                                                   SHIRAZ NOORMOHAMED LAKHANI, PETITIONER v.
                                                       COMMISSIONER OF INTERNAL REVENUE,
                                                                  RESPONDENT
                                                   SHIRAZ LAKHANI, PETITIONER v. COMMISSIONER
                                                       OF INTERNAL REVENUE, RESPONDENT

                                                Docket Nos. 21212–10, 24563–11. 1                      Filed March 11, 2014.

                                                  For 2005–09, P, a professional gambler who bet on horse
                                                races, deducted his net wagering losses (either incurred
                                                during the year or carried over from prior years) in contraven-

                                           1 Petitioner
                                                  filed a petition with respect to 2005 and 2006 (docket No.
                                     21212–10) in the name of Shiraz Noormohamed Lakhani and a petition
                                     with respect to 2007–09 (docket No. 24563–11) in the name of Shiraz
                                     Lakhani. The cases were consolidated by order of this Court dated August
                                     17, 2012.

                                                                                                                                    151




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                                     152                 142 UNITED STATES TAX COURT REPORTS                                     (151)


                                               tion of I.R.C. sec. 165(d). R disallowed those deductions and
                                               imposed an I.R.C. sec. 6662(a) accuracy-related penalty for all
                                               years. P argues (1) he is entitled to deductions for pro rata
                                               shares of the track’s ‘‘takeout’’ from the parimutuel betting
                                               pools, which would wholly or partially offset the disallowed
                                               net wagering losses for the years at issue and (2) I.R.C. sec.
                                               165(d) unreasonably discriminates against business losses of
                                               professional gamblers and constitutes a violation of their con-
                                               stitutional right to the equal protection of the laws. With
                                               respect to R’s imposition of the I.R.C. sec. 6662(a) penalty, P
                                               argues he acted with reasonable cause and in good faith in
                                               deducting his net wagering losses for the years at issue.
                                                  1. Held: Because ‘‘takeout’’ represents the track’s share of a
                                               parimutuel betting pool and the expenses discharged there-
                                               from are obligations imposed on the track, not the bettors, P
                                               is not entitled to deduct a pro rata share of all or any portion
                                               thereof.
                                                  2. Held, further, applying the I.R.C. sec. 165(d) limitation on
                                               the deductibility of wagering losses to the wagering losses of
                                               a professional gambler is not an unconstitutional violation of
                                               the Equal Protection Clause.
                                                  3. Held, further, the I.R.C. sec. 6662(a) accuracy-related
                                               penalty is sustained for all years.

                                       Shiraz Noormohamed Lakhani, pro se.
                                       Nathan C. Johnston and Linette B. Angelastro, for
                                     respondent.
                                       HALPERN, Judge: By notices of deficiency (notices),
                                     respondent determined deficiencies in income tax and pen-
                                     alties for petitioner’s 2005–09 calendar taxable years as fol-
                                     lows:
                                                                                                                Penalty
                                                        Year                   Deficiency                      sec. 6662

                                                        2005                     $22,571                        $4,514
                                                        2006                      18,462                         3,692
                                                        2007                       9,918                         1,984
                                                        2008                       7,401                         1,480
                                                        2009                       5,965                         1,193

                                       Unless otherwise indicated, all section references are to the
                                     Internal Revenue Code in effect for the years at issue, and
                                     all Rule references are to the Tax Court Rules of Practice
                                     and Procedure. All dollar amounts have been rounded to the
                                     nearest dollar.




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                                     (151)                          LAKHANI v. COMMISSIONER                                        153


                                        After concessions, the issues for decision are whether peti-
                                     tioner, a professional gambler, is, for the years at issue, (1)
                                     entitled to a deduction for his losses from wagering trans-
                                     actions in excess of his gains from such transactions
                                     (whether those net losses were incurred during the taxable
                                     year or used by means of a net operating loss carryover) and
                                     (2) liable for the section 6662 accuracy-related penalty. 2

