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STATE BOARD OF EQUALIZATION PERSONAL INCOME TAX APPEAL

BOARD OF EQUALIZATION STATE OF CALIFORNIA

In the Matter of the Appeal of:

MARSHA E. KAKALIA1

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SUMMARY DECISION PERSONAL INCOME TAX APPEAL Case No. 404650 Adopted: December 14, 2011

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Representing the Parties:

For Appellant: For Franchise Tax Board:

James Ireijo, Attorney at Law Judy F. Hirano, Tax Counsel III

Counsel for the Board of Equalization:

Charles D. Daly, Tax Counsel III

This appeal is made pursuant to section 19045 of the Revenue and Taxation Code (R&TC) from the action of respondent Franchise Tax Board (respondent or FTB) on appellants protest against a proposed assessment of additional tax in the amount of $6,083.00, plus a failure to provide information penalty in the amount of $1,520.75, for 2003.2 The issue in this appeal is whether appellant has established entitlement to a gambling loss deduction for 2003. /// ///

This case was pulled by a Board Member from the consent calendar of the Board meeting of September 20, 2011, for purposes of further review and discussion. As discussed below, respondent subsequently stated that it would withdraw the failure to provide information penalty and also reduced the additional tax from $6,083 to $3,730. Appeal of Marsha E. Kakalia
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FINDINGS AND DISCUSSION Background Appellant filed a timely California tax return for 2003. On that return, appellant reported federal adjusted gross income (AGI) of $89,980. On Schedule CA of that return, appellant reported gambling losses of $89,980, which she offset against the federal AGI of that amount to determine a California AGI of zero. Appellant also reported a California standard deduction of $3,070, taxable income of zero, and tax of zero. After examining her 2003 return, respondent twice requested appellant to provide documentation in relation to what its auditor understood to be her claim that her income was excludable from California tax because that income was earned on or received from an American Indian reservation. When respondent did not receive a reply from appellant, respondent issued a Notice of Proposed Assessment (NPA) against her on December 11, 2006. In its NPA, respondent added back to appellants taxable income the gambling losses she reported on Schedule CA of her return on the basis that she did not provide information substantiating that she met the requirements for her tribal income to be considered non-taxable by California. Respondent also imposed a 25 percent penalty for appellants failure to reply to its request for information. As a result, the NPA proposed the assessment of additional tax of $6,083.00 and a failure to furnish information penalty of $1,520.75, plus interest. Appellant filed a protest against respondents NPA. In her protest letter, appellant stated that she was not a member of any Indian tribe and requested elaboration on how that fact affected her tax liability. In a reply letter, respondent acknowledged its error in treating appellants matter as having any relevance to Indian issues and requested appellant to provide an IRS Form 1099-G for 2003 showing her gambling winnings for that year. When appellant did not reply, respondent issued a Notice of Action on May 2, 2007, affirming its NPA. This timely appeal followed.3 Contentions In appellants opening brief, her representative provided two statements, one from Harrahs dated June 7, 2007, and the other from Thunder Valley Casino dated July 2, 2007. The

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This appeal was deferred for over a year for bankruptcy proceedings and later was once more deferred to allow respondents counsel to review appellants amended return. Appeal of Marsha E. Kakalia
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statement from Harrahs indicated that appellants account associated with use of her Harrahs Total Rewards program card showed that she had total losses of $14,666 during 2003 as a result of gambling at four different Harrahs locations. Appellants total losses included hand-paid jackpot winnings of $14,585.75 that are required by the Internal Revenue Service (IRS) to be reported in its Form W-2G.4 Appellant had net losses of $12,736 from gambling at slot machines, while the remainder of her total losses resulted from table games or other unspecified gambling activities. The statement from Harrahs emphasized that only play that occurred when your Total Rewards Card was inserted into a slot machine or a manual rating was created at a table game, keno, or sports and race book area is included in this statement. The statement further emphasized that the information on it was not intended for tax reporting, and, therefore, the statement made no representation regarding the accuracy of the information or its effectiveness as proof of losses. The statement also indicated that the IRS recommends keeping a diary of gambling activity with such pertinent information as dates, slot machines, or table numbers, jackpots, and total wins and losses. The statement from Thunder Valley Casino indicated that, based on tracking when her players card was used, appellant had net slot machine losses of $35,861.20, after taking into account jackpot winnings of $51,110.00 reported on Form W-2G. The statement further indicated that she had net table game losses of $290.00 which, when combined with her net slot machine losses of $35,861.20, resulted in total net losses for 2003 of $36,151.20.5 The statement emphasized that Thunder Valley Casino was unable to provide any information about appellants gambling activities other than what appeared on the statement. The statement also explicitly disclaimed providing information for claiming wins/losses as part of your income tax and noted that the statement had not been audited. Her representative states that, after reviewing the two statements, respondent would determine that there was no doubt appellant had no gambling income for 2003 from any casino. Her representative concludes by asking whether the two statements were sufficient to allow respondent to complete its audit and offering to provide any further supplementary information that it might require.

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Form W-2G provides, in pertinent part, that winnings (not reduced by the wager) from a bingo game or slot machine of $1,200 or more are required to be reported on the form. Keno and other games have different minimum reporting amounts.
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The statement alleges that winnings and losses for table games were tracked by entries made by personnel of the casino. NOT TO BE CITED AS PRECEDENT
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Appeal of Marsha E. Kakalia

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STATE BOARD OF EQUALIZATION PERSONAL INCOME TAX APPEAL

In its opening brief, respondent argues that the statement from each of the two casinos showed only the amounts from gambling activities when appellant used a particular card from that casino. Respondent states that each of those statements explicitly disclaimed any intention that it be used for tax purposes. Further, respondent observes that the statement from Thunder Valley Casino indicated that it was unaudited. Respondent states that it twice left telephone messages for appellants representative during the appeal but received no reply. Respondent then sent appellant a letter, dated November 30, 2007, which requested her federal tax return for 2003, including all schedules and attachments, and documentation for deductions taken on Schedule A of that return for real estate taxes, home mortgage interest, and other miscellaneous items. In a note, dated December 28, 2007, handwritten on respondents letter, appellant stated that she needed additional time to obtain a copy of her 2003 federal return from the IRS and the other requested information. Respondent obtained transcripts from the IRS showing appellants winnings from the following casinos that were required to be reported on Form W-2G: (1) Thunder Valley Casino$62,186, (2) Harrahs Casino- $14,585, (3) Sparks Nugget Casino- $1,253, (4) Club Cal-Neva- $1,260, (5) Eldorado Resorts- $6,000, and (6) Cache Creek Indian Bingo and Casino- $4,550. The total amount of the foregoing winnings is $89,834. Respondent argues in its opening brief that appellant has not substantiated her gambling losses for 2003. Respondent also argues that appellant has not shown that her gambling losses exceeded her gambling income. Among other authorities, respondent cites Appeal of Robert E. Telles (Telles) (86-SBE-061), decided on March 4, 1986. Telles held that it is well settled that deductions are a matter of legislative grace, that the taxpayer bears the burden of establishing his entitlement to the claimed deduction and that, to carry that burden, the taxpayer must point to an applicable statute and show by credible evidence that he comes within its terms. Respondent also observes that Revenue Procedure 77-29, 1977-2 C.B. 538, section 3, provides that an accurate diary or similar record regularly maintained by a taxpayer, supplemented by verifiable documentation, will usually be acceptable evidence to substantiate wagering winnings and losses. Respondent notes that section 3 of the revenue procedure provides that, in general, the diary should contain at least the following information: (1) date and type
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of specific wager or wagering activity; (2) name of gambling establishment; (3) address or location of gambling establishment; (4) names of other persons present with the taxpayer at the gambling establishment; and (5) amounts won or lost. Respondent notes that section 3 of the revenue procedure further states that verifiable documentation includes, but is not limited to, Forms W-2G and 5754,6 cancelled checks, and bank statements.7 Respondent also notes that section 3 states that slot machine winnings and losses may be further supported by a record of all winnings by date and time that the machine was played. Respondent next states that adequate recordkeeping is essential to establish entitlement to a gambling loss deduction, citing Zielonka v. Commissioner (Zielonka) T.C. Memo 1997-81, Klabacka v. Commissioner T.C. Memo 1987-77, Metas v. Commissioner T.C. Memo 1982-36, and Glazer v. Commissioner (Glazer) T.C. Memo 1980-337. Respondent also states that [i]f a taxpayer fails to maintain adequate records, both her gambling income and gambling losses cannot be ascertained. In such a case, it cannot be determined whether her gambling losses exceeded her unreported gambling income. In those circumstances, courts have denied the taxpayer a gambling loss deduction. Respondent cites Norgaard v. Commissioner (Norgaard) (9th Cir. 1991) 939 F.2d 874, as well as the other cases cited in this paragraph, as supporting authority. Respondent further argues that, given the frequency and amount of her gambling winnings reported on her Forms W-2G, appellant probably had gambling winnings not reported on Form W-2G. Respondent states that the transcripts from the IRS stating appellants gambling winnings required to be reported on Form W-2G showed that the entire amount of $89,834 in her W-2G winnings during 2003 resulted from her playing slot machines. Respondent notes that, as explained in footnote 2 above, winnings in excess of $1,200 at a slot machine are required to be reported on Form W-2G. Respondent further notes that although appellant reported federal AGI of $89,980 on her 2003

