CLARANCE W. JONES v. COMMISSIONER OF REVENUE
Docket/Court: C287780; C299046, Massachusetts Appellate Tax Board
Date Issued: 10/05/2011
Tax Type(s): Personal Income Tax
These are appeals filed under the formal procedure pursuant to G.L. c. 58A, § 7 and G.L. c. 62C, § 39 from the refusal of the Commissioner of Revenue (“Commissioner” or the “appellee”), to abate income taxes assessed against Clarance W. Jones (“Mr. Jones” or the “appellant”) for the tax years 2001 through and including 2007 (“tax years at issue”).
Commissioner Scharaffa heard these appeals and was joined by Chairman Hammond and Commissioners Egan, Rose, and Mulhern in decisions for the appellant.
These findings of fact and report are made by the Appellate Tax Board (“Board”) on its own motion under G.L. c. 58A, § 13 and 831 CMR 1.32.
Domenic Finelli, Esq. for the appellant.
John J. Connors, Jr., Esq. for the appellee.
FINDINGS OF FACT AND REPORT
On the basis of the Statement of Agreed Facts and Stipulated Exhibits and the testimony and exhibits offered at the hearing of these appeals, the Board made the following findings of fact.
At all times relevant to these appeals, the appellant was a Massachusetts resident. The appellant timely filed his Massachusetts Resident Income Tax Returns (“Forms 1”) for tax years 2001, 2002, 2003 and 2004, and timely filed Forms 1 pursuant to valid extensions for tax years 2005, 2006 and 2007. On Schedule C of Form 1 for each tax year at issue, the appellant reported that he was a “professional gambler.”
Jurisdictional facts for tax years 2001 through 2006.
The appellant's Forms 1 for tax years 2001 through 2006 showed no tax due and requested refunds as follows:
2001 2002 2003 2004 2005 2006
$1,055.00 $4,075.00 $9,844.00 $19,932.00 $86,449.00 $112,642.00
-----------------------------------------------------------------------The Commissioner issued refunds to the appellant in the following amounts:
2001 2002 2003 2004 2005 2006
$1,055.00 $4,074.60 $0 $0 $0 $0
------------------------------------------------------On February 4, 2004, the Commissioner sent to the appellant a Notice of Change to Your 2003 Income Tax Return informing the appellant that the Commissioner had changed the tax due on the 2003 Form 1 to $49,976.00 based on an alleged erroneous reporting of Massachusetts Lottery winnings and the elimination of the Limited Income Credit. By Notice of Assessment (“NOA”) dated May 18, 2004, the Commissioner notified the appellant that she had assessed the tax of $49,976.00 as reported on the Notice of Change to Your 2003 Income Tax Return.
Pursuant to validly executed consents extending the time to assess, the Commissioner sent the appellant a Notice of Intent to Assess (“NIA”) dated July 20, 2005, notifying the appellant of her intent to assess additional income taxes, exclusive of interest and penalties, as follows:
2001 2002 2003 2004
$33,665.00 $53,872.00 $8,470.00<1> $77,545.00
<1>This amount is in addition to the $49,976.00 assessment referred to in
the NOA dated May 18, 2004.The appellant requested a conference with respect to the July 20, 2005 NIA. The Commissioner's Office of Appeals and the appellant and his representatives held a conference by telephone regarding the NIA on December 1, 2005. Following the conference, the Office of Appeals issued its letter of disposition on February 20, 2006. The Commissioner subsequently sent to the appellant an NOA dated March 7, 2006, notifying the appellant of the assessment on March 5, 2006 of additional income taxes, exclusive of interest and penalties, as follows:
2001 2002 2003 2004
$33,665.00 $53,872.00 $8,470.00<2> $77,545.00
<2> See note 1, supra.On March 31, 2006, the appellant timely filed an abatement application regarding the above assessments for tax years 2001 through 2004, in which he also requested a hearing. By letter dated December 1, 2006, the Commissioner denied the request for a hearing because “[y]our Application for Abatement raises no new relevant factual information or new legal precedent that was not available at the time of the pre-assessment conference.” By Notice of Abatement Determination dated December 8, 2006, the Commissioner informed the appellant that the abatement applications for tax years 2001 through 2004 had been denied. The appellant filed a Petition Under Formal Procedure with the Board on January 24, 2007 for tax years 2001 through 2004. Based on these facts, the Board found and ruled that it had jurisdiction over the appeals for tax years 2001 through and including 2004.
The Commissioner issued an NIA dated October 29, 2007 for tax year 2005 and an NIA dated May 11, 2008 for tax year 2006. The Commissioner's Office of Appeals held a conference by telephone with the appellant's representatives regarding the October 29, 2007 NIA and the May 11, 2008 NIA on October 2, 2008. By NOA dated October 16, 2008, the Commissioner assessed additional income taxes against the appellant for tax year 2006, in the amount of $140,002.00, exclusive of interest and penalties. By NOA dated October 21, 2008, the Commissioner assessed additional income taxes against the appellant for tax year 2005, in the amount of $102,214.00, exclusive of interest and penalties. On November 10, 2008, the appellant filed an abatement application for tax year 2006, and on November 11, 2008, the appellant filed an abatement application for tax year 2005. The appellant did not request hearings regarding the abatement applications for the 2005 and 2006 tax years. By Notice of Abatement Determination dated January 7, 2009, the Commissioner informed the appellant that the abatement applications for tax years 2005 and 2006 had been denied. On February 26, 2009, the appellant filed a Petition Under Formal Procedure with the Board for tax years 2005 and 2006. Based on these facts, the Board found and ruled that it had jurisdiction over the appeals for tax years 2005 and 2006.