                                                                         FINDINGS OF FACT 3

                                        Some facts are stipulated and are so found. The stipulation
                                     of facts, with accompanying exhibits, is incorporated herein
                                     by this reference.
                                        At the time the petition was filed, petitioner resided in
                                     Woodland Hills, California.
                                        For each of the years at issue, petitioner, a certified public
                                     accountant, maintained an accounting practice, which
                                     included the preparation of tax returns for clients. He
                                     reported the income and expenses from his accounting prac-
                                     tice on a Form 1040, U.S. Individual Income Tax Return,
                                     Schedule C, Profit or Loss From Business. During those
                                     years, petitioner was also a professional gambler whose gam-
                                     bling activities were limited to parimutuel wagering on horse
                                     races. To that end, petitioner placed bets on races occurring
                                     both at California racetracks and at racetracks in other
                                     States. He reported the results from his wagering on a sepa-
                                     rate Schedule C (gambling Schedule C) for each of the years
                                     at issue. On each of the gambling Schedules C, petitioner
                                     reported the gross amount he received on (winning) bets as
                                     ‘‘Gross receipts or sales’’, and he reported the amounts he
                                     had bet as ‘‘Cost of goods sold’’, subtracting the latter from
                                     the former, to determine his gross income or his loss from
                                       2 There are also certain computational adjustments that follow from the

                                     adjustments at issue, but they are not in controversy, and we need not dis-
                                     cuss them.
                                       3 Petitioner in his answering brief has not made reference by number to

                                     those findings of fact proposed by respondent to which he objects, as re-
                                     quired by Rule 151(e)(3). We, therefore, deem petitioner to have conceded
                                     the accuracy of respondent’s proposed findings of fact with respect to which
                                     we discern he raises no objection in his answering brief, except to the ex-
                                     tent that his own proposed findings of fact are inconsistent therewith. See
                                     Jonson v. Commissioner, 118 T.C. 106, 108 n.4 (2002), aff ’d, 353 F.3d 1181
                                     (10th Cir. 2003).




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                                     154                 142 UNITED STATES TAX COURT REPORTS                                     (151)


                                     gambling. He also reported and deducted miscellaneous other
                                     expenses associated with his gambling activities 4 and
                                     reported the sum of his gambling winnings, losses, and mis-
                                     cellaneous other expenses as his income or loss (net wagering
                                     income or loss, respectively) from gambling for the year. He
                                     then combined his net wagering income or loss with his
                                     accounting practice income for the year and reported the sum
                                     of the two on page 1, line 12 of his Form 1040 as his total
                                     net ‘‘Business income or (loss)’’ for the year.
                                        For each of 2005, 2006, 2008, and 2009 (gambling loss
                                     years), petitioner’s net wagering loss exceeded his accounting
                                     practice income, so that line 12 of each Form 1040 reported
                                     a business loss. For 2007, in which he reported a net
                                     wagering gain, and for 2009, petitioner claimed net operating
                                     loss carryover deductions all or a portion of which, presum-
                                     ably, arose out of unused net wagering losses incurred in
                                     prior years. Among respondent’s adjustments for each of the
                                     gambling loss years is the disallowance of petitioner’s deduc-
                                     tion for his net wagering losses on the basis of section 165(d),
                                     which provides: ‘‘Losses from wagering transactions shall be
                                     allowed only to the extent of the gains from such trans-
                                     actions.’’ 5 Respondent also disallowed the net operating loss
                                     carryovers to 2007 and 2009.




                                           4 Although
                                                   the miscellaneous other expenses petitioner deducted for 2005
                                     and 2006 are treated as nondeductible in the notice covering those years,
                                     respondent now concedes their deductibility on the grounds that they con-
                                     stitute deductible nonwagering business expenses of a professional gam-
                                     bler. See Mayo v. Commissioner, 136 T.C. 81, 97 (2011).
                                       5 Petitioner’s disallowed net wagering losses for the gambling loss years

                                     were as follows:
                                                            Year                Amount
                                                            2005                $81,793
                                                            2006                110,196
                                                            2008                  60,454
                                                            2009                  36,240




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                                     (151)                           LAKHANI v. COMMISSIONER                                        155


                                                                                   OPINION

                                     I. Deductibility of Petitioner’s Net Wagering Losses
                                           A. Parties’ Arguments
                                           1. Petitioner’s Arguments
                                       Petitioner bases his argument that he is entitled to deduct
                                     his wagering losses in excess of his wagering gains under
                                     sections 162(a) (as ordinary and necessary business
                                     expenses), 165(a) (as losses), and/or 212(1) (as expenses for
                                     the production of income) on two alternative grounds. One,
                                     for each of the parimutuel bets that he made he is entitled
                                     to deduct that portion of the bet equal to the takeout percent-
                                     age that applies to the parimutuel pool formed to receive
                                     that bet. Two, section 165(d) is inapplicable to professional
                                     gamblers. We will address those arguments in turn.
                                           a. Deductibility of Takeout
                                        Before addressing petitioner’s arguments, we will describe
                                     the concepts of parimutuel wagering and takeout. 6
                                        In parimutuel wagering, applicable to, among other events
                                     of chance, betting on horse races, the entire amount wagered
                                     is referred to as the betting pool or ‘‘handle’’. The pool can
                                     be managed to ensure that the event manager (in horse
                                     racing, the track) receives a share of the betting pool regard-
                                     less of who wins a particular event or race. That share is
                                     referred to as the takeout, and the percentage, set by State
                                     law, varies from State to State, generally ranging from 15%
                                     to 25% and often depending upon the type of bet, e.g.,
                                     ‘‘straight’’ or ‘‘conventional’’ win, place, or show wagers or
                                     ‘‘exotic’’ (multiple horse or multiple race) wagers, the latter

