T.C. Summary Opinion 2019-17
UNITED STATES TAX COURT
JUN WU, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8009-16S. Filed July 25, 2019.
Jun Wu, pro se.
Sandeep Singh, for respondent.
SUMMARY OPINION
CARLUZZO, Chief Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code (Code) in effect when
the petition was filed.1 Pursuant to section 7463(b), the decision to be entered is
1 Unless otherwise indicated, section references are to the Internal Revenue (continued...) -2-
not reviewable by any other court, and this opinion shall not be treated as
precedent for any other case.
In a notice of deficiency dated January 5, 2016 (notice), respondent
determined deficiencies in, and penalties with respect to, petitioner’s Federal
income tax for 2013 and 2014.
After concessions, the issues for decision are whether petitioner: (1) was
engaged in the trade or business of gambling in 2014; (2) had unreported gambling
losses up to the amount of his gambling income for 2014; (3) is entitled to
depreciation and section 179 deductions in excess of what respondent has already
allowed for each year in issue; (4) is entitled to deductions claimed on Schedule A,
Itemized Deductions, in excess of what respondent has already allowed for each
year in issue; (5) is entitled to deduct a loan origination fee paid in connection
with financing the purchase of a rental property in 2013; and (6) is liable for a
section 6662(a) accuracy-related penalty for either year in issue.
Background
Some of the facts have been stipulated and are so found. At the time the
petition was filed, petitioner resided in California.
1 (...continued) Code of 1986, as amended, in effect for the years in issue. Rule references are to the Tax Court Rules of Practice and Procedure. -3-
At all times relevant petitioner lived in San Francisco, California. During
each year in issue he was an employee of Savvis Communications Corp. (Savvis).
Petitioner worked from home because Savvis did not provide him with an office.
On May 3, 2013, petitioner purchased a house in San Francisco that he held
for rent and rented out during 2013 and 2014 (rental property), typically for
periods of one to three days. He paid an origination fee in order to acquire the
loan that he used to finance the purchase of the rental property. The rental
property was furnished with various items purchased in both 2013 and 2014. At
no time during either year in issue did petitioner use the rental property as a
residence.
Petitioner began to gamble at various casinos in Las Vegas, Nevada, and
various cities in California during 2014. Most of his gambling activities consisted
of slot machine play, although he did play blackjack and baccarat from time to
time as well. Petitioner intended to win when he gambled, and he developed his
winning strategies by reading a book he could not remember the name of, talking
to people and casino employees at the various casinos, taking a class that lasted “a
couple hours”, and “just by playing”. According to petitioner, he paid or incurred
substantial transportation, hotel, and other traveling expenses in order to pursue
his gambling activity. Petitioner did not treat his gambling activity as a trade or -4-
business or as an activity entered into for profit on his 2014 Federal income tax
return (2014 return), and, other than his gambling losses, he did not claim any
deductions relating to his gambling income on his 2014 return. Petitioner
prepared his 2014 return and his 2013 Federal income tax return (2013 return)
himself.
Forms W-2G, Certain Gambling Winnings, and other casino records show
that petitioner gambled frequently in 2014; however, he did not otherwise keep a
schedule of his casino visits. Nor did petitioner maintain any sort of business
records with respect to his gambling activity. Despite his intention to win at
gambling, like many other gamblers, casino statements show that petitioner’s
losses substantially exceeded his winnings during 2014.
Petitioner reported his wages from Savvis on his 2013 return; he did not
claim a deduction for unreimbursed employee business expenses related to that
employment on the Schedule A included with that return. Nothing on the 2013
return can be construed as an election under section 179 with respect to any of the
furniture or other assets used in connection with the rental property.
The income reported on petitioner’s 2014 return includes his wages from
Savvis and gambling winnings reported on Forms W-2G. The Schedule A
included with that return shows unreimbursed employee business expenses, but no -5-
deduction is claimed for those expenses because they do not exceed 2% of the
adjusted gross income reported on the return. See sec. 67(a). The Schedule A also
shows a deduction for gambling losses in the same amount as the gambling
income identified as “other” income on the 2014 return.
The 2014 return also includes: (1) Schedule C, Profit or Loss From
Business, and (2) Schedule E, Supplemental Income and Loss. The Schedule C
relates to petitioner’s employment with Savvis. No income is shown on the
Schedule C; expenses totaling $39,501 are deducted, resulting in a net loss in the
same amount. The Schedule E included with petitioner’s 2014 return shows that
the rental income exceeded rental deductions, including depreciation, for that year.
Nothing on the 2014 return can be construed as a section 179 election with respect
to furniture or other assets used in connection with the rental property.
