                  T.C. Summary Opinion 2010-55



                     UNITED STATES TAX COURT



            HOYT M. AND HELEN J. ORR, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11017-07S.              Filed April 26, 2010.



     Hoyt M. and Helen J. Orr, pro sese.

     Horace Crump, for respondent.



     MORRISON, Judge:   This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect

when the petition was filed.1   Pursuant to section 7463(b), the

decision to be entered is not reviewable by any other court, and



     1
      All section references are to the Internal Revenue Code
(Code) in effect for the year in issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated.
                               - 2 -

this opinion shall not be treated as precedent for any other

case.

     Respondent Commissioner of Internal Revenue (i.e., the IRS)

determined a deficiency in the Orrs’ 2004 federal income tax of

$16,653 and a section 6662(a) accuracy-related penalty of $3,331.

Petitioners Helen J. Orr (Orr) and Hoyt J. Orr (Orr’s husband)

disagree with the IRS’s determination.   The issues for decision

are (1) whether the Orrs are entitled to a deduction for Orr’s

net gambling loss because she was a professional gambler rather

than a casual gambler, (2) whether they are liable for an

accuracy-related penalty for a substantial understatement of

income tax for erroneously claiming the gambling-loss deduction

and omitting certain retirement benefits, and (3) the extent to

which the Orrs omitted certain retirement benefits from their

return.   We conclude that section 165(d) prohibits the Orrs from

deducting the net gambling loss even though Orr was a

professional gambler.   We further conclude that the Orrs are not

liable for the penalty because they acted in good faith and

because (a) Orr’s husband’s disabling illness, (b) Orr’s

diminished mental capacity associated with severe depression, and

(c) Orr’s efforts to prepare the return together constitute

reasonable cause for the errors.   We will direct that the parties

address the issue of whether the retirement benefits the Orrs did

report on their return are a portion of the amount the IRS says
                                - 3 -

they omitted (which may mean that their taxable income and

deficiency are lower than the IRS claims) or are a separate

amount through a Rule 155 computational proceeding.

                              Background

     Orr suffered from depression in and about 2004, the year in

issue.   (The record before the Court does not describe Orr’s

mental condition precisely.    We follow her in calling it simply

“depression”.)   Her condition is associated with diminished

mental capacity to address even moderately complex

responsibilities.   Her boss at the railroad for which she worked

“saw [she] was more than a little disturbed”, and sent her to a

psychologist, who sent her to a psychiatrist.   The psychiatrist

put her on medication and directed that she take a leave of

absence.   Later, in 1999, the railroad granted her early

retirement on account of permanent disability.2,3


     2
      The record reflects that the Orrs received payments from
the Railroad Retirement Board, but it does not reflect that they
received any payments from a particular railroad. It seems
possible, therefore, that Orr’s employer did not itself grant her
permanent disability benefits but instead helped her to apply for
Railroad Retirement Board disability benefits. We infer that
either organization would have required proof of disability.
     3
      On brief, the IRS suggested that we should not believe
Orr’s trial testimony thus describing her diagnosis of severe
depression on the ground that the testimony lacks corroboration.
But the IRS did not question the substance of or basis for the
testimony at trial or argue that it did not then have sufficient
notice of the issue of Orr’s depression and diminished mental
capacity. We observe that the testimony is congruous with Orr’s
undisputed overall explanation for becoming a professional
                                                   (continued...)
                               - 4 -

     Orr’s depression appears to have arisen, at least in part,

from a series of unfortunate circumstances that would have been a

severe emotional drain for almost anyone.    In 1994, Orr’s husband

was diagnosed with an illness believed to be terminal.    Some time

later, Orr’s elderly, ill mother came to live with the Orrs.      In

2000, Orr’s mother died.   In further explaining why she was

depressed, Orr also noted that she lost two brothers in one year

(about the time her mother died, we infer, although she did not

say which year).

     Orr’s husband was present at trial but did not participate

except to identify himself.   He appears not to have had any

significant economic activity during 2004.    (Some of the

retirement benefits at issue appear to have been his, and some of

the interest and dividends the Orrs received and some of the

shares they sold during 2004 may have belonged to him or the Orrs

jointly.)   We infer that he relied on Orr to prepare the Orrs’

joint return, which both he and she signed.    We find that his

illness was reasonable cause for him to rely on Orr to prepare

the return correctly.4   Moreover, nothing before the Court




     3
      (...continued)
gambler and otherwise apparently credible, and we reject the IRS’
challenge on this point.
     4
      Each spouse is generally responsible for ensuring that a
joint return the couple files is timely and correct. See LaBelle
v. Commissioner, T.C. Memo. 1984-69.
                                - 5 -

suggests that he did not act in good faith.    Substantially all of

the issues in this case thus relate solely to Orr.

     Orr’s mental ability was, as she testified, “very, very

limited” in 2004.5

     Orr’s economic activities for 2004 basically consisted of

losing money to gambling and to scams.    The Orrs also received

retirement benefits, dividends and interest, and sold some

shares.

     Orr decided to take up gambling as a business around the end

of 2003.   The parties agree that she gambled professionally

throughout 2004.6    It appears that all of her gambling for the

year was part of her gambling business.




     5
      She also testified, and we accept, that to some extent her
mental abilities were still diminished even at the time of trial.
     6
      For tax purposes, the term “professional gambler” refers to
a gambler who gambles as a “trade or business” (or simply a
“business”, as there appears not to be any distinction between a
“trade” and a “business” for tax purposes). See, e.g., Hochman
v. Commissioner, T.C. Memo. 1986-24. To be engaged in an
activity as a business, one must be engaged in that activity (1)
with regularity and continuity and (2) primarily for the purpose
of profit. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).
There need not actually be a profit or even a reasonable
expectation of profit. Dreicer v. Commissioner, 78 T.C. 642,
644-645 (1982), affd. without published opinion 702 F.2d 1205,
1983 U.S. App. LEXIS 30334 (D.C. Cir. 1983). Consequently, our
use of the term “professional gambler” does not imply
sophistication.
                               - 6 -

     Orr had previously been a casual gambler.7   She apparently

began to gamble heavily around the time her mother came to live

with the Orrs.8   Her metamorphosis into a professional gambler

was likely inspired by winning a $1.2 million jackpot at a casino

in 2003.   Even though, as she explained, Orr still had a “lot of

money” at the end of 2003, “it never registered on [her]”.    She

thought she “needed a job”, but that nobody would hire her.