                                       6 It is interesting to note that the nature of parimutuel betting came be-

                                     fore our predecessor, the Board of Tax Appeals, in its first year. See
                                     McKenna v. Commissioner, 1 B.T.A. 326, 332 (1925), in which we stated:
                                              The question before us resolves itself to this: What was the actual gain
                                           resulting to the taxpayer from his handbook operations? In the pari mu-
                                           tuel system of wagering on horse racing the odds are fixed after the race
                                           is won. All the money bet forms a pool out of which payments of a fixed
                                           percentage are made to the State and to the licensed commission under
                                           whose auspices the races are run, the residue being apportioned to the
                                           bettors. Thus the track odds determined. * * *




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                                     156                 142 UNITED STATES TAX COURT REPORTS                                     (151)


                                     usually resulting in higher takeout percentages. 7 The take-
                                     out is used to defray the track’s expenses, including purse
                                     money for the horse owners, taxes, license fees, and other
                                     State-mandated amounts. What remains from the takeout
                                     after those liabilities are provided for constitutes the track’s
                                     profits. The takeout may also be used to cover any shortfall
                                     in the amount available in the parimutuel pool, after reduc-
                                     tion for takeout, to pay off the winning bettors. That cir-
                                     cumstance, generally referred to as the creation of a ‘‘minus
                                     pool’’, arises by virtue of the requirement, in many States,
                                     that the track provide a minimum profit to winning ticket
                                     holders. See, for example, California Horse Racing Board
                                     Rule 1960, which provides, in pertinent part, as follows: ‘‘The
                                     association must pay to the holder of any * * * [winning
                                     ticket or tickets] the amount wagered * * * plus a minimum
                                     of 5% thereof. This requirement is unaffected by the exist-
                                     ence of a parimutuel pool which does not contain sufficient
                                     money to distribute said 5% to all persons holding such
                                     tickets.’’ Thus, on those presumably rare occasions when an
                                     overwhelming favorite finishes in the money (wins, places, or
                                     shows) and, pursuant to the actual odds, pays something less
                                     than $2.10 on a $2 bet (say $2.05), the extra nickel due each
                                     winning bettor on a $2 bet will constitute an additional
                                     amount that must be extracted from the takeout, see, e.g.,
                                     Cal. Bus. & Prof. Code (Cal. Code) sec. 19613.5 (West 2008),
                                     an occurrence that might cause the track to lose money on
                                     the race. The balance of the betting pool remaining after
                                     reductions for takeout and ‘‘breakage’’ (the odd cents not paid
                                     to winning bettors because payoffs are rounded down to the
                                     nearest dime), is paid out to the winning bettors.
                                        Petitioner argues that, in extracting takeout from the bet-
                                     ting pools, ‘‘[t]he tracks are acting in the capacity of a fidu-
                                     ciary, i.e., collection of taxes and fees which they are remit-
                                     ting to the different state and local tax authorities.’’ He
                                     likens the process to that of an ‘‘employer collecting payroll
                                     taxes from the employees and remitting them to the IRS and
                                     the state agencies.’’ He argues that his pro rata share of the
                                           7 The
                                              various types of straight or conventional wagers (i.e., bets to win,
                                     place, or show) and exotic wagers (e.g., exacta, quinella, and trifecta bets)
                                     each form separate and distinct parimutuel betting pools. See, e.g., Cal.
                                     Bus. & Prof. Code sec. 19412 (West 2008).




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                                     (151)                          LAKHANI v. COMMISSIONER                                        157


                                     takeout constitutes the business expense of a professional
                                     gambler and, as such, is not a loss from wagering trans-
                                     actions subject to disallowance under section 165(d). In sup-
                                     port of that argument, petitioner relies primarily upon our
                                     Opinion in Mayo v. Commissioner, 136 T.C. 81, 97 (2011), in
                                     which we held that nonwagering business expenses claimed
                                     in connection with carrying on a gambling business are
                                     deductible under section 162(a) and not subject to the section
                                     165(d) limitation on the deductibility of wagering losses.
                                       At trial, petitioner argued that he is entitled to deductions
                                     or losses under section 162, 165, or 212 on the basis of a
                                     blended (average) takeout rate of 19% as applied to his
                                     wagers for the years at issue. On brief, he states his willing-
                                     ness to settle for a ‘‘minimum 15% take out percentage’’ as
                                     applied to those wagers. In the gambling loss years, he cal-
                                     culates that that would result in expense or loss deductions
                                     of $64,235 for 2005, $78,359 for 2006, $66,624 for 2007, 8
                                     $46,919 for 2008, and $36,535 for 2009. 9 He argues for the
                                     deductibility of those amounts on the basis of Cohan v.
                                     Commissioner, 39 F.2d 540 (2d Cir. 1930), which holds that,
                                     in the absence of adequate substantiation of deductible
                                     expenditures, the taxpayer is entitled to a deduction, under
                                     section 162, for a reasonable estimate of such expenditures.
                                     See id. at 543–544. Only for 2009 does petitioner’s estimated
                                     takeout deduction exceed his disallowed net wagering loss. In
                                     the other three gambling loss years, the alleged takeout
                                     deduction covers only a fraction of the net wagering loss dis-
                                     allowance. See supra note 5.



                                       8 The deductibility of petitioner’s 2007 wagering losses is not in dispute

                                     because they did not exceed his 2007 wagering gains. Therefore, they are
                                     fully deductible against those gains under sec. 165(d).
                                       9 It is unclear whether petitioner is arguing that he should be able to de-

                                     duct those amounts in full or only that presumably lesser portion of each
                                     amount corresponding to the taxes and license fees paid by the track. On
                                     brief, he asks that we uphold his deducting the amounts that ‘‘he paid to
                                     the race tracks for taxes and licenses which in turn paid the same to the
                                     state and local [government]’’. The distinction is of no matter since we re-
                                     ject his argument that he is entitled to any deduction on account of take-
                                     out.




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                                     158                  142 UNITED STATES TAX COURT REPORTS                                     (151)


                                           b. Applicability of Section 165(d)
                                       Petitioner argues that section 165(d) does not apply to the
                                     expenses, including the net wagering losses, of a professional
                                     gambler. Petitioner states his position as follows:
                                           Professional gamblers should be allowed the same protection as any
                                           other profession when the activity is legal and conducted as a profession.
                                           In a lawful and democratic society, Congress enacted this law many dec-
                                           ades ago, only because at that time, ‘‘gambling was taboo’’. Now gam-
                                           bling is legal in most States in the Union and this law is unjust, not
                                           interpreted correctly. In my opinion the intention of Congress, even then,
                                           was not to penalize any profession but to prevent abuse when it was con-
                                           ducted as a recreation. Section 165(d) should be considered unconstitu-
                                           tional and struck down as gambling is part of American life and profes-
                                           sional gamblers are recognized in society and on television.

                                     In support of his view that, today, section 165(d) constitutes
                                     a discriminatory, unconstitutional deprivation of professional
                                     gamblers’ right to the equal protection of the laws, petitioner
                                     cites the following paragraph from our Memorandum Opinion
                                     in Tschetschot v. Commissioner, T.C. Memo. 2007–38, 2007
                                     WL 518989, at *5, in which we sustained the disallowance of
                                     a professional poker player’s net losses from tournament
                                     poker against the taxpayer’s equal protection argument:
                                             The moral climate surrounding gambling has changed since the tax
                                           provisions concerning wagering were enacted many years ago. Not only
                                           has tournament poker become a nationally televised event, but casinos
                                           or lotteries can be found in many States. Further, the ability for the
                                           Internal Revenue Service to accurately track money being lost and won
                                           has improved, and some of the substantiation concerns, particularly for
                                           professionals, no longer exist. That said, the Tax Court is not free to
                                           rewrite the Internal Revenue Code and regulations. We are bound by the
                                           law as it currently exists, and we are without the ability to speculate
                                           on what it should be. * * *

                                     Petitioner responds to the last two sentences of the quoted
                                     excerpt from Tschetschot with the hope that ‘‘the judiciary is
                                     at some time [presumably, meaning this Court in this case]
                                     going to take a bold stance and help to reverse section 165(d)
                                     of the Internal Revenue Code.’’
                                        Lastly, petitioner relies on Cronan v. Commissioner, 33
                                     B.T.A. 668, 670 (1935), and Beaumont v. Commissioner, 25
                                     B.T.A. 474, 482 (1932), aff ’d, 73 F.2d 110 (D.C. Cir. 1934),
                                     in which we acknowledged with approval the Commissioner’s




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                                     (151)                           LAKHANI v. COMMISSIONER                                        159


                                     position that losses incurred in betting on horse races for
                                     profit where legal are deductible.
                                           2. Respondent’s Arguments
                                         With respect to petitioner’s alleged right to a deduction for
                                     his pro rata share of the takeout, respondent argues (1)
                                     because takeout is paid from the pool remaining from losing
                                     bets, 10 it ‘‘is inseparable from the wagering transaction and
                                     constitutes wagering losses’’ subject to the section 165(d)
                                     limitation and (2) the taxes, license fees, and other expenses
                                     discharged from the takeout are expenses owed and paid by
                                     the track, not by the individual bettor. Respondent also
                                     argues that, even if a deduction for takeout were available to
                                     petitioner, his failure to furnish the factual information nec-
                                     essary to make a reasonable determination of the takeout
                                     percentage applicable to his losing bets (e.g., the extent to
                                     which those bets were attributable to the various parimutuel
                                     pools with varying takeout percentages at tracks in various
                                     States) is sufficient to bar petitioner’s right to a passthrough
                                     deduction for takeout.
                                         With respect to petitioner’s equal protection argument,
                                     respondent points out that, in Tschetschot, we rejected that
                                     argument on the basis of our holding in Valenti v. Commis-
                                     sioner, T.C. Memo. 1994–483, 1994 WL 534499. In Valenti,
                                     after noting the historical distinction between gambling and
                                     other forms of business activity, we held that ‘‘a classification
                                     that differentiates the business of gambling from other busi-
                                     ness has ‘a rational basis, and when subjected to judicial
                                     scrutiny * * * [it] must be presumed to rest on that basis if
                                     there is any conceivable state of facts which would support
                                     it’ ’’. Id., 1994 WL 534499, at *4 (quoting Carmichael v. S.
                                     Coal & Coke Co., 301 U.S. 495, 509 (1937)). We concluded:
                                     ‘‘The argument that section 165(d) violates equal protection
                                     as applied to those engaged in the trade or business of gam-
                                     bling borders on the frivolous.’’ Id. Thus, respondent argues
                                     that petitioner’s equal protection argument is contrary to set-
                                     tled law and, therefore, should be rejected.
                                           10 As
                                             noted supra, the takeout percentage is applied to the entire betting
                                     pool, but, because the winning bettors are entitled to recover the amounts
                                     of their bets (i.e., the amounts they contributed to the pool) plus their
                                     winnings, the takeout must, of necessity, come from the losing bets.




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                                     160                 142 UNITED STATES TAX COURT REPORTS                                     (151)


                                           B. Analysis
                                           1. Petitioner’s Right to a Deduction for Takeout
                                        Petitioner makes no argument that a parimutuel betting
                                     pool is either a cost-sharing arrangement or a business entity
                                     (such as a partnership) in whose profits and losses he is enti-
                                     tled to share. His only argument is that, on his behalf, the
                                     track was paying his expenses, of a type, such as taxes and
                                     license fees, that he could deduct as, for instance, section
                                     162(a) ordinary and necessary business expenses. We agree
                                     with respondent that the taxes, license fees, and other
                                     expenses discharged from the takeout are expenses imposed
                                     upon the track, not the bettors. That that is so may be illus-
                                     trated by Cal. Code secs. 19400–19668, addressing horse
                                     racing and, in particular, secs. 19610–19619, addressing
                                     license fees, commissions, and purses.
                                        The term ‘‘association’’ is defined in Cal. Code sec. 19403
                                     to mean ‘‘any person engaged in the conduct of a recognized
                                     horse race meeting.’’ Cal. Code sec. 19411 defines parimutuel
                                     wagering. In pertinent part, that section provides: ‘‘The
                                     association distributes the total wagers comprising each pool,
                                     less the amounts retained for purposes specified in this
                                     chapter [i.e., the takeout], to winning bettors based on the
                                     official race results.’’ The amounts retained represent a
                                     percentage of the total amount handled in conventional and
                                     exotic parimutuel pools. Cal. Code sec. 19610 (West 2008).
                                     The actual percentage retained is 15% for conventional pools,
                                     16.75% for exotic pools; it is 17.75% for harness racing
                                     tracks. Id. Cal. Code sec. 19611 sets forth the portions of the
                                     takeout that thoroughbred associations must pay as license
                                     fees, distribute to the California Thoroughbred Breeders
                                     Association (for expenses, educational, and other purposes),
                                     or distribute as purses and commissions. Nowhere in the
                                     statute is responsibility for any of those payments imposed
                                     on persons making bets. 11
                                        11 Petitioner’s testimony at the trial, in which he agreed with respond-

                                     ent’s counsel that ‘‘all my bets are not on California horse tracks only’’, in-
                                     dicates that a substantial portion of his bets, probably a majority, were
                                     placed at tracks in California, his State of residence. Thus, California law
                                     applicable to takeout is particularly relevant to petitioner. Moreover, the
                                     various descriptions of parimutuel betting, in general, and takeout, in par-
                                     ticular, available on the Internet indicate that California’s treatment of




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                                     (151)                          LAKHANI v. COMMISSIONER                                        161


                                        Petitioner’s attempt to analogize the track’s retention and
                                     disbursement of takeout to an employee’s payroll tax obliga-
                                     tions with respect to his employees is misguided. First and
                                     foremost, none of the payments the track makes from the
                                     handle discharge any obligation of any bettor. And while
                                     reduction of the parimutuel pool by the amount of the take-
                                     out reduces the amount in the pool available to pay winning
                                     wagers (i.e., it reduces the bettor’s odds should he win 12),
                                     none of the takeout can be said to come from a winning bet-
                                     tor’s wager, which in all events must be returned to him in
                                     full and with at least a small profit. 13 Nor can the takeout
                                     be said to add to the loss of a losing bettor, who loses the
                                     same $2 whether the takeout is 15% of the handle, 20% of
                                     the handle, or none of it on account of a minus pool so deep
                                     as to deprive the track of any take after paying all winning
                                     wagers. 14 Moreover, not being an obligation or expense of
                                     the bettor, takeout cannot qualify as the bettor’s deductible

                                     takeout is typical of the other States where horse racing and parimutuel
                                     betting are permitted. See, e.g., Library Index, Sports Gambling, http://
                                     www.libraryindex.com/pages/1611/Sports-Gambling-PARI–MUTUEL–
                                     GAMBLING: ‘‘The management’s share [of a betting pool] is called the
                                     takeout * * * [which is] set by state law and is usually around 20%. * * *
                                     This money goes toward track expenses, taxes, and the purse. Most states
                                     also require that a portion of the take-out goes into Breeder Funds to en-
                                     courage horse breeding and health in the state.’’
                                       12 For example, assume 20% of a $100 parimutuel bet-to-win pool (i.e.,

                                     $20) is wagered on a particular horse, and that horse wins. If the track’s
                                     takeout with respect to that pool is 20%, so that only $80 is available to
                                     pay the winners, the odds on that horse to win will have been 3:1; i.e., the
                                     $20 bet on the horse will return to the bettors $80 (the original $20 bet
                                     plus a $60 (3 × $20) profit). If the track’s takeout is 0% so that the entire
                                     $100 pool is available to pay the winners, the odds on that horse to win
                                     will have been 4:1; i.e., the $20 bet on the horse will return to the bettors
                                     $100 (the original $20 bet plus an $80 (4 × $20) profit).
                                       13 And since the amount paid out from the pool is net of takeout, no win-

                                     ner needs a deduction to make the amount distributed to him correspond
                                     to the sum of (1) his wager and (2) his taxable gain.
                                       14 Petitioner virtually concedes that point on brief when he emphasizes

                                     the function of the takeout, noting that ‘‘racetracks do not operate for free,
                                     they have to pay to operate the racetrack * * * [p]lus they have to comply
                                     with the regulations promulgated by the Business and Professions Code
                                     and the [S]tate and local authorities to pay taxes to operate the racetrack.’’
                                     (Emphasis added.)




