Playing It Smart: Can gambling losses be considered business expenses or entertainment costs?

In 1978, Robert Groetzinger joined the unemployed. Instead of crying, Mr. Groetzinger decided to turn his hobby into a business. The hobby was gambling at the dog tracks. He accordingly spent 60 to 80 hours per week betting as well as studying racing forms, programs, and other materials to help him wager skillfully.

Mr. Groetzinger earned $6,500 away from the track that year. He grossed $70,000 on the dogs, but bet $72,000 for a net deficit of $2,000. At tax time, he reported the $6,500 and ignored the $70,000 and $72,000. The Internal Revenue Service (IRS) balked. Worse, it said much of the win was subject to the Alternative Minimum Tax (AMT), such that most of the loss wasn't deductible.

Mr. Groetzinger then claimed his gambling was a business at which he intended to make a living. He should therefore be taxed on his net, like any other business. The IRS wasn't convinced, and sued.

The case eventually got to the U.S. Supreme Court, which examined the IRS rules for determining whether an activity is a business for tax purposes. The standards are "non-exclusive" and don't all have to be met. They are 1) how the activity is conducted for instance with accurate record-keeping and reporting; 2) the expertise applied; 3) the time and effort expended; 4) the expectation that assets utilized will grow in value; 5) the success of the operator in other businesses; 6) profits or losses in the present activity; 7) income that is offset by losses; 8) the financial status of the taxpayer including possible other jobs; and 8) the personal pleasure and recreation being derived.

The Court held in favor of Mr. Groetzinger. The decision was based primarily on the regularity and intensity of his efforts, the knowledge and skill he applied in handicapping, and his intent to make a living this way. His losing money at it was irrelevant.

In 1998, Estelle Busch turned 65 and quit her job. In her view she didn't retire. Instead, she took up gambling as a profession, logging 40 to 60 hours per week at the slots. She read some articles "on the computer" and talked to casino staff as well as solid citizens, gaining what she said was insight into patterns and tendencies indicating favorable conditions and impending jackpots. She did get some good payouts racking up gross wins of $80,000 in 1999, $430,000 in 2000, and $973,000 in 2001. She believed these proved her predictive abilities. Unfortunately, setbacks in those same years always outweighed the gains.

Ms. Busch reported everything in her tax filings. Washington accepted the losses as business expenses. But Minnesota assessed her for back taxes, penalties, and interest under its own AMT code. The state agreed that Ms Busch expected to come out ahead, but claimed that expectation of making a profit must be realistic to qualify as a business. It accordingly classified the wins as earnings and the losses as entertainment costs. The state also cited her not making a profit in three years, not attempting to acquire specific understanding of how the machines operate, and not having any actual expertise. Further, Minnesota officials argued that slot machines operated purely on chance, and only gambling involving skill could form the basis of a business.

This case got to the Minnesota Supreme Court, which made an admittedly "close call" in her favor. The Court noted she "sought to gain a profit" and "believed she was good at telling whether a slot machine was rolling favorably." The justices used the IRS rules for guidance as to what is a business. They found that Ms. Busch met four of the criteria. She kept detailed records and reported income, put in extensive time and effort doing what she said wasn't entertainment but "just plain hard work," hit jackpots which offset her losses and encouraged her belief she could win in the long run, and had no other job.

So, the laws of the land say you may gamble professionally. Whether the laws of math say you can subsist on it is another matter. Not only that, but as the poet, Sumner A Ingmark, penned: