Reporting Gains and Losses From Recreational Gambling

Reporting Gains and Losses From Recreational Gambling

Here’s a common scenario: Gavin spends a weekend in Las Vegas. His overall position from gambling is negative, but he made a couple of lucky bets. He receives Form W-2G showing $3,000 in winnings. If he does not report the $3000 on his Form 1040, the IRS computers will be likely to catch the discrepancy between their records and Gavin’s tax return, and Gavin will receive a notice that he owes additional taxes.

If Gavin already has itemized deductions that total to more than his standard deduction, he can deduct up to $3000 of gambling losses on Schedule A (itemized deductions) to offset the winnings.

Here’s how it works:

Scenario 1 – Overall Positive Outcome From Gambling

Gavin’s W2-G says $3,000, but this does not include losses of $2,500 from slot machines. Gavin also spent $645 on transportation and lodging.

Gavin can take the following deductions on Schedule A:

Gambling losses   $2,500
Travel Expenses    $   500

Taxable Gain         $   -0-

Scenario 2 – Overall Negative Outcome From Gambling

Gavin’s W2-G says $3,000, but this does not include losses of $2,500 from slot machines and $1,000 from other bets.

Gavin can take the following deduction on Schedule A:

Gambling losses   $3,000

Taxable Gain         $   -0-

In other words, you can offset gambling winnings with gambling losses and expenses, but only up to the amount shown on Form W-2G. A recreational gambler cannot use gambling losses or expenses to reduce his pre-gambling taxable income.

But what if Gavin’s itemized deductions total less than the standard deduction? In this case, Gavin will have to report his $3000 of winnings from Schedule W-2G. Period. He will not be able to offset any of the gambling winnings with gambling losses or other expenses, even though he had an overall loss from his gambling activities.

How to Deduct Entertainment Expenses Part 2

Can I deduct my wife´s dinner?

Ian is a software engineering consultant who works for a small firm of which he is a 25% owner. He much prefers working at his computer to going out on the town, but occasionally he finds it necessary to take clients or prospective clients to dinner.

“I can talk about software technology all day,” he told me, “but I´m a bumbling buffoon when it comes to socializing. The only way I manage to get through those ordeals where I´m supposed to wine and dine a client is to take Susan [Ian’s wife]. She´s just incredible. She can talk to anybody about anything. So … since the client would have a terrible time with just me there, can´t I deduct my wife´s dinner?”

The rule is that the cost of the dinner for both the host’s and the customer’s or client’s spouse is deductible if it´s not practical to entertain the client or customer without his or her spouse. But Ian needs Susan at dinner, regardless of the presence or absence of his client´s wife. Can Ian deduct the cost of Susan´s meal, even if the client comes alone? IRS would be likely to challenge this — the greater the amount deducted for Susan´s meals, the more likely it would be of interest to IRS.

For deductions of this sort that do not fit neatly within a section of the Tax Code or Treasury Regulation, you would want to have extra documentation. For example, Ian´s firm might want to record minutes of a meeting where they discuss the need for Ian to entertain clients and prospects, together with Ian´s difficulties in social situations and Susan´s social skills. If the other partners in Ian´s firm agree that Susan´s presence at client dinners will be very likely to help the firm increase sales and retain existing clients, it would be difficult for IRS to argue convincingly that the cost of Susan’s meals is not an ordinary and necessary business expense.

When is entertaining not entertainment?

In general, the deduction for meals and entertainment expenses is 50% of what you actually spend (75% for the transportation industry). But in some cases, the cost of a meal looks a lot more like a regular business expense than an entertainment expense.

Allan has a weekend business leading walking tours in Manhattan. A regular feature of each tour is a box lunch or snack pack for each participant, included in the price of the tour. In Allan´s case, the cost of lunch and snacks is 100% deductible, as Costs of Sales or Customer Supplies.

Likewise, for film or music critics, travel agents, food critics, certain costs that would ordinarily be 50% deductible as entertainment expenses are 100% deductible as regular business expenses. As always for costs of activities that people generally do for fun and pleasure, it is important to have abundant documentation of your profit motive and the relationship between the activity and the business. Calling yourself a film critic because you view lots of movies and tell your friends about them is probably not going to fly

How to Deduct Entertainment Expenses


Most business owners know that certain entertainment expenses are deductible under some circumstances, but judging by the large number of questions we get on this topic, I don´t think many people actually know the rules.

Like all business deductions, entertainment costs must be “ordinary and necessary” in order to qualify as tax deductible. If your business is a used furniture shop, it´s not very likely that the cost of taking one of your customers to dinner and a movie would be an ordinary and necessary business expense. On the other hand, it could be, if for example the customer you take out for the evening is furnishing a motel and is prepared to spend $45,000 on furniture.

The dictionary definition of entertainment is “something that amuses, pleases, or diverts,” activities that are pleasant, fun; in other words, entertainment is the opposite of job, labor, work. Congress and the IRS, along with most people in general, associate doing business with work — the opposite of entertainment. Therefore, in order for a business owner to convince IRS that she was having fun and working at the same time, the business owner has to satisfy a high standard of documentation (never mind that there are times when taking certain customers out to dinner is one of the very last things a business owner would choose to do for pleasure).

Sara is a financial planner who specializes in retirement planning for employees of small businesses. Emily owns a janitorial service that has 12 employees. For months Sara has been trying to get an appointment with Emily to show her how setting up a flex plan for her employees would make good financial sense for both the business and the employees, but Emily never has time. Finally, Sara says, “You have to eat lunch anyway. Why don´t you let me take you to your favorite restaurant, and we can talk about employee benefits over lunch.”

Here is the information Sara needs to record in order for the cost of taking Emily to lunch to qualify as a deductible business expense:

1. The location — Mavis´s Downtown Country Cooking
2. Names of people entertained — Emily (in “real life” you would want to include the person´s last name), owner of Clean as a Whistle Janitorial Service
3. Date — November 8, 2011
4. Business purpose — Discuss flex plan with business owner
5. Amount spent — $35

Treasury Regulations state that this information must be recorded in a timely manner — in other words, you should record the information soon after the entertainment event rather than waiting until the day before an IRS audit.

The location, date, and amount spent are already on the receipt Sara gets from the restaurant, so all Sara needs to do is write Emily´s name and the business purpose somewhere on the receipt and make sure the receipt is put into the proper place in her files.

Mavis´s Downtown Country Cooking is 7.5 miles from Sara´s office, so Sara also had a mileage deduction to record in connection with taking Emily to lunch. Some business owners find it convenient to keep a record of both entertainment costs and mileage in their appointment calendars. IRS auditors like to be able to cross check mileage and entertainment records against an appointment calendar or organizer. They are trained to look for inconsistencies, such as a receipt from McCormick & Schmick´s, November 8, 2012 claimed as a business entertainment expense “J. Smith — discussed potential referrals” and an entry on the calendar for November 8, 2006 that reads, “Sally´s birthday party — McCormick & Schmick´s 7:30”




How To Document Vehicle Expenses for the IRS


You may not have kept perfect records in the past, but you can begin now to document your business vehicle use. If the IRS should audit tax return for prior years, when you were not keeping good records, you can sometimes use current records as supplemental documentation for the prior years. The ideal documentation for your business automobile mileage would be the following:

  • Mileage log clearly showing the date, address you drove to, and business purpose. Examples: (1) 2/21/2011, 548 North Main, purchase office supplies, odometer out: 24937, odomenter in: 24945; (2) 2/21/2011, 23 NE Loop 410, call on prospective client Smith Construction, odometer out: 24945, odomenter in: 24960
  • Oil change or repair receipts toward the beginning and end of the year, providing 3rd party substantiation of your total mileage for the year;
  • Calendar showing appointments that match your mileage log. Example: 2:00 Monday Feb 21, 2011 – John Smith, Smith Construction 23 NE Loop 410
  • Some (most) people are in a hurry when they get into the car to go to a business appointment. If they keep a mileage log at all, it will often be on a sporadic basis. It’s best to have a log, but if you do not have a complete log, you can still substantiate your mileage using a calendar and third party documentation of your total mileage. In addition to repair or oil change receipts, you can use receipts for gasoline purchased and calculate your total mileage using this formula: miles driven = gasoline purchases/average price per gallon x miles per gallon. For example, if you spent $2000 for gasoline for 2010 and the average price of gasoline during 2010 was $2.75, you purchased about 727 gallons of gasoline in 2010. If you car travels an average of 20 miles per gallon of gasoline, your approximate mileage for 2010 would be 727 x 20 = 14,540 miles.
  • Once you have proved your total mileage for the year, you will need to show how much of that mileage was for business purposes. The following documents are useful for this: (1) a calendar that shows your business appointments; (2) invoices sent to clients or customers for work performed at the client’s or customer’s location; (3) print-out of Mapquest or Google Maps route between your office and the location.
  • A narrative description of your driving habits can also be helpful. Example: My base of operations is my office, located in my home. Each morning, I answer my email and return phone calls. Then I drive to my first appointment. I usually call on 4 or 5 prospective new customers each day, Monday through Friday. I also call on 1 or 2 existing customers each day, to make sure they are happy with the services they are receiving. My sales territory covers all of San Antonio and the surrounding small cities. I drive an average of 55 miles each day calling on prospective and existing customers. I also drive to the bank to make deposits once a week, and drive to purchase office supplies once every 2 or 3 weeks. 

Excludable Gifts

This question, in one form or another, comes up often enough that it’s worthwhile to address it here. One of my clients asked:

Is a gift under 13k tax deductible? I was reading the IRS website and I came across that.

Gifts are never tax deductible, unless they are made to a 501(c)(3) charity or similar organization. You can check here to search the IRS’s database for 501(c)(3) organizations:,,id=249767,00.html

The Tax Code specifically excludes gifts from the gross income of the recipient. So if you were to give your child $5000 as a graduation gift, your child does not even have to mention that $5000 when he prepares his tax return.

So what’s with the special treatment of gifts under $13,000 my client saw on the IRS website?

Gifts are not taxable to the recipient, but they are sometimes taxable to the donor. The reason for this is that people used to avoid federal estate taxes by giving everything away on their deathbed. Since the estate tax is calculated as a % of asset owned at death, this strategy worked nicely to lower the estate tax to zero.

To prevent people from escaping estate taxes quite so easily, Congress passed a law that said any gifts given within 3 years of death had to be included in the donor’s estate. So people started making gifts earlier in life. For example, a person could set up a trust and make her grandchildren the beneficiaries. She could then contribute an office building to the trust and thus get the office building out of her estate. As long as the person lived at least 3 more years, the value of the person’s assets was reduced, and therefore the estate tax was reduced.

Congress reacted to this by passing a Unified Estate and Gift Tax. Over the course of his entire lifetime, a person can give up to a million dollars in gifts to recipients other than 501(c)(3) organizations. Gifts in excess of $1 million are taxable. To track the lifetime amount of gifts, a person if required to file a gift tax return every year a gift has been given.

But Congress really didn’t mean to require every birthday and wedding and graduation holiday gift to be reported. So the law exempts gifts of $13,000/year or less per donee. As long as you don’t give more than $13,000 to any one person during any one year, you don’t have to file a gift tax return. The $13,000 per donee exemption is per person, so a husband and wife can together give $26,000 per donee.

One of the ways to transfer a family business to the owner’s children is to give each child stock or LLC ownership units worth $13,000 each year.

To get back to my client’s question: no, you cannot take a deduction for gifts under $13,000; but you can exclude them when you calculate taxable gifts made during the year.

Employee Fraud

The U.S. Marshall’s online auction of clothing seized from Sujata “Sue” Sachdeva continues at Gaston & Sheehan. I didn’t bid on anything, but I stopped by the website, curious to see what sort of things Ms. Sachdeva bought with the $34 million she embezzled from Koss Corporation (link to a Reuters summary of the fraud case; Ms. Sachdeva was convicted and sentenced to 11 years in prison last year). I was surprised to see how many items still had the tags attached, indicating they had never been worn. It would take a while to go through millions of dollars worth of apparel, even if you bought very expensive designer clothes and wore two or three different outfits each day. It must have taken many hours of shopping each week to accumulate so much stuff. In fact, Ms. Sachdeva’s attorney presented her in court as the pathetic victim of a compulsive shopping disorder.

I’m not sure what to think of classifying an urge to acquire stuff as a disabling mental illness. In SHAM – How the Self-Help Movement Made America Hopeless, Steve Salerno argues against excusing crimes based on the criminals’ reasons for committing them. Consideration of mitigating circumstances at the sentencing phase of a trial seems only fair in some cases (for example, a man stealing food to keep his starving children alive), but to lighten the sentence on someone who almost put her employer out of business by embezzling money to buy clothes and limousine rides … I don’t know … it seems that once someone accepts this view, it’s only a short step from holding the employer responsible for harming Ms. Sachdeva by enabling her compulsion.

At least two other Koss employees knew about the thefts, which took place over a period of five years. Both employees reported directly to Ms. Sachdeva. No charges were ever filed against the other employees, so their reasons for keeping quiet are not public information. Were they afraid of losing their jobs? Did Ms. Sachdeva somehow convince them that she was doing nothing wrong?

Can small business owners learn something from this? Having an upper management open door policy comes to mind, so that employees could feel somewhat less uncomfortable about going over their supervisors’ heads. Personal review by the CEO or CFO of all expenditures over a certain amount I another. Koss actually had a review policy for expenditures over $5000. It’s not clear how Sachdeval circumvented this, or why the CPA’s who audited the company didn’t notice it.

The Internal Controls section of Koss’s 2010 annual report states that “approximately 98.1% of the of the unauthorized transactions from fiscal years 2005 through December 2009 was misappropriated by circumventing the Company’s internal controls and other operating procedures for the payment of Company expenditures by using wire transfers or cashier’s checks from the Company’s bank accounts to pay for personal expenditures.”  The remaining 2% of the money apparently was stolen via the petty cash funds.

All purchases of more than $5000 were supposed to be approved by the CEO, Michael Koss, and the auditors should have chosen representative samples of wire transfers and cashier’s checks and matched them to signed CEO approvals. Since this somehow didn’t happen, it made sense for Koss to change whatever it had been doing. The annual report says that Koss remedied the situation in the following way: “This has been remediated by: (1) disallowing the use of any cashier’s checks; (2) enforcing that all wire transfers are initiated within the financial function and electronically approved by the CEO; and (3) performing an enhanced review, reconciliation and reporting of cash activities.”

The fraud was first discovered by Michael Koss when American Express notified Koss of large wire transfers being used to pay personal expenses.

Lawsuits were filed by Koss v Grant Thornton (their auditor);shareholders v Koss Corp, Michael Koss, and Grant Thornton; Koss v American Express. A quick online search indicates that the shareholders’ class action lawsuit against Grant Thornton was dismissed, and the shareholders’ case against Michael Koss and the corporation was settled. I believe the Koss v Grant Thornton is still pending.

One point about this case that especially caught my attention was that the Koss family was said to have been not entirely careful about their own transfers of cash and other assets into and out of the company. Michael Koss held several corporate offices, including CEO and CFO, an arrangement which tends to encourage financially loose behavior.

Commingling business and personal assets is one of the most common mistakes I see in my own clients’ businesses. When I set up a business entity for a client, I tell them that if they can remember only one bullet point from their organizational meeting with me, it should be NEVER COMMINGLE.

The attitude of business owners, especially of a closely held business is, “It’s my money, I can do whatever I like with it.” This is true where there are no other owners, but it has to be done correctly in order to prevent tears in the “corporate veil.”

Where there are other owners, such as partners or investors, the owners have to be far more careful about taking assets out of the entity, or using entity equipment for personal purposes. Most business owners are aware of this, even if they do not always act accordingly. It’s less common to consider the effect it has on employees when they see the owners freely helping themselves to money and other assets belonging to the business entity. Not only does a general attitude of financial carelessness on the part of management encourage employees to have the same outlook, it can also make it more difficult to notice when fraud is taking place. For example, constantly transferring cash between various entity and personal accounts provides a great springboard for dishonest employees to add a few discreet transfers of their own.

I do not know the details of the Sachdeva case, but if the Grant Thornton auditors overlooked $34 million of bogus payments, I’d be willing to bet that the Koss accounting practices were not shiny-clean.