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                                     162                  142 UNITED STATES TAX COURT REPORTS                                     (151)


                                     nonwagering business expense under Mayo v. Commissioner,
                                     136 T.C. at 97.
                                       On the basis of the foregoing, we hold that petitioner is not
                                     entitled to a passthrough deduction, under section 162, 165,
                                     or 212, for a pro rata share of takeout.
                                           2. The Validity of Section 165(d)
                                        We agree with respondent that the reasoning in our
                                     Opinion in Valenti is dispositive of petitioner’s equal protec-
                                     tion claim. In Valenti, we held that the application of section
                                     165(d) to the net gambling losses of a professional gambler
                                     does not violate the gambler’s constitutional right to the
                                     equal protection of the laws. We would add to Judge Raum’s
                                     refutation of the taxpayer’s argument to the contrary only
                                     that the dissipation, in recent times, of the historical moral
                                     opposition to gambling does not undercut the ‘‘rational basis’’
                                     for treating professional gambling losses differently from
                                     other business-related losses. H.R. Rept. No. 73–704 (1934),
                                     1939–1 C.B. (Part 2) 554, is the report of the Committee on
                                     Ways and Means accompanying H.R. 7835, 73d Cong. (1934),
                                     which, as enacted, became the Revenue Act of 1934, ch. 277,
                                     48 Stat. 680. The Revenue Act of 1934 sec. 23(g), 48 Stat. at
                                     689, is the predecessor to section 165(d), and H.R. Rept. No.
                                     73–704, supra, 1939–1 C.B. (Part 2) at 570, explains that
                                     new provision as follows:
                                              Section 23(g). Wagering losses: Existing law does not limit the deduc-
                                           tion of losses from gambling transactions where such transactions are
                                           legal. Under the interpretation of the courts, illegal gambling losses can
                                           only be taken to the extent of the gains on such transactions. A similar
                                           limitation on losses from legalized gambling is provided for in the bill.
                                           Under the present law many taxpayers take deductions for gambling
                                           losses but fail to report gambling gains. This limitation will force tax-
                                           payers to report their gambling gains if they desire to deduct their gam-
                                           bling losses.

                                     The basis for the enactment of section 23(g), as set forth in
                                     the last sentence of the foregoing committee report, still per-
                                     tains to taxpayer reporting of gambling gains and losses.
                                     Therefore, it still constitutes a ‘‘rational basis’’ for the contin-
                                     ued application of section 165(d) to the losses. 15 There being
                                        15 The problem of unreported gambling gains has been mitigated, but not

                                     eliminated, by the payor’s obligation to report and, in some cases, withhold
                                     Federal and State taxes from large winnings. See IRS Form W–2G,




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                                     (151)                          LAKHANI v. COMMISSIONER                                        163


                                     no constitutional impediment to the continued application of
                                     section 165(d), we reiterate our admonition in Tschetschot
                                     that this Court ‘‘is not free to rewrite the Internal Revenue
                                     Code and regulations * * * [but is] bound by the law as it
                                     currently exists’’. Tschetschot v. Commissioner, 2007 WL
                                     518989, at *5. See also Nitzberg v. Commissioner, 580 F.2d
                                     357, 358 (9th Cir. 1978), rev’g T.C. Memo. 1975–228, and
                                     Mayo v. Commissioner, 136 T.C. 81, 90 (2011), both of which
                                     hold that a professional gambler’s wagering losses in excess
                                     of wagering gains are nondeductible under section 165(d).
                                        Lastly, we note that petitioner’s reliance on our decisions
                                     in Cronan and Beaumont is misplaced as both those
                                     decisions involved tax years before the effective date, and
                                     were superseded by the 1934 enactment, of section 23(g).
                                           C. Conclusion
                                       Petitioner is not entitled to deduct all or any portion of his
                                     net gambling losses.
                                     II. Imposition of the Section 6662(a) Accuracy-Related Penalty
                                           A. Applicable Law
                                        Section 6662(a) and (b)(1)–(3) provides for an accuracy-
                                     related penalty (penalty) in the amount of 20% of the portion
                                     of any underpayment attributable to, among other things,
                                     negligence or intentional disregard of rules or regulations
                                     (without distinction, negligence), any substantial understate-
                                     ment of income tax, or any substantial valuation
                                     misstatement. Although the notices issued to petitioner state
                                     that respondent bases his imposition of the penalty upon
                                     ‘‘one’’ of the three above-referenced grounds, it is clear that
                                     only the first two (negligence and substantial understate-
                                     ment of income tax) are potentially applicable herein.
                                        A substantial understatement of income tax exists for an
                                     individual if the amount of the understatement exceeds the
                                     greater of 10% of the tax required to be shown on the return
                                     or $5,000. See sec. 6662(d)(1)(A). At the conclusion of the
                                     trial, the Court asked respondent to provide the Court with
                                     computations, incorporating the issues settled before trial,
                                     that would show whether there would be a substantial
                                     understatement of income tax for each of the years at issue

                                     Certain Gambling Winnings, and accompanying instructions.