Therefore, after consulting three other gamblers who said they

made their living through gambling, she decided to take up

gambling as a business.   She explained that her professional

gambling activity differed from her earlier casual gambling

activity in that she made a greater effort to learn to gamble

profitably.

     Although Orr became a professional gambler “to try to win

some money”, she now realizes that “it was not a smart decision.”

Orr found that she could not make money at blackjack or poker,

games in which a skilled player may in some circumstances

reasonably expect to profit over time.   Nor could she make money

at craps, a game in which it is generally accepted that one

playing under typical casino rules cannot reasonably expect to

profit over time.   She then focused on slot machines.


     7
      A casual gambler is a gambler who is not a professional
gambler. Hochman v. Commissioner, supra.
     8
      Orr explained that her mother enjoyed being taken to the
casino regularly.
                                - 7 -

     Slot machines are devices that allow the player to engage in

simple games of chance.    It is generally accepted that a slot-

machine player cannot reasonably expect to profit over time.      Orr

tried various misguided “strategies” in her attempt to make money

playing slot machines.    Not surprisingly, they failed.   As

discussed in more detail later, Orr had an overall loss of about

$200,000 from gambling in 2004.

     Orr had two other ventures during 2004.9   These appear to

have been scams of which she was a victim.    She described one as

“some kind of a program for grants and setting up a Web site, and

they talked about how you could get grants to--for different

things.   They concentrated on low-income housing and housing

prospects.”   The promoters’ high-pressure tactics would have

warned most people to stay away:    Orr had to agree up front to

pay for the program for 39 months, and the program was promoted

to her through a seminar at which she “had to sign up then or not

sign up.”   She signed up, and had expenses of $1,360 for the Web

site business for 2004 but “was mentally unable to do anything

with it” and never received any money through it.

     Another, for which Orr received $1,920 in 2004 (which she

reported as gross income) but “never even got my original money

back” (suggesting that she had over time “invested” a greater



     9
      The IRS does not dispute that these activities were
businesses for tax purposes.
                                - 8 -

amount), was an arrangement that would supposedly “multiply” her

investment every 90 days.   She now thinks that it “was just fed

by people coming in and paying * * * to begin with”, meaning that

it was a Ponzi scheme.   We infer that she was correct.10

     Orr prepared the Orrs’ 2004 joint return (the “return”)

herself.   She used the tax-preparation software TurboTax to

prepare the return.    She used the program because she wanted to

avoid computational errors, not because she wanted the program to

tell her the appropriate tax treatment of the gambling business

(or any other item).   As she recalls (and as we find for purposes

of deciding this case), TurboTax did not give her any warning

that the amount of gambling losses she claimed might not be

deductible.11

     The Orrs reported the tax consequences of the three

businesses on three respective Schedules C, Profit or Loss from

Business (Sole Proprietorship), attached to the return.     These

Schedules C are simple, and apparently required little accounting



     10
      Orr did not mention this business in her petition, nothing
suggests that the IRS had even informal notice that it would be
addressed at trial, and the parties address it only briefly in
the course of a general explanation of the entries on the Orrs’
return. Consequently, we conclude that it is not appropriate to
redetermine the Orrs’ gross income from that business, or to
determine that they suffered any loss from it.
     11
      We understand that Orr did not receive a warning to review
her entries for the gambling business either on the ground that
the deductibility of gambling losses is limited or on a less
specific ground such as that the amounts were unusually large.
                               - 9 -

work to prepare.   (Orr kept track of her winnings and losses for

the gambling business by using a “player’s club card” issued by a

casino.   Apparently, she gambled only at one casino, or perhaps

one group of related casinos, during 2004.12)    The IRS does not

question the accuracy of the Schedules C except in arguing that

the net gambling loss is nondeductible.

     The Schedule C for the gambling business identified the

business as “Gambling”.   It listed “Other income” of $909,058 (an

amount, the parties have stipulated, consisting entirely of

“gross winnings”);13 travel expenses of $10,780 on the designated

line; and “Other expenses”, described specifically as “gambling

losses”, of $1,113,766.   It stated on the designated line that

the net loss for the business was $215,488.     Of this amount, the

IRS challenges the deductibility of $204,708, which is the excess

of the amounts Orr bet over her proceeds from the bets.    We refer

to this excess as the “net gambling loss”.




     12
      We understand that a “player’s club card” is a card
resembling a credit card by means of which a gambler enables a
casino to automatically track the gambler’s winnings and losses.
See, e.g., Merkin v. Commissioner, T.C. Memo. 2008-146.
     13
      It appears that the Orrs may have reported their gross
receipts from gambling (including, for instance, all coins paid
out of slot machines) as gross income, and their gross
expenditures on bets (including, for instance, all coins inserted
into slot machines) as losses. As discussed later, this practice
may not have been technically correct, but the IRS does not
challenge the practice’s correctness, and the use of the practice
probably does not in itself prevent the correct determination of
their tax liability.
                              - 10 -

     The Schedule C for her Web site business (described as

“computer web site and affordable homes for rent”) listed five

items of expenses, each apparently a sum of monthly fees that she

paid to the promoter of the business, for Web site maintenance,

or for banking or similar services, which totaled to the $1,360

loss she reported for the business.    The Schedule C for her

business which now seems to have been a Ponzi scheme described

the business as “reading advertisements” and listed the $1,920 in

payments she received as both gross receipts and gross income.