Jurisdictional facts for tax year 2007.
Pursuant to a valid extension, the appellant timely filed his Form 1 for tax year 2007. On Schedule C of the 2007 Form 1, the appellant reported that his gross receipts were $2,888,386, his costs of goods sold were $2,839,686, his total expenses were $23,309, and his gross profits were $25,391. Gambling profits of $25,391 were reported on line 6 of the return, while line 8b for “Mass. lottery profits” was blank. The appellant reported a tax due of $984 and withholdings of $129,329, and he requested a refund of $128,345.00.
The Commissioner sent the appellant a Notice of Change to Your 2007 Income Tax Return, dated September 30, 2008, in which the Commissioner stated:
The Massachusetts Lottery Commission has reported to the Department of Revenue that you received $258,759,150.00 3 of lottery winnings for the tax year 2007. You reported $0.00 of winnings on your tax return. Consequently, we have adjusted your tax return as detailed in this notice. This resulted in change to the amount of tax due for this year.
Following are the “Reason(s) for Change:”
Line 8B — Lottery Claimed Does Not Agree With Lottery Winnings On File
The Commissioner thus changed the appellant's tax to $13,715,219.00 and also changed the amount of withholdings to $388,087.00.
By NOA dated October 6, 2008, the Commissioner notified the appellant of the assessment, on September 29, 2008, of income taxes for tax year 2007 in the amount of $13,715,219.00 as shown on the Notice of Change to Your 2007 Income Tax Return. The appellant filed an abatement application for tax year 2007 with the Commissioner on October 14, 2008 and a second abatement application on November 4, 2008. The appellant subsequently requested that the Commissioner deny both abatement applications for 2007 so that he could join the 2007 appeal with those from the previous tax years at issue. By Notice of Abatement Determination dated January 27, 2009, the Commissioner informed the appellant that “[y]our application had been denied.” On February 26, 2009, the appellant seasonably filed his Petition Under Formal Procedure for tax year 2007 with the Board.
Prior to the hearing of these appeals, the Commissioner admitted that the assessment for fiscal year 2007 was erroneous because of a misplaced decimal point. 4 Then, after the commencement of these appeals, the Commissioner purported to abate the erroneous assessment by issuing an Abatement Approval Notice, which was unsigned. The following is excerpted from the Board's Decision dated August 16, 2010:
On February 6, 2010, two days before the hearing of these appeals, the Commissioner's Customer Service Bureau issued an Abatement Approval Notice, stating that the appellant's “application filed on [his] INCOME tax account has been approved.” The notice was unsigned and did not state the amount of the abatement. The Commissioner has agreed that the $13,715,219.00 assessment was an error attributable to the placement of a decimal point on the Notice of Change regarding the taxpayer's lottery winnings.
The Board finds and rules that the so-called Abatement Approval Notice was not sufficient to abate the erroneous assessment. Appellant had previously received a denial of his abatement request, dated January 27, 2009, and was therefore a person aggrieved under G.L c. 62C, § 39 when he filed his appeal with the Board. Although the Commissioner may abate an erroneously assessed tax after the commencement of an appeal to the Board, the February 6, 2010 notice was unsigned and contained no abatement amount and therefore did not constitute a valid abatement.
Because the Board found that the so-called Abatement Approval Notice was not sufficient to abate the Commissioner's erroneous assessment and that the appellant was still a person aggrieved under G.L. c. 62C, § 39 , the Board found and ruled that it had jurisdiction over the appeal for tax year 2007.
Findings with respect to tax years 2001 through 2006.
The appellant claimed that, at all times relevant to these appeals, he was and held himself out as a professional gambler. The appellant's gambling activities consisted of betting at various horse- and dog-racing tracks where he engaged in both live and simulcast betting, casino betting, and Lottery ticket betting. He explained that during tax year 2004 onward, his business consisted of more Lottery gambling than any other form. The appellant's gambling revenue constituted his main source of income, aside from Social Security payments and minimal bank interest.
The parties stipulated that the appellant maintained numerous boxes of losing dog and horse racing tickets from both live and simulcast races, along with programs, losing Foxwoods Keno tickets, and losing Massachusetts Lottery tickets, including scratch tickets and various numbers games including, among others, Keno, Daily Numbers Games, Mega Bucks, Mega Millions, Mass Millions, Cash Windfall, Big Game, Powerball and Daily Race Game. The appellant testified that he maintained at least 200 boxes at a storage facility in Lynn, Massachusetts. A sample, as agreed to by both parties, of about fifteen boxes of those records, was submitted to the Board. The boxes were filled with various losing Lottery tickets, losing Foxwoods Casino Keno tickets, losing racing tickets and racetrack programs. All items were bagged and/or bound together in groups and labeled by notations which either included dates, places, number of tickets and total cost of tickets, or a number corresponding to the appellant's personal numbering system from his records where that same information would be listed.
The appellant presented his case-in-chief through his own testimony as well as the testimony of: Harold Litchfield, a fellow gambler; Louis Ristaino, a racetrack employee; and Edward Sherman, CPA, his accountant.