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                                     164                  142 UNITED STATES TAX COURT REPORTS                                     (151)


                                     assuming we found for respondent on the section 165(d)
                                     issue. In response to that request, on May 16, 2013,
                                     respondent filed a status report for each of the consolidated
                                     cases establishing that petitioner’s understatements of
                                     income tax for the years at issue are substantial as they
                                     exceed both 10% of the correct tax and $5,000. 16 Therefore,
                                     we need not consider the grounds for determining whether
                                     petitioner was negligent within the meaning of section
                                     6662(b)(1).
                                       Section 6664(c)(1) provides that the penalty shall not be
                                     imposed with respect to any portion of an underpayment if
                                     a taxpayer shows that there was reasonable cause for, and
                                     that the taxpayer acted in good faith with respect to, that
                                     portion.
                                           The determination of whether a taxpayer acted with reasonable cause
                                           and in good faith is made on a case-by-case basis, taking into account
                                           all pertinent facts and circumstances. * * * Circumstances that may
                                           indicate reasonable cause and good faith include an honest misunder-
                                           standing of * * * law that is reasonable in light of all of the facts and
                                           circumstances, including the experience, knowledge, and education of the
                                           taxpayer. * * * [Sec. 1.6664–4(b)(1), Income Tax Regs.]
                                           B. Analysis
                                        Under section 7491(c), respondent bears the burden of
                                     production, but not the overall burden of proof, with respect
                                     to petitioner’s liability for the section 6662(a) penalty. See
                                     Higbee v. Commissioner, 116 T.C. 438, 446–447 (2001). We
                                     have previously stated that the ‘‘burden imposed by section
                                     7491(c) is only to come forward with evidence regarding the
                                     appropriateness of applying a particular addition to tax or
                                     penalty to the taxpayer.’’ Weir v. Commissioner, T.C. Memo.
                                     2001–184, 2001 WL 829881, at *5. By demonstrating that
                                     petitioner’s understatements of income tax exceed the thresh-
                                     olds for a finding of ‘‘substantial understatement of income
                                     tax’’ under section 6662, respondent has satisfied his burden
                                     of production.
                                        On brief, petitioner argues that he ‘‘should not be liable for
                                     the section 6662 penalty * * * because * * * [he] was not
                                     aware of section 165(d) * * * [,] there was reasonable cause
                                           16 Although
                                                   petitioner did not incur (and, therefore, did not report) a net
                                     wagering loss for 2007, there was, nonetheless, a substantial understate-
                                     ment of income tax for that year attributable to petitioner’s carryover of
                                     net wagering losses from prior years.




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                                     (151)                          LAKHANI v. COMMISSIONER                                        165


                                     and * * * [he] acted in good faith with respect to the under-
                                     statement * * * [,] [he] did not intentionally ignore the law
                                     [, and he] exercised due care in reporting the numbers on his
                                     tax returns’’. We held in Carlebach v. Commissioner, 139
                                     T.C. 1, 16–17 (2012), that a taxpayer cannot avoid the
                                     application of the section 6662(a) penalty by pleading that he
                                     acted with reasonable cause and good faith on account of his
                                     ignorance of the applicable law. As we stated in that case: ‘‘A
                                     taxpayer’s ignorance of the law is no excuse for failure to
                                     comply with it.’’
                                        Moreover, petitioner, a certified public accountant with an
                                     active tax preparation practice, and admittedly aware of sec-
                                     tion 165 governing the deductibility of losses, should have
                                     been aware of the section 165(d) limitation on net gambling
                                     losses. Also, as a professional gambler who regularly bets on
                                     horse races and understands parimutuel betting, he must
                                     have known that takeout represents the track’s share of the
                                     betting pool and that the expenditures therefrom satisfy
                                     obligations of the track, not the bettors. Moreover, as
                                     respondent points out, petitioner’s argument that he is enti-
                                     tled to deduct a pro rata portion of the takeout was not
                                     reflected on his returns for the years at issue and, more than
                                     likely, represents an argument developed for trial rather
                                     than a good-faith position taken at the time he prepared
                                     those returns.
                                           C. Conclusion
                                       Petitioner is liable for the section 6662(a) accuracy-related
                                     penalty for the years at issue.
                                                                        Decisions will be entered under Rule 155.

                                                                               f




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