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IRS Form 5754 is used to prepare Form W-2G when the person receiving gambling winnings subject to reporting or withholding is not the actual winner or is a member of a group of two or more people sharing the winnings, such as by sharing the same winning ticket. We note that section 3 of the revenue procedure also provides that bank withdrawals and statements of actual winnings or payment slips provided to the taxpayer by the gambling establishment are other kinds of verifiable documentations. Further, section 3 states that additional supporting evidence could include, among other types of evidence, affidavits or testimony from responsible gambling officials regarding wagering activities. Appeal of Marsha E. Kakalia
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California return, her Forms W-2G showed winnings of $89,834 and her Forms 1099-B showed income from sales of stock and bonds of $278 and dividend income of $5, for a total reported income during 2003 of $90,117. Respondent argues that because appellant failed to provide adequate contemporaneous records of her gambling activities, including income, losses, and wagered amounts, her gambling winnings of less than the amounts reported on her Forms W-2G cannot be ascertained. Respondent points out that the statement from Harrahs explicitly disclaims any intention that it should be used for tax reporting purposes. Respondent also points out that the statement from Thunder Valley Casino indicated that it was unaudited. Citing Mayer v. Commissioner T.C. Memo 2000-295, respondent notes that the statements from the two casinos are unsigned and argues that, for that reason, they are unreliable to establish appellants gambling winnings and losses for 2003. In that regard, respondent also argues that because appellants winnings at Thunder Valley Casino reported on her Forms W-2G for 2003 exceeded by $11,076 the amount of W-2G winnings indicated on her statement from that casino, the statements from the two casinos do not establish all of her gambling winnings and losses at the those casinos for that year. Respondent acknowledges that, in view of her considerable gambling activities, appellant must have sustained some losses during 2003. However, respondent states that the income appellant reported on her 2003 return was solely or primarily from winnings reported on her Forms W-2G and argues there is no assurance that appellant reported all of her gambling winnings for that year. Respondent also argues that there is a lack of credible corroborating evidence regarding her gambling losses during 2003. Citing Zieolonka and Glazer, respondent concludes that, under those circumstances, appellant has failed to establish her entitlement to a gambling loss deduction for that year. However, respondent states that it will withdraw the penalty for failure to provide information that it imposed against appellant for 2003. In appellants reply brief, appellants representative alleges that the statements from Harrahs and Thunder Valley Casino captured all of her winnings, as well as all of her losses, through electronic tracking. Appellants representative argues that it would be absurd for the two casinos not to report all winnings, including those below the minimum amount of $1,200 required to be reported on Form W-2G for slot machine winnings. The representative argues further that it would be self-defeating
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for tax authorities not to accept gambling losses recorded by that method because electronic tracking is allegedly the most accurate method for proving casino winnings or losses during a taxable year. Appellants representative includes with the reply brief appellants amended California return for 2003. The representative states that some, but not all, of the exhibits attached to the amended return were included with the reply brief. The exhibits that were both attached to the amended return and included with the reply brief are (1) a work sheet explaining the gambling losses and itemized deductions for mortgage interest and property taxes claimed on the amended return, (2) account statements showing mortgage interest payments in the total amount of $24,309 ($17,802 + $7,507) with regard to two mortgages on property owned by appellant, and (3) a letter from the Tax Collector of El Dorado County indicating property tax payments paid during 2002 and 2003 in the total amount of $4,907. On the work sheet, appellant argues that bank records, in the form of statements from the Bank of America and US Bank, indicating cash withdrawals in the total amount of $78,620 from branches of those banks at various casinos (primarily, according to appellant, branches at Harrahs, Thunder Valley Casino, and Cache Creek) show that appellant had gambling losses of that total amount during 2003. Those bank records were attached to the amended return but not included with the reply brief. Appellant also argues on the work sheet that the account statements establish deductible mortgage interest payments of $24,309 and deductible property tax payment of $4,907 for 2003. The representative argues in the reply brief that appellants amended return was consistent with her original return for 2003 in the respect that both indicated she did not owe California tax for that year. With regard to the bank records attached to the amended return but not included with the reply brief, the representative argues that they were proof of appellants gambling losses during 2003 and states that they were provided to respondent when the 2003 amended return was filed. In its reply brief, respondent states that, contrary to the request of its attorney that appellants amended 2003 return be sent to the attorneys attention, appellant submitted the amended return to respondents Filing Division. Respondent states further that, as a result of the pending appeal in the instant matter, the amended return was not processed. Respondents attorney later became aware of the amended return and obtained it. At respondents request, the BPD deferred the appeal until respondent reviewed the amended return and supporting documentation.
Appeal of Marsha E. Kakalia
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After reviewing the amended return and supporting documentation, respondent accepted as valid appellants claim on the amended return that she was entitled to deductions for real estate taxes of $4,081 and home mortgage interest of $24,310.8 However, respondent determined that the bank records attached to the amended return did not substantiate appellants claimed gambling losses for 2003. As a result, respondent concluded that appellant had California taxable income of $61,589 during 2003 and reduced its assessment of additional tax for that year from $6,083 to $3,730. Respondent argues that the bank records at issue are inadequate to substantiate appellants claimed gambling losses for several reasons. First, respondent notes that the gambling losses claimed on the amended return are $78,620 rather than the amount of $77,120 the bank records allegedly show were withdrawn from ATM machines in casinos at which appellant gambled during 2003. Respondent argues that because appellant is taking the position that the record of withdrawals from the ATM machines in the casinos at which she gambled substantiates her gambling losses during 2003, the discrepancy between the gambling losses reported on her amended return and the amount of ATM withdrawals in the casinos undercuts her position. Second, respondent argues that the bank records of the withdrawals do not, by themselves, substantiate appellants gambling losses because the withdrawals could have been used for any purpose, including transportation, lodging, food, and gifts. Finally, respondent states that appellant deposited $97,274 during 2003 into accounts at two banks from which she allegedly withdrew $77,120 at branches located in the casinos at which she gambled. Respondent also points that deposits in excess of withdrawals sometimes occurred on the same day. Respondent argues that the pattern of deposits in excess of withdrawals on the same day undermines appellants position that the withdrawals were used solely for gambling because some of the withdrawn amounts might have been deposited again on that day. In appellants supplemental brief, appellants representative argues that the bank records were of withdrawals from ATMs located in the casinos at which appellant gambled during 2003. The representative argues that because those banks records were consistent with computer generated losses indicated on the statements produced by Harrahs and Thunder Valley Casino, appellant has

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Upon review of the amended return and its attachments, respondent properly concluded that only the amount of $4,081 in property taxes was deductible because that was the amount of property taxes appellant paid during 2003. Appeal of Marsha E. Kakalia
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substantiated her claimed gambling losses for 2003. The representative also argues that appellant should prevail because respondent has violated a number of appellants constitutional rights, including the right to receive due process of law, through its treatment of the documentary evidence provided by appellant and by respondents attorney allegedly reviewing appellants amended 2003 return without the benefit of a previous evaluation by its audit staff. Applicable Law R&TC section 17201, subdivision (a), incorporates by reference Internal Revenue Code (IRC) section 165, except as otherwise provided. IRC section 165(a) provides that there shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. IRC section 165(c) provides, in pertinent part, that, in the case of any individual, the deduction under subsection (a) shall be limited to (1) losses incurred in a trade or business or (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business. IRC section 165(d) provides that losses from wagering transactions shall be allowed only to the extent of the gains from such transactions. It is well settled that deductions are a matter of legislative grace and that the taxpayer bears the burden of establishing his entitlement to the claimed deduction. It is also well settled that, to carry that burden, the taxpayer must point to an applicable statute and show by credible evidence that he comes within its terms. (Appeal of Robert E. Telles, supra.) In the event that a taxpayer establishes that a deduction expense has been paid but is unable to substantiate the precise amount, the amount of the deductible expense may generally be estimated, bearing heavily against the taxpayer whose inexactitude in substantiating the amount of the expense is of his own making. (Fleming v. Commissioner T.C. Memo 2010-60 [citing Cohan v. Commissioner (2nd Cir. 1930) 39 F.2d 540, 543-544 (the Cohan rule)].) However, the Ninth Circuit Court of Appeals (the Ninth Circuit) in Norgaard upheld the conclusion of the Tax Court that the latter court could not apply the Cohan rule because the taxpayers there had not established that their unreported, unquantified gambling income did not equal or exceed their claimed gambling losses. The Ninth Circuit stated that the Cohan rule may not be applied in the presence of unreported, unquantified winnings unless both winnings and losses are estimated. The Ninth Circuit stated further that neither
Appeal of Marsha E. Kakalia
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winnings nor losses can reasonably be estimated without a credible basis for making such an estimate. (Norgaard v. Commissioner, supra, 939 F.2d at 848.) It is well established that a presumption of correctness attends respondents determination of fact and that an appellant has the burden of proving such determinations erroneous. (Appeals of George H. and Sky Williams, et al., 82-SBE-018, Jan. 5, 1982.) This presumption is a rebuttable one and will support a finding only in the absence of sufficient evidence to the contrary. Respondents determinations cannot, however, be successfully rebutted when the taxpayer fails to present credible, competent, and relevant evidence as to the issues in dispute. (Appeals of George H. and Sky Williams, et al., supra.) Section 3.5 of Article III of the California Constitution prevents this Board from determining that statutory provisions are unconstitutional or unenforceable unless an appellate court has made such a determination. Further, this Board has a well-established policy of abstention from deciding constitutional issues in an appeal involving proposed assessments of additional tax. (Appeal of Aimor Corporation, 83-SBE-221, Oct. 26, 1983.) The rationale for this policy is the absence of any specific statutory authority that would allow respondent to obtain judicial review of a decision in such cases and our belief that judicial review should be available for questions of constitutional importance. (Appeal of Aimor Corporation, supra.) Discussion Appellant has not established her entitlement under IRC section 165 to her claimed gambling loss deductions for 2003. Appellant argues that the electronic tracking of her gaming card transactions captured all of her losses at Harrahs and Thunder Valley Casino and