Mr. Litchfield testified to the appellant's gambling activities. He testified that the appellant was regularly engaged in gambling, attending the dog or horse racetrack from about eleven in the morning until about midnight, either four or five days a week. He testified that he witnessed the appellant engaging in racetrack betting as well as Keno. Mr. Litchfield also testified that he had placed bets for the appellant. He explained that this was common practice among friends, particularly at a busy gambling establishment with long lines. But Mr. Litchfield emphasized that he always used the appellant's money, that he followed the express direction of the appellant and that he never accepted compensation from the appellant to place these bets. The Commissioner did not meaningfully challenge Mr. Litchfield's testimony on cross-examination, and the Board found his testimony credible.
Mr. Ristaino then testified as to how a gambler could place a bet while avoiding a long line at a busy gambling establishment. He explained that regular gamblers curry favor with racetrack window tellers by tipping generously. Then, instead of waiting in line, the gambler calls in the favor by surreptitiously giving the teller a hand signal, which the teller will interpret and then place the bet accordingly. Through the use of hand signals, a regular gambler can thus place multiple bets quickly, using his own money, without having to wait in long lines. Again, the Commissioner did not meaningfully challenge Mr. Ristaino's testimony on cross-examination, and the Board found his testimony credible.
Mr. Sherman offered detailed testimony with respect to the sufficiency of the appellant's records. He explained that the appellant maintained more than 200 boxes of records in a storage facility and that he had seen these records and had advised the appellant on his record keeping. Mr. Sherman testified that the appellant had been audited previously by the Commissioner for tax years 1988, 1994 and 1995, as well as by the Internal Revenue Service (“IRS”) in 1994. He stated that for the previous audit conducted by the Commissioner, he and the appellant provided the prior auditor, Jim Reynolds, with 11 boxes of documents. He noted that each of the federal and state audits had resulted in no change to the appellant's returns.
Mr. Sherman explained that, after the prior audits, the appellant continuously attempted to improve his record-keeping system and to keep more extensive information throughout the years at issue. Mr. Sherman testified further that he had a discussion with the appellant sometime during early 2004 about the new directive issued by the Commissioner with respect to record keeping, Department Directive 03-3 (“DD 03-3”), and that in his opinion, the appellant's records were in keeping with that directive. For example, Mr. Sherman explained that the appellant maintained personal calendars detailing his gambling activities, and his race track programs, with all of his losing tickets inside the program and a summary on the outside of all of the losing tickets. Mr. Sherman further testified that the appellant also maintained so-called “tax organizers” that listed his income and expenses and the information from the Forms W-2G Certain Gambling Winnings (“W-2G”), the forms issued by the Massachusetts State Lottery to gamblers for reporting lottery winnings over $600. Mr. Sherman explained that the appellant used the tax organizers to organize his tax information for the current tax year based on the income and deductions that he had had for the previous tax year. The appellant maintained tax organizers for each of the tax years at issue, and the stipulated exhibits included each of those tax organizers. The stipulated exhibits also included copies of the contents of three-ring binders that the appellant maintained for each of the tax years at issue, what the appellant and his representatives referred to as his “tax books,” which included: various correspondence between the appellant or his representatives and the auditors; copies of the appellant's tax returns; listings of the appellant's gambling losses; and his calendars. Mr. Sherman explained that the entries in these “tax books” corresponded to the receipts that the appellant maintained in storage.
Mr. Sherman next testified to the disagreements between the appellant and the Commissioner's auditors with respect to the examination of his records during the course of the audit for the tax years at issue. Mr. Sherman explained that the auditor originally assigned to the appellant's case was replaced by another auditor, Judith D'Auteuil, midway through the audit. He also testified that he had repeatedly requested that the Commissioner's auditors come to see the appellant's records at the storage facility, but that the auditors refused all requests for examination. He explained that the auditors sent out form requests seeking certain types of records, such as logs of the appellant's gambling activities, but that the appellant did not maintain his records in the specific format requested. Mr. Sherman explained, however, that he had advised the appellant to retain all of his racetrack tickets and programs and Lottery tickets because they collectively contained all of the information required for completing and verifying a tax return. Particularly with respect to a Lottery ticket, Mr. Sherman explained that “[a]ll of the information is on the ticket,” including the date and location of purchase and the amount of the wager.
The stipulated evidence contained correspondence between the parties, including a letter dated November 3, 2004 sent by the Commissioner's Tax Examiner, Sandra Sparrock, requesting, among other items: a daily log or journal showing the name and location of each gambling establishment visited, the dates gambled, and travel times with mileage to and from each gambling activity; records of wagers and winnings and programs from race tracks; names of individuals that participated in his gambling; receipts for food, lodging and air travel; bank records; Forms W-2G; gambling research materials; and losing scratch tickets grouped together by purchase date and locations and correlated to the daily log. By letter dated December 3, 2004, Mr. Sherman sent copies of the appellant's tax returns for tax years 2001, 2002 and 2003, and representative samples of the appellant's bank statements. Mr. Sherman's letter listed the documents that the appellant maintained in storage. These documents included lottery ticket stubs for cashed tickets, which identified the location of the establishment where the ticket was purchased, and twenty-five to thirty boxes per year which contained every program purchased and “all the losing tickets sorted by race number” as well as a list of all losses by date, track and box, and all losing scratch tickets. Mr. Sherman's letter then offered, “[y]ou may examine this information on site or, if requested, Mr. Jones will make arrangements to deliver them to you.” Mr. Sherman reiterated that, while the appellant's records were not necessarily maintained in the exact form as requested by the auditors, the information sought by the auditors was nonetheless contained in the records maintained by the appellant.