Most of the adjustments made in the notice have been agreed on between
the parties or conceded by one or the other of them; other adjustments are
computational. Those adjustments will not be discussed. Instead we turn our
attention to those items that must be considered in the resolution of the issues now
before us regardless of whether the issue stems from an adjustment made in the
notice or a claim petitioner made after the notice was issued. -6-
Discussion
As we have observed in countless opinions, deductions are a matter of
legislative grace, and the taxpayer bears the burden of proof to establish
entitlement to any claimed deduction.2 Rule 142(a); INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934). A taxpayer claiming a deduction on a Federal income tax
return must demonstrate that the deduction is allowable pursuant to some statutory
provision and must further substantiate that the expense to which the deduction
relates has been paid or incurred. Sec. 6001; Hradesky v. Commissioner, 65 T.C.
87, 89-90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976); Meneguzzo v.
Commissioner, 43 T.C. 824, 831-832 (1965); sec. 1.6001-1(a), Income Tax Regs.
Taxpayers may deduct ordinary and necessary expenses paid in connection
with operating a trade or business. Sec. 162(a); Boyd v. Commissioner, 122 T.C.
305, 313 (2004). It has long been recognized that a taxpayer’s status as an
employee may constitute a trade or business within the meaning of section 162.
On the other hand, section 262(a) generally disallows a deduction for personal,
living, or family expenses.
2 Petitioner does not claim and the record does not demonstrate that the provisions of sec. 7491(a) are applicable, and we proceed as though they are not. -7-
With these fundamental principles of Federal income taxation in mind, we
consider petitioner’s claims to the various deductions in dispute for the years in
issue.
I. Gambling Activity
A. Wagering Losses
Consistent with an adjustment in the notice, petitioner agrees that his
winnings from gambling in 2014 exceeded the amount of the winnings shown as
“other” income on his 2014 return. He now claims a deduction for losing wagers
in an amount that equals his winnings and exceeds the deduction shown for
gambling losses on the 2014 return. The casino records introduced into evidence
support his claim that his gambling losses exceeded his winnings in 2014.
Accordingly, petitioner is entitled to a section 165(d) deduction equal to the 2014
gambling winnings that respondent determined are includable in his 2014 income.3
B. Gambling Activity as a Trade or Business
Petitioner did not treat his gambling activity as a trade or business on his
2014 return. He now claims that the activity constituted a trade or business and
that he is entitled to section 162(a) deductions for traveling expenses he claims to
3 The deduction is properly claimed as a miscellaneous itemized deduction not subject to reduction under sec. 67(a). See sec. 67(b)(3). -8-
have paid or incurred in connection with the gambling activity. According to
respondent, petitioner’s gambling activity was not carried on with the requisite
profit motive so as to constitute a trade or business within the meaning of section
162 or an activity conducted for profit within the meaning of section 212. Under
the circumstances we expect that petitioner’s position on the point has been
prompted, at least in part, in attempt to reduce the 2014 deficiency determined in
the notice. Whether it was or was not, for the following reasons we reject his
claimed deductions in excess of gambling losses.
Under section 183(a), if an activity is not engaged in for profit, then no
deduction attributable to that activity is allowed except to the extent provided by
section 183(b). In pertinent part section 183(b) allows those deductions that
would have been allowable had the activity been engaged in for profit only to the
extent of gross income derived from the activity (reduced by deductions
attributable to the activity that are allowable without regard to whether the activity
was engaged in for profit). In this case, deductions allowable under section 165(d)
in effect prevent any deductions under section 183(b).
Section 183(c) defines an activity not engaged in for profit as “any activity
other than one with respect to which deductions are allowable for the taxable year
under section 162 or under paragraph (1) or (2) of section 212.” Deductions are -9-
allowable under section 162 or under section 212(1) or (2) if the taxpayer is
engaged in the activity with the actual and honest objective of making a profit.
Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), aff’d without published
opinion, 702 F.2d 1205 (D.C. Cir. 1983); Golanty v. Commissioner, 72 T.C. 411,
425-426 (1979), aff’d without published opinion, 647 F.2d 170 (9th Cir. 1981).
The profit standard applicable to section 212 is the same as that used in section
162. See Antonides v. Commissioner, 893 F.2d 656, 659 (4th Cir. 1990), aff’g 91
T.C. 686 (1988); Allen v. Commissioner, 72 T.C. 28, 33 (1979).
The existence of the requisite profit objective is a question of fact that must
be decided on the basis of the entire record. Groetzinger v. Commissioner, 82
T.C. 793, 803 (1984), aff’d, 771 F.2d 269 (7th Cir. 1985), aff’d, 480 U.S. 23
(1987); sec. 1.183-2(b), Income Tax Regs. In resolving this factual question,
greater weight is given to objective facts than to a taxpayer’s statement of intent.
Sec. 1.183-2(a), Income Tax Regs.