     The Orrs reported $16,470 on the return’s line entitled

“Pensions and annuities”, and, of this, $9,529 on the return’s

next line, entitled “Taxable amount” (of the “Pensions and

annuities”).   As we explain later, it is not clear whether these

entries reflect some portion of the Railroad Retirement Board and

Social Security benefits the couple received, which would mean

that the remainder of those amounts may contribute to a

deficiency; or whether the entries reflect other income, which

would mean that the entirety of the Railroad Retirement Board and

Social Security benefits may contribute to a deficiency.

     The Orrs reported several thousand dollars in interest and

dividend income and about $100,000 in capital gains (from a sale

of shares of Norfolk Southern stock; as one line in the short-

term capital gain and loss schedule and another in the long-term

schedule indicate, sales of “various amsouth funds”, which we
                                 - 11 -

infer probably means mutual-fund shares; and capital-gain

distributions, probably from the mutual funds) on the return.14

These entries were not complex, and the IRS did not question

them.

     The Orrs did not report any further items on the return

other than the standard deduction, personal exemptions, and

credits for a small amount of tax already paid.

     Orr deducted the entire net loss of $215,488 from the

gambling business against all of the Orrs’ other income for the

year in computing the taxable income to be reported on the

return.      The result was a reduction of taxable income to zero.

     We now turn to Orr’s attempts to determine how to properly

report her gambling business.      She focused on the deductibility

of gambling losses.

     In filing the Orrs’ return for 2003, a year in which she was

a casual gambler, Orr had limited the Orrs’ gambling-loss

deduction to their gambling winnings.      In response to a question

by counsel for the IRS at trial, she explained that she filed

this way not because of section 165(d) (a provision that she did

not seem to fully understand even by then), but because an IRS

publication explained that she should do so.      She believed that




        14
      Nothing before the Court suggests that receiving these
gains reflected special skill or judgment.
                               - 12 -

the guidance in the IRS publication did not apply for 2004

because she had become a professional gambler.

      Orr did not inquire as systematically or thoroughly as a

sophisticated tax practitioner might.     She did not examine the

Code, tax regulations, or a treatise on tax law.     But she

satisfied herself that (1) she was a professional gambler (which

is correct) and (2) therefore her gambling losses could offset

her other income in the same manner as most other business losses

would (which, as discussed later, is incorrect).

     Orr made limited attempts to seek advice from tax

professionals and from other professional gamblers.15    She did not

have a regular tax adviser at the time.

     Orr visited an IRS office in Chattanooga, Tennessee.      One

IRS employee there, who appeared to be new, expressed doubt that

she could claim the deduction; while another in the next cubicle

said, as Orr recalls:   “I’ve seen it done; I don’t know how they

do it, but I know that it’s been done.”

     Orr did legal research.   She went to the main library at a

courthouse in Trenton, Georgia.   The librarian there was unable

to help Orr except to suggest that she go to the courthouse’s tax


     15
      These people were not called as witnesses. Given Orr’s
overall situation, it seems possible that she may not have fully
understood their advice. We find, however, that she testified
honestly, and that an honest misunderstanding of their advice
(which we would accept in the light of her situation) would
similarly inform our consideration of whether there was
reasonable cause for the errors on her return.
                                - 13 -

library.    There was no librarian or anyone else at the tax

library to help her.    On her own, Orr found the case of

Commissioner v. Groetzinger, 480 U.S. 23 (1987), which we discuss

later.     She believed (as she continued to believe throughout the

proceedings in this case) that it meant that a professional

gambler can deduct gambling losses in the same manner that one

engaged in a business can generally deduct losses.    She did not

find any other materials there that she understood to be

relevant.

     Orr went to a lawyer whom someone had recommended to her.

The lawyer explained that he was not a tax practitioner, but

recommended an accountant, Ben Hill.

     Orr asked Hill whether she could claim the deduction.     She

recalls that Hill responded:    “I’m not saying it can’t be done,

but I don’t know.”

     Orr also approached another accountant.    This second

accountant had in the past filed returns for another gambler.

But she would not tell Orr about the tax treatment of gambling

losses because she wanted a fee and Orr did not want to pay her.

The other professional gamblers that Orr knew would not discuss

their tax affairs with her.
                              - 14 -

     Orr relied in part on her past experience as a tax preparer.

She had “done business taxes”16 and understood that “you deduct

business losses” (a proposition that is correct generally, but

subject to numerous exceptions and limitations).   She “used to be

familiar with taxes” and had worked as a tax preparer at the

mass-market tax-preparation company H&R Block.   At trial, counsel

for the IRS did not ask Orr about her work at H&R Block, and the

record before the Court reveals very little about it.   We do not

know when she worked there, how long she worked there, what kinds

of tax work she did there, or what kinds of skills they involved.

We infer that she worked there well before 2004 because her early

retirement for permanent disability was granted by the railroad,

not H&R Block, and because she was unable to find any job after

beginning to receive benefits.17   We also do not know what further

tax experience she may have had.   Her legal research and analysis

leading to this case, and the form and content of her arguments

in it, indicate that her understanding of tax law is limited.

See Kees v. Commissioner, T.C. Memo. 1999-41.

     After filing the return, in preparing for this case (or the

administrative proceedings which led to it) Orr obtained a copy



     16
      We do not know what kind of “business taxes” these were.
She could have, for instance, merely prepared simple Schedules C
to IRS Forms 1040, U.S. Individual Income Tax Return, to report
individuals’ business activities.
     17
      We do not know what Orr’s job at the railroad was, but the
record does not indicate that it was tax related.
                               - 15 -

of Commissioner v. Groetzinger, supra, from legal-research

provider Westlaw.    The parties attached this copy to the

stipulation.   She also read the Web site “Professional Gambler

Status”, at www.professionalgamblerstatus.com, and attached an

excerpt from its “Case Law” page, to the Orrs’ pretrial

memorandum.    The Web site discusses various differences in the

tax treatment of casual and professional gamblers and reproduces

several gambling-related Tax Court opinions.