The stipulated exhibits also included further correspondence between Ms. Sparrock and Mr. Sherman in which Ms. Sparrock requested materials in specific form — business records in chronological order and daily records for all lottery transactions showing date and location of purchase, amount spent and amount of winnings — and Mr. Sherman informed her that the appellant's records were not maintained in the form requested, but that the information requested could be deduced from an examination of the numerous records that the appellant maintained in storage. At the hearing, Mr. Sherman posited that it was because the records were not in the form requested that the auditors refused to examine them. When asked directly by the Presiding Commissioner whether someone from the Department of Revenue (“DOR”) had actually refused to look at the appellant's records because they were not maintained as specified by the auditors' requests, Mr. Sherman responded affirmatively and testified that it was Ms. D'Auteuil who had made this statement to him. The stipulated exhibits also included correspondence between Ms. Sparrock and the appellant's former attorney, Peter Otis, including one letter in which Attorney Otis specifically suggested to Ms. Sparrock that a field audit be conducted, meaning that the auditor would come to the appellant's representative's office “to review the 100 or so boxes” at that location. The Commissioner's auditors, however, never accepted the appellant's invitation.
Next, the appellant testified in detail to the types and regularity of his gambling activities. He testified that, since selling his industrial cleaning company in 1986 and up to the tax years at issue, his only source of business income had been gambling. He testified that in a typical week, he would spend between 60 to 80 hours on gambling activities and that Lottery gambling had been his primary activity since about 2004. When asked where he gambled, the appellant responded, “I do the whole state,” as well as out of state. He testified that, in his opinion, Massachusetts has “the easiest lottery system” for a regular gambler to successfully play. He explained some of his methodologies, like buying Lottery tickets in the middle of a pack where, he believed, the winning tickets were grouped, and purchasing tickets at stores that have had recent large winnings, because, in his opinion, those stores have a higher chance of selling winning tickets. The appellant submitted into evidence a manual that he had written entitled “The Gambler,” which contained some of the observations and “trade secrets” for successful gambling that he has accumulated over his gambling career. The appellant also corroborated Mr. Litchfield's and Mr. Ristaino's testimony, explaining how he was able to place numerous bets at a racetrack without waiting in line, either through the use of hand signals or by asking a friend to place bets on his behalf. He emphasized that he used his own money to place bets and that he did not compensate anyone to place bets for him. The Commissioner did not meaningfully challenge Mr. Jones' testimony on cross-examination, and the Board found the appellant's testimony to be credible.
The appellant next described his system of keeping records. He testified that he recognized that he was not an expert in taxes, and he thus hired an accountant to assist him with his filing and record-keeping duties. He also testified that he heeded his accountant's advice and that he continuously tried to improve his record-keeping system, particularly after his accountant advised him about DD 03-3. He emphasized that his records contained all of the information required to discern how much he expended on wagers and where he gambled during each tax year. The appellant testified that he maintained three storage rooms at a storage facility in Lynn and that the files in his boxes — which included ticket stubs, programs and his calendars marked with the amounts of small winnings for which no Forms W-2G would have been generated, which he used to compile ledgers of small winnings — corresponded to entries in his “tax books.” On direct examination, the appellant was asked to trace his records from a random date — January 17, 2002 — to his “tax book” for that year. The appellant was able to locate the entry using his entry system. The appellant's explanations of some of his short-hand entries — for example, “Sam means something to me. Sam to me is Summit Variety.... It's in Peabody, Mass.” — indicated that his entry system was not self-explanatory but was personal to him.
The appellant also reiterated Mr. Sherman's testimony that the Commissioner's auditors refused to examine his voluminous records, despite his requests. He explained that no auditor had ever taken the records from the storage facility to inspect them, nor did they ever ask to look through them at their offices. With respect to his “tax books,” the appellant testified that “they refused my lawyer to even submit them.” In preparation for the hearing, the attorney for the Commissioner accompanied the appellant and his attorney to the storage facility to choose the sample of records which were brought to the hearing. Prior to that, the appellant explained, no representative of the Commissioner had ever agreed to examine his records. The Board also found this part of the appellant's testimony to be credible.
The Commissioner presented its case through the testimony of Brian Taylor, a director within the Massachusetts State Lottery, and of Judith D'Auteuil, a tax auditor within the Department of Revenue's Audit Division.
Mr. Taylor testified regarding the computer system by which the State Lottery tracked frequent cashers of lottery tickets. He testified that the appellant was the highest or second-highest casher of winning tickets in the Commonwealth during each tax year at issue. He next explained that this computer system gleans crucial information from the bar code located on each Lottery ticket, which enables the State Lottery to determine the type of Lottery game played and where the ticket was purchased:
Well, we know it when we scan the ticket. There's a lot of intelligence on that bar code and that will tell our cashing system immediately where the ticket was issued.
Mr. Taylor's testimony thus corroborated Mr. Sherman's testimony that the Lottery tickets contain the relevant information for verifying tax return data.