Section 1.183-2(b), Income Tax Regs., provides a nonexclusive list of
factors to be weighed when considering whether a taxpayer is engaged in an
activity for profit. The relevant factors are: (1) the manner in which the taxpayer
carried on the activity; (2) the expertise of the taxpayer or his advisors; (3) the
time and effort the taxpayer expended in carrying on the activity; (4) the - 10 -
expectation that the assets used in the activity may appreciate in value; (5) the
success of the taxpayer in carrying on other activities for profit; (6) the taxpayer’s
history of income or losses with respect to the activity; (7) the amount of
occasional profits, if any, that are earned from the activity; (8) the financial status
of the taxpayer; and (9) whether elements of personal pleasure or recreation are
involved in the activity. Id. No one factor is determinative of whether an activity
is engaged in for profit. Brannen v. Commissioner, 722 F.2d 695, 704 (11th Cir.
1984), aff’g 78 T.C. 471 (1982); Golanty v. Commissioner, 72 T.C. at 426; sec.
1.183-2(b), Income Tax Regs. In this case, some of the factors do not apply or are
neutral.
Forms W-2G and other casino records establish, as petitioner claims, that he
gambled frequently during 2014 and further that his losses substantially exceeded
his winnings. A review of the 2014 return makes it obvious that petitioner’s
gambling activity was not his “means of making a living”. Commissioner v.
Groetzinger, 480 U.S. at 32.
Furthermore, he did not conduct the gambling activity in a businesslike
manner. Other than the win/loss statements provided by the casinos, petitioner did
not maintain any records for the activity, and he did not develop or follow any
form of business plan. See Carmody v. Commissioner, T.C. Memo. 2016-225, - 11 -
at *20-*23 (holding that a taxpayer was not engaged in horse-racing activity for
profit when he did not have a written business plan, did not use spreadsheets and
invoices to minimize losses or generate profits, and did not engage in any
meaningful financial management with respect to his horse-racing activity).
Gambling is routinely thought of as a recreational activity, see sec. 1.183-2(b)(9),
Income Tax Regs., and while we have noted that no one factor is determinative,
the recreational aspect of the gambling activity coupled with his failure to treat the
activity as a trade or business from its inception go a long way in undermining his
claim that he conducted the activity as a trade or business.
On the basis of all the facts and circumstances, we find that petitioner is not
entitled to the trade or business deductions he now claims for the travel expenses
related to his gambling activity because he did not engage in that activity with the
sufficient profit motive to allow for the activity to be considered a trade or
business within the meaning of section 162.4
4 Our finding on the point also precludes deductions for the expenses under sec. 212. See sec. 212(1); Antonides v. Commissioner, 893 F.2d 656, 659 (4th Cir. 1990), aff’g 91 T.C. 686 (1988); Allen v. Commissioner, 72 T.C. 28, 33 (1979). - 12 -
II. Schedule C Depreciation
In the joint stipulation of settled issues respondent concedes that petitioner
is entitled to the following Schedule C depreciation: furniture (7-year class) with a
depreciable basis of $27,220, placed in service on July 1, 2013; computer (5-year
class) with a depreciable basis of $5,767, placed in service on July 1, 2013;
appliances (5-year class) with a depreciable basis of $1,930, placed in service on
July 1, 2013; and building (27.5-year class) with a depreciable basis of $274,500,
placed in service on July 1, 2013. Petitioner now contends that he is entitled to an
additional depreciation deduction, as well as a section 179 deduction for furniture.
A reasonable depreciation deduction may be allowed for the “exhaustion,
wear and tear” of property used in a trade or business. Secs. 161, 167(a)(1). To
substantiate entitlement to a depreciation deduction, a taxpayer not only has to
show that the property was used in a business but also must establish the
property’s depreciable basis by showing the cost of the property, its useful life or
recovery period, and its previously allowable depreciation. See, e.g., Cluck v.
Commissioner, 105 T.C. 324, 337 (1995).
Alternatively, a taxpayer may elect to treat the cost of certain property used
in an active trade or business as a current expense in the year that property is
placed in service. Sec. 179(a), (d). The election must be made on the taxpayer’s - 13 -
first income tax return (whether or not the return is timely) or on an amended
return filed within the time prescribed by law (including extensions) for filing the
original return for such year. Sec. 179(c)(1)(B); Genck v. Commissioner, T.C.
Memo. 1998-105; sec 1.179-5(a), Income Tax Regs.
Petitioner’s records do not establish that he purchased depreciable business
property for which respondent has not already allowed a deduction for either year
in issue. Moreover, petitioner did not elect to expense the cost of the furniture in
the years the furniture was placed in service. That election had to be made on his
2013 or 2014 tax return or on an amended return filed within the time prescribed
by law (including extensions) for filing the original return. Accordingly, we reject
petitioner’s claim to a depreciation expense deduction or a section 179 deduction
in excess of what respondent has already allowed.