     The Web site “Professional Gambler Status” repeatedly and

consistently states that net gambling losses are not deductible,

for professional as well as casual gamblers, and explains what

section 165(d) is and what it means.    But since the Web site is

fairly large and complex, we infer that one suffering from

diminished mental capacity might well fail to recognize the

significance of the Web site’s material about net gambling

losses’ being nondeductible for professional as well as casual

gamblers.   The Court asked Orr whether she had seen parts of the

Web site that referred to section 165(d), which by that point in

the trial had been repeatedly described to her as the section of

the Code that, in the IRS’ view, would generally disallow net

gambling losses.    She said she had, but that she had understood

other parts of the site to be more important.    We accept this

explanation.
                                             - 16 -

        The IRS issued a notice of deficiency to the Orrs for 2004.

The explanatory material accompanying the notice showed that the

deficiency and penalty on the notice resulted from the following

determinations.          One determination appears to be that the Orrs

received the $30,391 in now-stipulated retirement benefits

discussed earlier, that the now-stipulated taxable portion of

those benefits was $25,832, and that this entire taxable portion

was to be added to their income because none of it had been shown

on the return.18          Another determination was that no deduction was

allowed for the net gambling loss.                     A third determination was



        18
      The IRS Notice CP2000 accompanying the notice of
deficiency asserts as follows that the Orrs failed to report any
of the stipulated retirement benefits:

                                                                   Amount       Amount
                                                                  Reported    Included
 Item                                              Account       to IRS by     on Your
  No.        Issue        Received From          Information       Others       Return   Difference

 1       Social          US Railroad        SSN [for Orr]          $ 17,784          -            -
         Security/       Retirement Board   Form 1099-SSA
         Railroad
         Retirement

 2       Social          Social Security    SSN [for Orr’s         $ 12,607          -            -
         Security/       Administration     husband]
         Railroad                           Form 1099-SSA
         Retirement

                         Social Security/Railroad Retirement       $ 30,391        $ -          $ -
                         Total [Fn. ref. omitted.]


     In another table, it asserts that the taxable amount of
these benefits is $25,832:

    Changes to Your                                    Reported to IRS,
 Income and Deductions        Shown on Return          or as Corrected            Difference

 Social                                         $ 0              $ 25,832                  $ 25,832
 Security/Railroad
 Retirement
                                 - 17 -

that a section 6662 accuracy-related penalty was imposed for the

substantial understatement of income tax due to these alleged

errors.

     The record before the Court does not indicate that Orr had

notice before she filed the 2004 return that she was incapable of

complying with her tax obligations on her own.     For example, it

does not indicate that any tax-return errors for previous years

had been revealed by an audit.

     The Orrs timely filed a petition for redetermination of

their deficiency in which they “request[ed] that professional

gambler status be granted.”     The IRS agrees that Orr’s gambling

activity was a business in 2004.     Thus, the contention in the

petition is moot.     Even so, the main issues actually relevant to

the Orrs’ tax liability for 2004--the omission of certain

retirement benefits, the deductibility of net gambling losses,

and the existence of reasonable cause to except the Orrs from an

accuracy-related penalty for errors on their return--are properly

before the Court because the IRS presented them in its pretrial

memorandum19 and addressed them without objection at trial and in

its posttrial brief.20


     19
      We appreciate the IRS’ introduction of these issues, which
are genuine issues that the Orrs appear not to have grasped on
their own. It likely helped them to more fully present their
case to the Court.
     20
          Since the Orrs have the burden of proof on these issues
                                                       (continued...)
                                 - 18 -

                               Discussion

I.   Deductibility of Net Gambling Loss

     The Orrs present several theories why they are entitled to

deduct their net gambling loss (i.e., the $204,708 excess of the

amounts Orr bet over her proceeds from bets).21    The IRS argues

that section 165(d), which provides that “[l]osses from wagering

transactions shall be allowed only to the extent of the gains

from such transactions”, makes the loss nondeductible, noting

that we held in Valenti v. Commissioner, T.C. Memo. 1994-483,

that section 165(d) denies professional gamblers deductions for

their net gambling losses.22    We agree with the IRS, and we


     20
      (...continued)
under Rule 142(a)(1), they benefit from our decision to consider
the issues at all.
      21
      Since the Orrs are representing themselves, we have
construed their arguments liberally. Cf., e.g., Erickson v.
Pardus, 551 U.S. 89, 94 (2007). Some of the Orrs’ theories of
why their net gambling loss should be deductible are procedurally
improper because the Orrs raised the theories only in their reply
brief. Since we can determine on our own that these theories are
not correct, we need not consider whether to reject them as
untimely or give the IRS an opportunity to respond to them.
      22
      The IRS does not dispute that Orr’s gambling-related
travel expenses are deductible. Courts have disagreed on whether
the sec. 165(d) limitation applies only to net losses from bets
themselves (for instance, an excess of money paid into a slot
machine over money paid out from the slot machine) or also to
other expenses (such as travel expenses) that constitute part of
an overall loss from a gambling activity. A recent IRS internal
memorandum, AM2008-013, summarizes precedent on each side of the
issue and concludes that because the statute refers to wagering
“transactions”, which the memorandum asserts to be a narrower
term than “activity” or others used in comparable provisions,
                                                   (continued...)
                               - 19 -

explain our reasoning in the course of addressing the Orrs’

various arguments.