Mr. Taylor also explained that the odds of winning for each Massachusetts Lottery game and whether a winner had claimed the grand prize were published on the Massachusetts Lottery's website. Mr. Taylor, however, presented no evidence relating to the odds of any of the particular Massachusetts Lottery games, including those played by the appellant.
Next, Ms. D'Auteuil testified as to her conduct of the audit of the tax years at issue, beginning on October 29, 2007. Ms. D'Auteuil conducted a “correspondence audit” of the appellant, that is, one in which the auditor conducts the audit by seeking records from the taxpayer through remote correspondence, usually form letters. Ms. D'Auteuil explained that she audited tax year 2006 and a portion of tax year 2005 after the file had been to the Office of Appeals. She testified that the audit file was transferred to her after she had been assigned to replace the previous auditor, Zlatan Caticz, and that she received the case after the Office of Appeals had made its determination on tax year 2005. Ms. D'Auteuil testified that she had reviewed the files for tax years 2001 through 2004 in preparation for the hearing at the Board.
The stipulated exhibits included Ms. D'Auteuil's first letter to the appellant, dated October 29, 2007, requesting certain records from the appellant, including daily logs or journals showing dates when and places where the appellant gambled, losing tickets, and any “patron data logs” from gambling casinos. Ms. D'Auteuil testified that she reviewed the Commissioner's audit files concerning the appellant, which included the documents that his representative had submitted to the Commissioner's auditors, and from these she determined “[t]hat Mr. Jones was not in the trade or business of professional gambling.” When asked the reason for her determination, Ms. D'Auteuil replied, “[i]nadequate, incomplete, insufficient records.” Ms. D'Auteuil admitted, however, that she did not look through a single box maintained by the appellant in storage. She claimed that she was willing to pick up the documents but that her offer was refused by the appellant's prior attorney, Peter Otis. According to Ms. D'Auteuil:
I wanted the tickets at my office and he said the boxes were voluminous. I offered to go out there with someone and a two-wheeled dolly to get them and bring them back to my office. And he told me, no, I had to go out by myself and I had to look at them, but I couldn't touch them. So I told him, “I can't do that. I want them in the office as I requested.”
Attorney Otis was not brought into the hearing as a witness to corroborate or deny the above statements. However, his letter in response to Ms. D'Auteuil's request was admitted into evidence. By letter dated November 28, 2007, Attorney Otis explained that the appellant required additional time to compile his records into the daily-log format requested by Ms. D'Auteuil. The letter further offered to Ms. D'Auteuil that “[a]ll losing scratch tickets amounting to approximately 33 cases of paper can be made available at our office or delivered to you.” Nowhere in the letter did Attorney Otis deny Ms. D'Auteuil access to any records that she had requested, nor did he restrict her access to the appellant's storage facility where, according to her, she would be permitted to merely “look” but not “touch.” Moreover, Ms. D'Auteuil's audit log, otherwise very detailed and including notations about other telephone calls with Attorney Otis, contained no notation indicating that Attorney Otis ever refused her access to, or delivery of, the appellant's records.
Ms. D'Auteuil further admitted that she did not fully understand the records which she received from the appellant pursuant to her request. As the appellant demonstrated on direct examination, the appellant's entry system consisted of numerous shorthand terms that were not self-explanatory. However, Ms. D'Auteuil never attempted to conduct a “desk audit,” that is, to have the appellant meet with her at her office to allow him the opportunity to explain his record-keeping methods, nor did she conduct a “field audit,” that is, look through the appellant's boxes at the storage facility or at his attorney's office to examine the records of his losses. Ms. D'Auteuil also admitted that she did not suggest a sampling of the appellant's voluminous records as permitted by G.L. c 62C, § 24. She testified that she did not request a sampling because she did not understand the records, so “you didn't need to do a sampling when you didn't even know what he had in the boxes based on the file.” However, the Board found that it was impossible for the auditor to make a determination of the sufficiency of the appellant's records without actually examining the records that he maintained in storage or requesting a sample of those records. When asked on cross-examination, “[h]ow do you know they tie into his records?” Ms. D'Auteuil replied simply, “I don't.”
On the basis of the testimony and evidence, the Board found that the appellant was engaged in the trade or business of gambling and was thus entitled to take wagering losses as deductions on Schedule C of his Form 1. The Board found that the testimony of the appellant, as well as that of Mr. Litchfield and Mr. Ristaino, established that the appellant was regularly engaged in gambling, that he used his own money to gamble, and that he was the person who paid for and played (either himself or through a friend who played the ticket on the appellant's direction using the appellant's money) the tickets for racetracks and Lottery games that he maintained in storage.
The Board further found that the appellant's records, such as tickets, personal calendars, racetrack programs and his tax books, contained the information needed to substantiate his tax returns, specifically: the dates and places where the appellant gambled; the types and amounts of his wagers; and the amounts that he won and lost. Although the Commissioner alleged, for the first time in her post-trial brief, that the appellant was simply collecting losing Lottery tickets to support fraudulent deductions, the Commissioner failed to support that allegation with any evidence. Given the volume of tickets, programs and other records maintained by the appellant, and the fact that they contained many shorthand notations that were not self-explanatory, the Board found that the auditors could not assume that the records were not adequate based on the extraordinarily small portion of records that they reviewed, particularly when no auditor ever conducted a desk audit with the appellant in order to give the appellant an opportunity to explain those records.
Finally, the Board did not find credible Ms. D'Auteuil's assertions that the appellant or his representatives were uncooperative with respect to submitting records to the Commissioner during the course of the audit. Ms. D'Auteuil's claims that Attorney Otis refused to transport any documents to her and that she would be permitted to “look at them but [not] touch them,” amounted to mere uncorroborated statements that were undocumented in her own otherwise detailed audit log. Moreover, these statements were contradicted by a letter by Attorney Otis and by the appellant's and Mr. Sherman's testimony, which the Board found credible, that the appellant repeatedly requested a meeting with the Commissioner's auditors in order to submit and explain his records, but the auditors refused to conduct a field audit or even a desk audit.
Therefore, on the basis of the evidence of record, and as will be explained in the Opinion, the Board found that the appellant's records and his credible testimony and the credible testimony of his witnesses were sufficient to prove that the appellant was engaged in the trade or business of gambling and thus entitled to take deductions for the cost of his losing wagers and other related business expenses.
Findings with respect to tax year 2007.
The Board found that the unsigned so-called Abatement Approval Notice was not sufficient to abate the Commissioner's erroneous assessment for tax year 2007. The Commissioner admitted that the amount of the assessment was an error attributable to the misplacement of a decimal point, and the Board so found. The Board further found that the appellant met his burden of proving that he was engaged in the trade or business of gambling for all tax years at issue, including tax year 2007, and that he was thus entitled to take deductions for the cost of his losing wagers and other related business expenses on his return for tax year 2007.
On the basis of its findings for the tax years at issue, the Board issued decisions for the appellant and granted abatements of tax, exclusive of interest and penalties, in the following amounts:
Tax year Abatement
For Massachusetts income tax purposes, “[r]esidents shall be taxed on their taxable income.” G.L. c. 62, § 4 . The starting point for determining Massachusetts taxable income is Massachusetts gross income, which is “federal gross income” with certain modifications not relevant to these appeals. G.L. c. 62, § 2(a) . Federal gross income includes income “from whatever source derived,” and thus includes gambling income. See Internal Revenue Code (“Code”) § 61 . Thus, gambling winnings are included in Massachusetts gross income. Id.; see also Technical Information Release (“TIR”) 79-6, DD 86-24 and DD 03-3.
In the present appeals, the appellant claimed deductions for his gambling losses. Massachusetts adopts the deductions allowed in Code § 62, with certain modifications not relevant to these appeals. See G.L. c. 62, § 2(d)(1) . Code § 62(a)(1) provides for “deductions allowed by this chapter (other than by part VII of this subchapter) [namely, Code §§ 161 through 199] which are attributable to a trade or business carried on by the taxpayer.” In particular, Code § 162(a) allows a deduction for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” As a deduction allowed under Code § 62(a)(1), the trade or business deduction is in turn allowed to arrive at Massachusetts Part B adjusted gross income under G.L. c. 62, § 2(d)(1) . Accordingly, a Massachusetts taxpayer may deduct all ordinary and necessary expenses paid or incurred in carrying on the trade or business of gambling, including wagering losses subject to the limitation of Code § 165(d) discussed below.
In contrast to federal law, Massachusetts has not adopted Code § 212, which allows a deduction for ordinary and necessary expenses paid or incurred for the production or collection of income, even though not connected with a trade or business. Code § 212 is found at part VII of subchapter B, which is explicitly excluded from the deductions allowed under Code § 62(a)(1) and, therefore, not deductible for Massachusetts purposes under G.L. c. 62, § 2(d)(1) . Accordingly, a Massachusetts taxpayer may deduct only gambling expenses that constitute ordinary and necessary expenses in the conduct of the trade or business of gambling. See DiCarlo v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 1989-119 .
In addition, Code § 165(d) specifically allows the deduction of wagering losses but only to the extent of gains from wagering transactions. However, the gambling loss deduction for Massachusetts purposes is subject to the basic restriction of G.L. c. 62, § 2(d)(1) and Code § 62(a)(1) that such losses are deductible only if they are incurred in a trade or business.
Accordingly, gambling expenses are deductible in Massachusetts only if: (1) the taxpayer demonstrates that he or she is in the “trade or business” of gambling; (2) the expenses constitute ordinary and necessary expenses in the conduct of the trade or business of gambling; and (3) gambling losses do not exceed gains from gambling.
In the present appeals, the taxpayer has claimed deductions for his gambling losses which do not exceed his gambling winnings. The parties do not dispute that gambling losses would be “ordinary and necessary” expenses in a gambling trade or business. Accordingly, the only issue in dispute is whether the appellant was engaged in the trade or business of gambling.
The United States Supreme Court has articulated the standard for determining whether a taxpayer is engaged in the trade or business of gambling: “if one's gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and it is not a mere hobby, it is a trade or business ....” Commissioner of Internal Revenue v. Groetzinger, 480 U.S. 23, 35 (1987) . For Massachusetts tax purposes, the Commissioner has promulgated DD 03-3, which provides a list of factors which are “not exclusive” but are intended to “provide illustrative guidance” in determining whether a taxpayer meets the criteria to qualify as being engaged in the trade or business of gambling. These factors are as follows:
•gambling activities are entered into and carried on in good faith for the purpose of making a profit;
•gambling activities are carried on with regularity;
•gambling activities are pursued on a full-time basis, or to the fullest extent possible if taxpayer is engaged in another trade or business or has employment elsewhere;
•gambling activities are solely for the taxpayer's own account and taxpayer does not function as a bookmaker;
•taxpayer maintains adequate records, including accounting of daily wagers, winnings and losses (see I.R.S. Rev. Proc. 77-29);
•the extent and nature of taxpayer's activities which further the development of a gambling enterprise; and
•taxpayer claims deductions associated with the conduct of a trade or business for gambling-related expenses.
