Judge Finds IRS Must Accept Likelihood of Gambling Losses

However, losses are much harder to substantiate, and in its normal bullying manner, the IRS refuses to accept withdrawal slips, ATM receipts, and such as proof.

A Tax Court judge has handed down a precedent-setting decision regarding taxation of gambling winnings and losses. After the Internal Revenue Service refused to accept three years of returns filed by Frank Gagliardi, sating he couldn't prove his losses, Gagliardi took the government to court.

The IRS traditionally expects to be paid tax on winnings, and requires casinos paying over certain amounts, $1200 at that time, to record customer information. However, losses are much harder to substantiate, and in its normal bullying manner, the IRS refuses to accept withdrawal slips, ATM receipts, and such as proof.

The IRS sugests that gamblers keep a detailed and specific diary of play to document losing. Leave it to the IRS to find a way to make losing more painful, and in a dull, beancounter way, as well.

But Gagliardi turned out to be the IRS'  worst nightmare. He had won the California Lottery in1991, hitting for $26.7 million. After taking the payments over twenty years, and eventually splitting with his ex-wife, Gagliardi still pulled down almost $700,000 yearly.

This meant that he had the time and money to fight the IRS in court, a rare opportunity for one of the agency's victims. Gagliardi had developed a compulsive gambling habit, but unlike many, he could afford it. He claimed losses of over $2.5 million, more than offsetting his wins during the three years. The IRS disallowed the losses, and wanted $1 miilion in back taxes against provable winnings.

Gagliardi brought in psychologists who testified to the nature of addictive gambling; a girlfriend who said he was so busy plaing slots it took three days for him to realize she had left him; and witnesses who swore he played right through the 9/11 catastrophe.

Gaming experts also testified, giving details about the odds of winning and losing and the probability someone who played as frequently as Gagliardi would win more than lose, generally seen as highly unlikely. As one industry insider put it, slot machines take in more than they pay out. That's what keeps casinos in business.

In court, Mark Nicely, a probability and mathematics expert, testified, "“If you play long enough, even on a 98 percent game, your chance – your probability of being ahead – tends to zero."

The judge found that Gagliardi's case was irrefutable, and found against the IRS. This could mean a future in which players' losses are as easy to substantiate as winnings, preventing the IRS from forcing losing players to pay taxes on winnings that went right back to the casino.