     The Orrs argue that the status of Orr’s gambling as a

business made the net gambling loss deductible.   In support of

this argument, they present Commissioner v. Groetzinger, 480 U.S.

at 35, Clemons v. Commissioner, T.C. Summary Opinion 2005-109,

and Panages v. Commissioner, T.C. Summary Opinion 2005-3.23

     However, Groetzinger, Clemons and Panages do not focus on

whether a net gambling loss arising in a gambling business is

deductible.24   Groetzinger held that gambling losses to the extent


     22
      (...continued)
sec. 165(d) addresses only net losses from bets themselves as
described above, which we discuss as “net gambling losses”. For
this case, we accept the parties’ agreement that the Orrs’
gambling-related travel expenses are not limited by sec. 165(d)
because this position has a reasonable basis in law. (An
internal memorandum does not normally bind the IRS, but it may
cite law and contain reasoning that can inform our consideration
of a case.)
      23
      Although sec. 7463(b) prohibits us from treating Clemons
v. Commissioner, T.C. Summary Opinion 2005-109, and Panages v.
Commissioner, T.C. Summary Opinion 2005-3, as precedent, meaning
that we cannot base our decision in this case on having made a
similar decision on comparable facts in those cases, we consider
the law they address and the reasoning they contain in deciding
whether the Orrs’ treatment of their net gambling loss was
correct.
      24
      We understand, however, how Orr, who suffers from
diminished mental capacity, might infer from them that net
gambling losses are deductible. Commissioner v. Groetzinger, 480
U.S. 23 (1987), discusses the status of a gambler as a
professional and a deduction for gambling losses; Clemons and
Panages discuss the status of gamblers as casual gamblers and
unavailability of certain tax benefits. The Web site
                                                   (continued...)
                                - 20 -

of gambling winnings are deductible in computing alternative

minimum taxable income (under the significantly different

alternative minimum tax rules in effect for 1978), and discussed

more generally what kinds of activities constitute a business for

tax purposes.    Clemons and Panages both concluded that a casual

gambler must include gambling winnings in gross income and may

deduct gambling losses that do not exceed winnings as an itemized

deduction.25    As discussed later, treatment of a deduction as

“above-the-line” or “itemized” affects various other tax items.


     24
      (...continued)
“Professional Gambler Status”, from whose “Case Law” page Orr
printed excerpts from Clemons and Panages, uses bold text for
parts of the cases about status of gambling activities as a
business and about gambling losses being deducted on Schedule A,
Itemized Deductions, or Schedule C of Form 1040.
      25
      Commissioner v. Groetzinger, supra at 32, briefly and
indirectly discusses sec. 165(d)’s limitation on net gambling
losses, stating in dicta:

      the confinement of gambling-loss deductions to the
      amount of gambling gains, a provision brought into the
      income tax law as § 23(g) of the Revenue Act of 1934,
      48 Stat. 689, and carried forward into § 165(d) of the
      1954 Code, closed the door on suspected abuses
      * * * but served partially to differentiate genuine
      gambling losses from many other types of adverse
      financial consequences sustained during the tax year.
      * * *

     Note 3 in Panages v. Commissioner, supra, states that “If
petitioner qualified as a professional gambler for purposes of
sec. 162, she still could claim her losses only to the extent she
had gains. Sec. 165(d); Praytor v. Commissioner, T.C. Memo.
2000-282.”

     We infer that Orr did not understand the significance of the
foregoing passages.
                               - 21 -

     In their posttrial brief, the Orrs noted that there is no

mention of section 165(d) in section 162 (subsection (a) of which

provides that “There shall be allowed as a deduction all the

ordinary and necessary expenses paid or incurred during the

taxable year in carrying on any trade or business”).   Their

argument, we infer, is that section 165(d) does not limit the

scope of section 162.26   Although an explicit cross-reference

might make the law easier to understand, we reject this

argument.27

     Section 165(d) provides that “Losses from wagering

transactions shall be allowed only to the extent of gains from

such transactions.”28   The word “wagering” is synonymous with

“gambling”.   Tschetschot v. Commissioner, T.C. Memo. 2007-38

(generally, and in the federal tax context).



      26
      The brief states in relevant part: “In the case of a
taxpayer not engaged in the trade or business of gambling, losses
are allowable as a miscellaneous itemized deduction, but only to
the extent of gains. Professional gamblers have qualified as
being eligible to file as a business according to tax code
162(a). NO WHERE in irc code 162 does it mention 165(d).”
      27
      It appears that, at least until trial, Orr did not merely
draw an incorrect conclusion from the absence of a cross-
reference to sec. 165(d) but failed more generally to understand
the significance of that section and its relation to other tax
rules. Consequently, we need not focus on the absence of a
cross-reference in deciding whether Orr’s misunderstanding of law
is consistent with the reasonable-cause exception to the
accuracy-related penalty.
      28
      Sec. 1.165-10, Income Tax Regs., provides that this
limitation of wagering losses to wagering gains applies on a
year-by-year basis rather than over a shorter period.
                               - 22 -

     Section 165(d) denies a deduction for a net gambling loss

even if the loss is also described as a kind of generally

deductible item, such as a section 162(a) business expense, a

section 165(a) loss from a transaction entered into for profit, or

a section 212 expense for the production of income.     This broad

interpretation of section 165(d) is supported by its history, the

plain language of the Code, and, as discussed earlier, judicial

precedent.

     Congress first enacted the language now reflected in Section

165(d) as section 23(g) of the Revenue Act of 1934 (1934 Act), ch.

277, 48 Stat. 689.   According to committee reports, Congress

wished to reverse caselaw that allowed legal gamblers to deduct

their gambling losses against nongambling income:29

     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 taxpayers to report their gambling
     gains if they desire to deduct their gambling losses.

H. Rept. 704, 73d Cong., 2d Sess. 22 (1934), 1939-1 C.B. (Part 2)

554, 570, and S. Rept. 558, 73d Cong., 2d Sess. 25 (1934), 1939-1

C.B. (Part 2) 586, 605 (following the House committee’s language,

except in referring to the bill as the “House bill”).    Thus, the



     29
      See Beaumont v. Commissioner, 25 B.T.A. 474, 482 (1932),
affd. 73 F.2d 110 (D.C. Cir. 1934), for a discussion of gambling
taxation before the 1934 Act.
                               - 23 -

committee reports provide no support for an argument that Congress

intended to express any distinction between professional and

casual gambling in enacting section 23(g) of the 1934 Act.

Neither does any other authority of which we are aware.

