The Important of Conducting a Business Like a Business

When in business do as business’ do is an important idea for a person entering business to grasp and act on. As an accountant with a growing tax practice people retain my service to prepare returns and many times represent them before the IRS. Usually after not conducting their profit motivated activity like a business. A recent tax case illustrates the importance of acting like a business as a business.

A Mr. Boneparte, an employee of the NY and New Jersey Port Authority claimed on his federal tax return to be a professional gambler. The treatment of gambling losses for a professional gambler is to deduct the losses to the extent of winnings directly from the winnings. Much as a merchant deducts the cost of goods sold from the sales proceeds from those goods. Casual gamblers deduct the losses as a miscellaneous expense subject to the 2% floor on Schedule A to the extent of winnings. The ability to deduct the losses directly from the winnings has huge tax implications. Primarily a lower Adjusted Gross Income (AGI), a number used in many critical tests for various credits and deductions and for a self-employed person a lower SE tax.

When the losses are deducted subject to the 2% floor on Schedule A AGI is higher and the deduction may not be used if less than the standard deduction leading to a higher tax on total income.

The Tax Court looked at the facts of Mr. Boneparte’s return and relevant law and ruled the taxpayer was not a professional gambler. The court’s questioned if Mr. Boneparte had as an objective of being a gambler a profit motive. A profit motive is evidence partly by the fact the taxpayer maintains complete and accurate books and records. (Reg. §1.1832(b)(1))

Central to the Tax Court’s ruling was Mr. Boneparte’s failure to keep complete and accurate records of his gambling activities. Mr. Boneparte maintained a running total of winnings and losses in his head. He did not record where, when, and the amount of each wager or each day of gambling activity. The handwritten notes he provided to the auditor were created while the audit was in progress. Part of the complete and accurate records requirement is that the records be contemporaneous to the activity meaning “originating, arising, or being formed or made at the same time; marked by characteristics compatible with such origin.” (Merriam –Webster) A classic example is the receipt showing the name of the vendor, the date and time, the amount paid or received.

Mr. Boneparte could not demonstrate he had a profit motive in being a gambler and lost the deduction of his losses directly against his winnings. Keep the receipts, keep books showing a detailed accounting of income and expenses using those receipts.

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