Audit gamble a losing bet

Odds are rarely in your favor when playing fast and loose with unsupportable deductions on income tax return

The Unites States has what is often referred to as a self-assessed tax system. We file a tax return reporting income, deductions and credits, and compute a net tax payment or refund. The government may then question us through the audit process.

Some people fear a post-filing follow-up from the IRS, so they act with excessive caution when preparing their return. Others are gamblers. It’s OK to be a gambler, but you need to pick the games where the odds are in your favor.

James Bonaparte Jr. was a gambler, in many ways. He gambled at casinos and racetracks, and he gambled with the IRS. The casinos got the best of him, even after he consulted a more experienced gambler for advice.

The IRS really got the best of him, in large part because he didn’t consult a more experienced person for advice. Mr. Bonaparte, spelled just like Napoleon’s surname, tried many forms of attack, but found the IRS and Tax Court to be like Wellington’s forces at Waterloo.

His case presents some interesting lessons about how to approach a selfassessed tax system and how to react when confronted with an attack from a superior force.

Bonaparte worked as a bridge agent with the New York-New Jersey Port Authority. Thanks to New Jersey Gov. Chris Christie, even people out West know a little bit about bridges and the Port Authority. But I digress.

Bonaparte made $76,779 in salary in 2010. But he had no home. He lived out of a storage locker. Not a problem, however, because, as soon as his shift was done, he drove 125 miles to Atlantic City to gamble. If he worked the next day, he drove back the following morning.

He filed his 2010 return reporting no gambling activity because he had lost money for the year. But he did claim deductions for medical expenses, charitable contributions, taxes and home mortgage interest. Yes, home mortgage interest, I suppose for a storage locker. I did not know banks made mortgage loans on storage lockers.

The medical expenses were a bit fishy also and there was no substantiation for the charitable contributions. Most people itemize deductions only because they own a home. But Bonaparte crafted $66,297 of itemized deductions with no home.

He received an IRS audit notice. He knew his facts were bad. So he filed an amended return dropping the charitable gifts and mortgage interest, but adding a huge gambling loss, and some purported bad-debt deductions for loans made to friends and family.

The problem with the amended return is that he was under audit — it was no longer really self-assessment because he knew the IRS would closely examine the amended filing claims. That is, some people gamble by hoping they won’t be audited. Bonaparte tried that strategy, but doubled down when his bluff was called. The gambling loss was significant to his liability because he claimed he was

a professional gambler. This allowed him to use the loss on schedule C, reserved for business reporting. Casual gamblers report losses as itemized deductions and cannot report a net loss.

He also claimed per-diem amounts for trips made to the doctor for a wrist injury. Per diems are for out-of-town travel. But Bonaparte said he had to travel from Atlantic City to his doctor. A badloan loss was claimed on the under-audit amendment for 2010, although no loan was made until 2011.

Well, Mr. Bonaparte lost his gamble. He owed taxes and a 20 percent penalty. Applying gambling terms to his tax filings, Mr. Bonaparte was a mark, a hayseed, a mooch, a cucumber.

His case is not really interesting to a tax adviser, but it should be instructive to someone playing the selfassessment tax system. Play with the odds in your favor. Bonaparte never tried to learn the tax game and, as a result, he dealt himself a bad hand.

If audited, don’t double down with undocumented deductions. Mr. Bonaparte had no record of any of his gambling winnings and losses, other than what he kept in his head. And he didn’t claim that to start with — he claimed it with the IRS watching his shuffle. When playing with the IRS, don’t have a tell.