III. Schedule A Itemized Deductions
For each year petitioner claims that he is entitled to Schedule A deductions
in excess of the amounts respondent allowed in the notice, but he has failed to
offer any evidence to substantiate the aforementioned items. See sec. 6001;
Hradesky v. Commissioner, 65 T.C. at 89-90; sec. 1.6001-1(a), Income Tax Regs.
Accordingly, petitioner is not entitled to Schedule A deductions in excess of the
amounts respondent has already allowed. - 14 -
IV. Loan Origination Fee
Petitioner claims that he is entitled to deduct a loan origination fee paid in
2013 in connection with the purchase of the rental property. Petitioner has
established that he paid the fee. According to respondent, however, because the
rental property was not petitioner’s residence, the fee must be amortized and
deducted over the life of the loan. See sec. 461(g); Goodwin v. Commissioner, 75
T.C. 424, 440-441 (1980), aff’d without published opinion, 691 F.2d 490 (3d Cir.
1982); Enoch v. Commissioner, 57 T.C. 781, 794-795 (1972). We agree with
respondent. Petitioner is not entitled to a current deduction for 2013 for the loan
origination fee.
V. Section 6662(a) Accuracy-Related Penalty
Lastly, we consider whether petitioner is liable for a section 6662(a)
accuracy-related penalty for either year in issue. That section imposes an
accuracy-related penalty equal to 20% of the underpayment of tax that is
attributable to negligence or other specified grounds. See sec. 6662(b).
Negligence as used in section 6662(b)(1) is defined as any failure to make a
reasonable attempt to comply with the Code and includes any failure to keep
adequate books and records or to substantiate items properly. Sec. 6662(c); sec.
1.6662-3(b)(1), Income Tax Regs. Respondent bears the burden of production - 15 -
with respect to the imposition of a section 6662(a) accuracy-related penalty. See
sec. 7491(c). In support of that burden, respondent points out that petitioner failed
to maintain adequate substantiating records for many of the expenses underlying
the deductions claimed on his 2013 and 2014 returns.
Section 6751(b)(1) provides that, subject to certain exceptions in section
6751(b)(2), no penalty shall be assessed unless the initial determination of the
assessment is personally approved in writing by the immediate supervisor of the
individual making the determination or such higher level official as the
Commissioner may designate. Written approval of the initial penalty
determination under section 6751(b)(1) must be obtained no later than the date the
notice of deficiency is issued or the date the Commissioner files an answer or
amended answer asserting the penalty. Chai v. Commissioner, 851 F.3d 190, 221
(2d Cir. 2017), aff’g in part, rev’g in part T.C. Memo. 2015-42; see also Graev v.
Commissioner, 149 T.C. 485 (2017), supplementing and overruling in part 147
T.C. 460 (2016). Compliance with section 6751(b)(1) is part of the
Commissioner’s burden of production in any deficiency case in which a penalty
subject to section 6751(b)(1) is asserted. Graev v. Commissioner, 149 T.C. at 493.
The section 6662(a) accuracy-related penalties determined in the notice
were properly approved as required by section 6751(b)(1). The record includes a - 16 -
Civil Penalty Approval Form, approving imposition of accuracy-related penalties
against petitioner for 2013 and 2014 and executed by the Internal Revenue Service
tax examiner’s immediate supervisor before the date the notice was issued; and
nothing in the record suggests that petitioner was formally notified of the
imposition of the penalties before the requisite supervisory approval was obtained.
See Clay v. Commissioner, 152 T.C. __ (Apr. 24, 2019). As a result, we find that
respondent met his burden of production with respect to the negligence penalties.
The accuracy-related penalty does not apply to any part of an underpayment
of tax if it is shown that the taxpayer acted with reasonable cause and in good faith
with respect to that portion. Sec. 6664(c)(1). The determination of whether a
taxpayer acted with reasonable cause and in good faith is made on a case-by-case
basis, taking into account all the pertinent facts and circumstances. Sec.
1.6664-4(b)(1), Income Tax Regs. Petitioner bears the burden of proving that he
had reasonable cause and acted in good faith with respect to the underpayments.
See Higbee v. Commissioner, 116 T.C. 438, 449 (2001).
Petitioner has not shown reasonable cause for his failure to maintain
adequate substantiating records for the disallowed Schedule A deductions.
Furthermore, petitioner has not provided any explanation for the portions of the
underpayments of tax attributable to items he conceded. Accordingly, he is liable - 17 -
for section 6662(a) accuracy-related penalties on the portions of the
underpayments of tax attributable to those items and to the disallowed Schedule A
deductions specifically addressed in this opinion.
To reflect the foregoing,
Decision will be entered under
Rule 155.