Of these factors, the Commissioner specifically challenged only one, that is, whether the appellant “maintain[ed] adequate records, including accounting of daily wagers, winnings and losses.” The Commissioner, for the first time in her post-trial brief, also raised the suggestion that the appellant may have been a so-called “ten percenter,” an individual who cashes winning tickets on behalf of another gambler in return for a percentage — generally ten percent — of the winnings.
As indicated above, the adequate records requirement in DD 03-3 references Revenue Procedure 77-29, promulgated by the IRS (“I.R.S. Rev. Proc. 77-29”). In its description of adequate records, I.R.S. Rev. Proc. 77-29 provides in relevant part:
An accurate diary or similar record regularly maintained by the taxpayer, supplemented by verifiable documentation will usually be acceptable evidence for substantiation of wagering winnings and losses. In general, the diary should contain at least the following information:
1) Date and type of specific wager or wagering activity;
2) Name of gambling establishment;
3) Address or location of gambling establishment;
4) Name(s) of other person(s) (if any) present with taxpayer at gambling establishment; and
5) Amount(s) won or lost.
Like the factors set forth in DD 03-3, those in I.R.S. Rev. Proc. 77-29 are not to be exclusive, but rather are meant as guidelines for taxpayers.
When a taxpayer challenges an assessment made by the Commissioner, “[t]he burden is on the taxpayer to show error in the assessment and impropriety in the method used.” Allied Building Credits, Inc. v. State Tax Comm'n, 344 Mass. 503, 509 (1962) (citing State Tax Comm'n v. John H. Breck, Inc., 336 Mass. 277, 299 (1957) ). The Board has previously ruled that that burden “extends only to persuading the Board that the sales reported on his returns are more probable than those calculated by the appellee.” Suprenant v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 1991-209, 219 . Thus, if the Commissioner's assessments were based on speculative assumptions, they will not be upheld. For example, in Food Service Associates, Inc. and Dennis G. Maxwell v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports, 2001-341, 349-51, 354 , the auditor made such glaring errors as presuming that all credit card receipts reflected taxable sales (and thus failing to consider nontaxable sales and tips) and presuming that all cash was taxable revenue (and thus failing to consider any cash on hand at the beginning of an analysis period). The Board thus favored the taxpayer's analysis of tax due over the auditor's analysis, ruling that the auditor's conclusion “was predicated on impermissible presumptions and dubious assumptions and was thus unreliable and invalid.” Id. at 2001-363.
Furthermore, the auditor must make a good faith effort to review all of the taxpayer's records, or at minimum, a sample of those records, before making a determination. For example, in Trodes, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 1988-230 , the Commissioner's auditor disregarded the taxpayer's records of its alcoholic beverage sales, because the taxpayer failed to produce itemized sales records. The auditor based his audit on purchase invoices for liquor, and then assumed that each drink sold contained a one-and-one-half ounce “pour” measure, contrary to the taxpayer's actual “free pour” method. Id. at 232, 236. The Board found that the records submitted by the taxpayer, while not in strict compliance with the Commissioner's regulatory record-keeping requirements, nonetheless were “sufficient to satisfy the requirements of record-keeping” imposed by G.L. c. 62C, § 25 and 830 CMR 62C.24 (8)(g) on registered vendors of meals and thus “constituted a full compliance with the appellee's request for books, records and other materials.” Id. at 235. Therefore, on the basis of the witnesses' credible testimony as to the taxpayer's business practices and the taxpayer's business records, the Board found that the taxpayer met its burden of proving that the deficiency assessments were improper. Id. at 239.
In Chef Chang's House, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 1996-738 , another appeal pertaining to the sales tax on cash sales of bar liquor, the auditor completely disregarded the restaurant taxpayer's records because daily records, rather than cash register tapes, were used to record cash transactions at the bar. Id. at 743. The auditor made his assessments using speculative data and unjustified assumptions, such as assuming that all alcohol purchased was sold at retail, thereby ignoring factors like breakage, spillage and complimentary drinks. Id. at 746-48. Comparing the Commissioner's audit records with the data supplied by the taxpayer, the Board found that “the method used by the Commissioner's auditor was not justified,” while the records maintained by the taxpayer “were reliable and complete in most respects.” Id. at 756. The Board thus ruled that the amount of sales tax on the appellant's returns was more probable than the amount as calculated by the auditor. Id. at 758.