     Section 23 of the 1934 Act is entitled “Deductions from Gross

Income”.   Its flush language is simply “In computing net income

there shall be allowed as deductions:”.    It set forth most of the

deductions allowable against gross income in computing net (i.e.,

taxable) income.30   These included, among others, business expenses

(section 23(a) of the 1934 Act, ch. 277, 48 Stat. 688) and losses

on transactions entered into for profit (sections 23(e)(1) and (2)

of the 1934 Act, ch. 277, 48 Stat. 689).

     The location of section 23(g) of the 1934 Act alongside the

other subsections of section 23, which in turn set forth most of

the deductions allowed by the Code (including the deduction for

business expenses), confirms what we believe to be the most

logical reading of section 23(g):   section 23(g) limited all net

gambling losses, even those that could also be described as

another kind of generally deductible item, such as business




     30
      The deductions not addressed in sec. 23 of the Revenue Act
of 1934 (the “1934 Act”) were generally limited to special
classes of taxpayers, such as trusts and estates, and lack
relevance to gambling transactions as such (addressing instead,
for example, distributions by trusts and estates). See sec.
162(b) of the 1934 Act, ch. 277, 48 Stat. 728.
                               - 24 -

expenses.31   The 1934 Act did not contain a provision similar to

current section 7806(b), which provides that “No inference,

implication, or presumption of legislative construction shall be

drawn or made by reason of the location or grouping of any

particular section or provision or portion of this title”.

     Section 23(g) of the 1934 Act came into the Internal Revenue

Code of 1939 as subsection (h) of section 23.   Ch. 2, 53 Stat. 13.

Section 23 of the 1939 Code was still entitled “Deductions from

Gross Income” and still contained most of the deductions allowed

under the income-tax law.

     The Internal Revenue Code of 1954, ch. 736, 68A Stat. 49,

brought what is now section 165(d) to its present location within

section 165, a section that addresses “Losses”.   The 1954 Code,

like the currently effective Internal Revenue Code of 1986, placed

section 165 in part VI of subchapter B of chapter 1, a part

entitled “Itemized Deductions for Individuals and Corporations”.

The 1954 Code placed some other kinds of deductions that might


      31
      It is a longstanding maxim of statutory construction that
if two statutes overlap, the later enacted statute prevails over
the earlier to the extent of the inconsistency. Posadas v.
National City Bank, 296 U.S. 497, 503 (1936). Business losses as
such had long been deductible at the time the 1934 Act introduced
disallowance of net gambling losses. (Until 1939, Congress’
regular practice was to enact a comprehensive tax statute
including incremental changes from the prior version rather than
to enact a statute containing only the incremental changes to a
longstanding code. Even so, the maxim is relevant because it
reflects, among other considerations, the legislature’s ability
to consider an older rule and take care in drafting the newer
rule to overlap it or not.)
                                - 25 -

address gambling losses, such as section 162 business expenses, in

other sections of part VI.    But other kinds of deductions that

might also address gambling losses, such as the section 212

deduction for expenses for the production of income, were placed

in part VII of subchapter B of chapter 1, a part that was entitled

“Additional Itemized Deductions for Individuals”.32

     Viewed in isolation, the 1954 Code’s rearrangement of the

1939 Code’s deduction-related provisions may appear to indicate a

significant change in the relationship of those provisions to each

other.    The designation of section 165(d) as a subsection of

section 165 (which, unlike section 23 of the 1934 Act and 1939

Code, contains only a few of the kinds of deductions the income-

tax law allows) might suggest that section 165(d) does not limit

deductions allowable under other sections of the Code (such as

section 162).   Similarly, the location of section 165(d) within

part VI of subchapter B of chapter I might suggest that it does




     32
      Valenti v. Commissioner, T.C. Memo. 1994-483, describes
the history of what is now sec. 165(d):

     Moreover, the provisions in section 165(d) first
     appeared in our revenue law as section 23(g) of the
     Revenue Act of 1934, ch. 277, tit. I, 48 Stat. 689.4
     * * *
            4
           The provisions were redesignated section 23(h) in
     the Revenue Act of 1938, ch. 298, 52 Stat. 447, 461,
     and continued as such in the 1939 Code until they
     became the current section 165(d) as enacted in the
     1954 Code.
                               - 26 -

not limit deductions allowable under other “parts” of the Code

(such as part VII, which contains section 212).

      However, the House and Senate reports on the 1954 Code stated

that “Rules for the treatment of losses contained in various

subsections of section 23 of the 1939 Code have been brought

together in [section 165].   * * * No substantive change is made by

this rearrangement.”   H. Rept. 1337, 83d Cong., 2d Sess. A46

(1954); S. Rept. 1622, 83d Cong. 2d Sess. 198 (1954).   In

addition, the 1954 Code introduced section 7806(b) (inference of

legislative construction not to be drawn from location or grouping

of provisions of Code) in its present form, carrying forward

similar language from section 6 of the introductory “enacting

clause” of the statute containing the 1939 Code (ch. 2, 53 Stat.

1).   Section 7806(b) confirms that the designation of section

165(d) as a subsection of a section addressing only a particular

kind of deduction (the deduction for certain “losses”) does not in

itself prevent section 165(d) from applying to other kinds of

deductions.33


      33
      Sec. 165(d)’s use of sec. 165’s term “losses”, rather than
the sec. 162 and 212 term “expenses”, might also in isolation
suggest that the sec. 165(d) limitation does not extend to
deductions described in the latter sections. But we and other
courts have consistently held that net gambling losses incurred
in a business are nondeductible under sec. 165(d) and its
predecessors. See, e.g., Nitzberg v. Commissioner, 580 F.2d 357,
358 (9th Cir. 1978); Valenti v. Commissioner, supra; Skeeles v.
United States, 118 Ct. Cl. 362, 371-372, 95 F. Supp. 242, 246-247
(1951). Although gambling losses may be described as, for
                                                    (continued...)
                               - 27 -

II.   Applicability of Section 165(d) to Orr’s Gambling

      The Orrs make a comment in their posttrial brief that we

construe as an argument that section 165(d) should not be applied

to Orr’s gambling activity because no meaningful distinction can

be drawn between her gambling activity and other activities whose

net losses are undisputedly deductible.   The brief says:

      When Mr. Eric Evans, of the IRS office in Birmingham,
      interviewed us for our preliminary court case,[34] we
      mentioned losing a lot of money in the stock market[35]
      and Mr. Evans said “another form of gambling” and so it
      is, yet, these losses are deductible. Webster’s defines
      gamble as to play a game for money, to take risks in the
      hope of getting better results than by some safer means;
      to stake one’s money. Any business anywhere in the
      world is a risk, i.e., gamble. If you can name one that
      is not a risk, I and many others would like to
      participate in that business.

