS disagreed that Coleman was entitled to offset his gambling winnings with an equal amount of gambling losses.
At trial, the IRS maintained that Coleman could not prove his gambling losses because he had not kept a daily record of his losses at each casino. To overcome his poor recordkeeping, Coleman presented the expert testimony of Mark C. Nicely.
The Tax Court recognized Nicely “as an expert in mathematics, the casino gaming industry, and casino gaming equipment, particularly slot machines.” Nicely worked as a computer software engineer who specialized in algorithm development before focusing his career on the gaming industry. He has testified as an expert witness in a variety of cases that involve gambling.
Nicely made mathematical calculations of Coleman’s probable losses based on the frequency with which he gambled and the expected win percentage of the slot machines in the casinos where he gambled. He based his conclusions on the mathematical likelihood that Coleman lost more often than he won.
Slot machines in Maryland and Delaware are programmed to return 87% to 95% of gamblers’ bets as winnings. A gambler might beat the odds by placing a bet, winning, and going home, but a gambler who continues to gamble on slot machines over a significant period of time is statistically destined to lose more money than the gambler will win. Based on Nicely’s calculations, the odds that Coleman could have won more than he lost over the course of 2014 were about 140 million to one.
Tax Court Decision
While noting that deductions must be supported by evidence, the court recognized that not all gamblers keep meticulous records of their losses. In the absence of those records, the Tax Court can estimate losses, but only if the estimate can be substantiated by reliable evidence.
In Coleman’s case, Nicely’s expert testimony provided that evidence. The court found that Nicely’s testimony was consistent with evidence that Coleman made substantial cash withdrawals to support his gambling habit. In addition, Coleman’s lifestyle and debt problems suggested that Coleman did not spend gambling winnings on anything other that continued gambling. The Court was satisfied that Nicely’s expert methodology confirmed that Coleman’s gambling losses offset his winnings.
Don’t Try This at Home
Coleman benefited from playing slot machines that have a fixed ratio of wins versus losses. Nicely was able to calculate Coleman’s probable losses based on that ratio. When gambling depends on skill as well as luck — poker, for example — an expert may not be able to save a taxpayer who did not keep adequate records.
Gamblers on horse racing sometimes try to claim losses by gathering losing tickets that other gamblers have discarded. Since they are so easily acquired, the IRS will not accept losing tickets as evidence of gambling losses. For the same reason, the Tax Court is unlikely to so.
Taxpayers rarely win disputes with the IRS about their gambling losses. The safest practice is to avoid disputes by keeping a daily log of money spent gambling and by supporting that log with bank records and other documentary evidence. Under some circumstances, however, the Coleman case demonstrates that expert testimony can help gamblers avoid substantial tax liability.