allowed them to be reported on the statements from those casinos. However, she has provided no persuasive evidence or legal argument explaining how electronic tracking actually operated and why we should regard that technique as an accurate method of accounting for her gambling losses. In fact, the statement from each of the casinos generally raises questions regarding the accuracy of the information on it and explicitly disclaims any intent that the information be used for tax reporting purposes. For example, the Harrahs statement says it is not intended for tax reporting and cautions that only play that occurred when your Total Rewards card was inserted into a slot machine or manual rating was created at a table game,
Appeal of Marsha E. Kakalia
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keno, or sports and race book area is included in this statement. It further cautions that the statement may not include all hand-paid jackpots reportable to the IRS . . . and that the IRS recommends keeping a diary of your gaming activity . . . . The Thunder Valley statement says that only play tracked with your Boarding Pass card is shown in these totals . . . [,] and we are unable to provide any information about play, other than what is shown on this statement. In addition, as respondent points out, there is a discrepancy of $11,076 between the W-2G winnings reported on the statement from Thunder Valley Casino ($51,110) and those reported on documentation respondent received from the IRS ($62,186). Such a discrepancy raises concerns that appellants losses, as well as her W-2G winnings, might not be accurately reported on the statement from at least one of the casinos. The bank statements attached to appellants amended 2003 return do not establish that the withdrawn funds were used for gambling because, in the absence of reliable corroborative evidence, such as a diary or similar record containing information of the nature indicated in Revenue Procedure 77-29, the bank statements have little probative value with regard the gambling losses appellant has claimed. Although not explicitly raised by the parties but discussed in Norgaard and other cases cited by respondent, we have considered whether the Cohan doctrine might be available to benefit appellant and applied the analysis in Norgaard. To determine under Norgaard whether appellant has met the requirement that she did not have unreported gambling winnings during 2003 that equaled or exceeded her claimed gambling losses for that year, each of appellants winnings and losses during 2003 must be estimated on a credible basis. However, there is no credible basis for estimating appellants gambling winnings during 2003. As respondent suggests, winnings of less than $1,200 from slot machines are not reported on Form W-2G, and, taking into account the extent of appellants gambling activities, it is very possible that appellant had significant unreported slot machine and other winnings during 2003 that were less than the amounts required to be reported on Form W-2G. Such winnings may have resulted from her gambling at Harrahs and Thunder Valley Casino without the respective cards issued by those casinos as well as her gambling at other casinos during 2003. With regard to appellants gambling losses during 2003, we have no credible basis for estimating them in view of the reasons stated in the immediately preceding paragraph. Because we have no credible basis for estimating either appellants gambling winnings or her losses during 2003, we conclude under Norgaard
Appeal of Marsha E. Kakalia
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that relief under the Cohan doctrine is unavailable to appellant. Finally, provisions of the California constitution and our own well-established policy of abstaining from deciding constitutional issues in an appeal involving the proposed assessment of additional tax preclude our resolving the instant matter on the basis of appellants constitutional arguments. In any event, appellants allegation that respondents attorney reviewed appellants amended 2003 return without a previous evaluation of the return by its audit staff is without support in the record. CONCLUSION Accordingly, respondents action is modified to reflect its concession that the amount of appellants additional tax should be reduced from $6,083 to $3,730 and its abatement of the penalty for failure to provide information. Otherwise, respondents action is hereby sustained. /// /// ///
Kakalia_cdd

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Appeal of Marsha E. Kakalia

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