      Conway Twitty (Harold Jenkins) started a restaurant
      (Twitty Burgers) with 75 of his friends investing in the
      business. The business went under in 1971 and Mr.
      Twitty reimbursed his friends for their losses and



      33
      (...continued)
instance, “ordinary and necessary expenditures directly connected
with or pertaining to the taxpayer’s trade or business” (sec.
1.162-1, Income Tax Regs., describing sec. 162 business
expenses), nothing suggests that they thereby cease to be
“losses”.
       34
      At trial, Orr testified that “Eric in the Appeals court”
gave her the copy of Commissioner v. Groetzinger, 480 U.S. 23
(1987), which the parties attached to their transcript. We infer
that Eric Evans was an officer in the IRS Office of Appeals,
which offers taxpayers an opportunity to attempt to resolve their
disputes with the IRS in a relatively informal setting.
       35
       Nothing else in the record addresses these losses. We
infer they may have occurred in years other than the one in
issue.
                                - 28 -

     claimed and was allowed the reimbursements as business
     expenses.[36]

     We reject this argument.     Even if it is difficult to define

the outer reaches of the term “gambling”, it is undisputed that

what Orr did was gambling.   To hold that playing a slot machine is

not gambling would be an absurd interpretation of the word

“wagering” in section 165(d).37    Furthermore, such a holding would

be tantamount to saying that there is no activity that qualifies

as gambling, which would render section 165(d) surplus language.

See Calafati v. Commissioner, 127 T.C. 219, 229 (2006)     (“all



     36
      The Court characterized the reimbursements as expenses of
preserving the famous country singer’s reputation, which we found
to be essential to his country music business.

     Had Conway not repaid the investors
     His career would have been under cloud,
     Under the unique facts of this case
     Held: The deductions are allowed.

Excerpt from “Ode to Conway Twitty”, Jenkins v. Commissioner, T.C.
Memo. 1983-667 n.14.
     37
      The Orrs appear to argue that defining gambling to include
slot-machine playing would require the equally absurd result that
every business is “gambling”. It does not. Courts interpreting
“gambling” for tax purposes have followed common understandings
of the term which do not include most businesses. For instance,
betting on horse races (Schooler v. Commissioner, 68 T.C. 867,
867-868 (1977)), bookmaking (Winkler v. United States, 230 F.2d
766 (1st Cir. 1956)), playing poker (Tschetschot v. Commissioner,
T.C. Memo. 2007-38), and playing slot machines (Chow v.
Commissioner, T.C. Memo. 2010-48; LaPlante v. Commissioner, T.C.
Memo. 2009-226) are all “gambling”. But speculating in junk
bonds is not “gambling”. Jasinski v. Commissioner, T.C. Memo.
1978-1. See also Skeeles v. Commissioner, supra at 365-367, 95
F. Supp. at 242-243 (betting on sports, cards, and dice is
gambling).
                               - 29 -

parts of a statute, if at all possible, are to be given effect”

(quoting Weinberger v. Hynson, Westcott & Dunning, Inc., 412 U.S.

609, 633 (1973))); Schoneberger v. Commissioner, 74 T.C. 1016,

1024 (1980).

III. Does Section 165(d) Unconstitutionally Discriminate Against
     Gambling Businesses?

     The Orrs ask in their brief:

          How can a business (professional gambler) be
     subject to self employment tax and yet be unable to
     claim business deductions as any other business. It is
     the only business the IRS places the restriction that
     can’t show a loss. What part of the law makes that
     distinction and is that constitutional? We understand
     our laws are created by Congress, but shouldn’t the
     rules made by the IRS be governed by someone?

     As we have discussed, section 165(d) contains the gambling-

loss limitation relevant to this case.    Section 165(d) is a part

of the Internal Revenue Code, a statute enacted and amended from

time to time by Congress.   Through section 7805 and other more

specific delegations of authority, Congress has authorized the

Department of the Treasury, of which the IRS is a part, to issue

official interpretations of the Code.    But we do not base our

decision that a professional gambler is not entitled to deduct

gambling losses in excess of gambling gains upon an IRS

interpretation.   We base it on the language and history of the

Code and a longstanding principle of statutory construction.

     We acknowledge that the Internal Revenue Code treats gambling

less favorably than most other businesses.    But we have previously
                               - 30 -

rejected the argument that the Constitution does not permit

Congress to single out the business of gambling for unfavorable

tax treatment.   See Valenti v. Commissioner, supra; cf. Gordon v.

Commissioner, 63 T.C. 51, 80-81 (1974) (addressing unfavorable

treatment of gambling income under “income averaging” provisions

of prior law), revd. in part on other grounds 572 F.2d 193 (9th

Cir. 1977).   In Valenti, we noted that “the due process clause of

the Fifth Amendment has been construed as imposing an equal

protection requirement in respect of classification” by the

federal government, but that the Supreme Court has recognized

legislatures to have wide powers to distinguish between even

closely related businesses in the exercise of their taxing powers.

We cited the extensive history of gambling set forth in Skeeles v.