“Evidence of a party having the burden of proof may not be disbelieved without an explicit and objectively adequate reason .... If the proponent has presented the best available evidence, which is logically adequate, and is neither contradicted nor improbable, it must be credited ....” New Boston Garden Corp. v. Board of Assessors of Boston, 383 Mass. 456, 470-471 (1981) . In the instant appeals, the Board found and ruled that the appellant's records, while not maintained in the exact manner as demanded by the auditor, were nonetheless voluminous, related to each of the tax years at issue, and contained key materials, including: personal calendars detailing his gambling activities; race track programs, with his losing ticket stubs from the day attached to the program together with a notation of the date, number of tickets and total amount of wagers; “tax organizers” that list his income and expenses and the information from the Forms W-2G; and the appellant's “tax books” for each year. These records, taken together, contained the date and type of wagering activity, the name and address of the gambling location, and the amount won or lost; they thus constituted the “diary or similar record” referred to in I.R.S. Rev. Proc. 77-29. Contrast Leite v. Commissioner, Mass. ATB Findings of Fact and Reports 2006-842, 851 (in ruling that taxpayer was not engaged in the trade or business of gambling, Board finds that taxpayer's “record-keeping with respect to his gambling was sparse, incomplete, and apparently begun after-the-fact [of audit]”).
As Ms. D'Auteuil demonstrated through her testimony, however, the Commissioner's auditors did not know what these records contained. Yet no auditor ever requested a field audit in which the auditor would go to the taxpayer's location to review the records maintained by the taxpayer, or a desk audit in which the taxpayer would be invited to the auditor's office for a meeting in order to review the records with the auditor. Instead, the auditors performed a limited correspondence audit, during which the auditors sent written requests to the appellant seeking records which were to be maintained in a certain format or else the auditors would refuse to review them. Yet nothing in DD 03-3, I.R.S. Rev. Proc. 77-29, or any relevant statute, departmental promulgation or case law required the appellant to keep records in the precise form demanded by the auditor. Each of the previous audits by the Commissioner for tax years 1988, 1994 and 1995, as well as by the IRS in 1994, had resulted in no change to the appellant's returns based on the records retained by the appellant, and the Board found that the appellant had consistently improved his record-keeping system, following the advice of his accountant after each audit, and especially after being advised of the issuance of DD 03-3. The Board found and ruled that, with a greater understanding of what the taxpayer's records contained, the auditors could have used these records to verify the appellant's returns, and therefore, the records met the record-keeping requirement of DD 03-3.
The Board also found credible the appellant's testimony, which was substantiated by Mr. Sherman's testimony and letters submitted into evidence, establishing that Mr. Sherman attempted to submit records to the auditors and that the auditors refused to examine them. On the other hand, the Board did not find credible Ms. D'Auteuil's testimony that she was refused access to the appellant's records. Therefore, the Board found and ruled that, under the facts of these appeals, the appellant's voluminous records and the testimony of the appellant and his witnesses constituted the best evidence of the appellant's regular and consistent gambling activities, which evidence was neither contradicted nor improbable. Accordingly, the Board found and ruled that this evidence established that the appellant was engaged in the trade or business of gambling and therefore was entitled to the deduction of his wagering losses, as well as other related business expenses, against his business income.
“The credibility of witnesses, the weight of the evidence, and inferences to be drawn from evidence are matters for the board.” Cummington School of the Arts, Inc. v. Assessors of Cummington, 373 Mass. 597, 605 (1977) . The appellant's voluminous records, maintained by him, were the best evidence of the gambling losses to which the appellant was entitled. The Commissioner presented no objectively adequate reason why the appellant's records should have been disbelieved, and in fact, the auditors lacked a firm understanding of what the records contained and how to interpret their notations, and they lacked a willingness to inquire further. The auditors never conducted a field audit to gain a better understanding of how thorough his records of losses were, nor even a desk audit in order to gain first-hand knowledge from the appellant as to how to interpret his records. Instead, Ms. D'Auteuil summarily deemed the appellant's records to be inadequate, and she made this arbitrary assumption based on her lack of understanding of the appellant's organizational system. The Board found and ruled that, because the Commissioner's auditors virtually ignored the appellant's records, their conclusions concerning the appellant's activities, including the Commissioner's eleventh-hour allegation that the appellant was a “ten percenter,” were not supported by the credible evidence of record.
On the basis of the evidence submitted, with particular weight being given to the credibility of the witnesses, the Board found and ruled that the appellant was engaged in the trade or business of gambling and thus entitled to take his gambling losses and other related expenses as deductions against his business income. The Board also found that the appellant's evidence, and not the auditor's conclusions, was the best available evidence with respect to the deductions for his gambling losses. Accordingly, the Board issued decisions for the appellant in these appeals for tax years 2001 through and including 2006.
With respect to tax year 2007, the Board found and ruled that the unsigned so-called Abatement Approval Notice was not sufficient to abate the assessment for that tax year. The Commissioner admitted that the amount of the assessment was an error attributable to the misplacement of a decimal point, and the Board so found and ruled. The Board further found and ruled that the appellant was engaged in the trade or business of gambling for tax year 2007 and was thus entitled to take his gambling losses and other related expenses as business deductions on his 2007 return. The Board thus issued a decision for the appellant for tax year 2007.
Accordingly, the Board granted abatements of tax, exclusive of interest and penalties, in the following amounts:
Tax year Abatement
2007 $13,715,912.00THE APPELLATE TAX BOARD
Thomas W. Hammond, Jr., Chairman
A true copy:
Clerk of the Board
In accordance with the parties' Statement of Agreed Facts, ¶ 74, and the appellant's abatement application, Form CA-6, and Amended Individual Income Tax Return (at pages 2944 to 2953 of the Stipulated Exhibits), the correct amount of lottery winnings was $2,587,591, not $258,759,150.
See note 3, supra.