United States, 118 Ct. Cl. 362, 365-368, 95 F. Supp. 242, 242-244

(1951) in observing that “Plainly, a classification that

differentiates the business of gambling from other business [may

be justified in that it] has ‘a rational basis, and when subjected

to judicial scrutiny * * * must be presumed to rest on that basis

if there is any conceivable state of facts which would support

it.’”   Valenti v. Commissioner, supra (quoting Carmichael v. S.

Coal & Coke Co., 301 U.S. 495, 509 (1937)).
                                 - 31 -

IV.   Deductibility of the Net Gambling Loss “Above the Line”

      A.    The Classification of the Orrs’ Net Gambling Loss as an
            “Above-the-Line Deduction” Does Not Affect the Section
            165(d) Limitation

      The Orrs claimed their gambling losses on Schedule C, a

standard preprinted attachment to an individual income tax return

(IRS Form 1040).     The instructions for Form 1040 and Schedule C

provide for deductions listed on Schedule C to be claimed “above

the line”, which means that the deductions are subtracted in

computing adjusted gross income.    As we explain later, the Code

does provide for a professional gambler to deduct allowable

gambling losses “above the line”.

      The Orrs stated in their pretrial memorandum that they

believed the issue in this case is whether “To allow or disallow

gambling losses above the line.”     It is not.   The IRS did not

dispute that the Orrs could deduct the allowable losses “above the

line”.     The Orrs did not explain at trial or in their posttrial

briefs why they thought the IRS disagreed with an above-the-line

deduction for their gambling losses.

      We infer that the Orrs believed that deducting the losses

“above the line” would except the losses from the limitation of

section 165(d).     Such a belief would not be correct.   It is well

established that section 165(d) applies both to professional

gamblers, who, as discussed later, deduct their allowable gambling

losses above the line, and to casual gamblers, who deduct their
                                 - 32 -

allowable gambling losses below the line.    See, e.g., Tschetschot

v. Commissioner, T.C. Memo. 2007-38 n.7 (citing Boyd v. United

States, 762 F.2d 1369 (9th Cir. 1985), Offutt v. Commissioner, 16

T.C. 1214 (1951), and Heidelberg v. Commissioner, T.C. Memo.

1977-133).

     B.   Consequences of Deducting Business-Related Gambling
          Losses Above the Line

     A deduction which is subtracted from gross income to

determine adjusted gross income (AGI) is known as an “above-the-

line” deduction because it is taken into account above a

conspicuous line at the end of the section of Form 1040 relating

to AGI.   Section 62(a) lists the kinds of deductions that are

claimed “above the line.”     One set of above-the-line deductions is

“The deductions allowed by this chapter (other than by part VII of

this chapter)[38] which are attributable to a trade or business

carried on by the taxpayer, if such trade or business does not

consist of the performance of services by the taxpayer as an

employee.”   Sec. 62(a)(1).   Therefore, a professional gambler




     38
      The Code is divided into “subtitles”, “chapters”,
“subchapters”, “parts”, “subparts”, and “sections”. (Sec.
7806(b), discussed earlier, explains that this classification
does not in itself have any legal effect.) The subchapter to
which the quoted passage refers is entitled “Computation of
Taxable Income” (containing, as of the year at issue, secs. 61-
291), and the “part” whose deductions it excludes is entitled
“Additional Itemized Deductions for Individuals” (secs. 211-224).
                                - 33 -

claims allowable gambling losses and expenses as deductions above

the line.39

     Deductions other than (1) above-the-line deductions or (2)

the section 151 deduction for personal exemptions are known as

“itemized deductions”.   Sec. 63(d).     (An individual may claim

“itemized deductions” only if he or she does not claim the

“standard deduction”.    Sec. 63(e).)    Therefore, a casual gambler’s

gambling losses and expenses are normally itemized (i.e., “below-

the-line”) deductions.   See sec. 62(a); Hochman v. Commissioner,

T.C. Memo. 1986-24.

     Above-the-line deductions and itemized deductions both

generally reduce taxable income dollar-for-dollar.     But an above-

the-line deduction for a gambling loss is sometimes more valuable

than an itemized deduction because (a) a taxpayer is entitled to

claim an above-the-line deduction even if the standard deduction

is also claimed and (b) an above-the-line deduction reduces AGI,




      39
      Since sec. 62(a)(1) requires merely that the deductions be
attributable to a trade or business, not that they be deductible
under sec. 162, “Trade or Business Expenses”, this result does
not depend on whether the professional gambler’s deduction for
gambling losses (1) arises under sec. 162(a) and is limited by
sec. 165(d), see Valenti v. Commissioner, supra, or (2) both
arises under and is limited by sec. 165(d), see Humphrey v.
Commissioner, 162 F.2d 853, 855-856 (5th Cir. 1947) (holding that
sec. 23(h) of the 1939 Code, a predecessor to sec. 165(d), both
allowed gambling losses without regard to profit motive and
limited them to gambling gains), affg. in part and revg. in part
a Memorandum Opinion of this Court.
                                    - 34 -

and AGI is used to limit certain tax benefits.40       See Calvao v.

Commissioner, T.C. Memo. 2007-57 n.6 (discussing reduction of

certain itemized deductions by reference to adjusted gross income

under section 68); cf., e.g., sec. 170(b)(1)(A), (B), (F)

(relating to the deduction for charitable contributions).

        We noted earlier that Orr may have reported the Orrs’ gross

receipts from gambling as gross income and their gross

expenditures on bets as losses, and that even if technically

incorrect this practice probably does not in itself affect their

tax liability.        This follows in part from the fact that Orr, as a

professional gambler, deducts allowable gambling losses above the

line.        We and other courts have from time to time held that a

gambler’s gross income is properly determined by reducing gross

receipts from a particular bet, and, in the case of a professional

gambler, a series of related bets, by the amount wagered on those

bets.        (Any net loss would still be subject to section 165(d).)

See Winkler v. United States, 230 F.2d 766, 770-776 (1st Cir.

1956) (offsetting costs of related winning and losing bets by

professional gamblers against their proceeds from those related


        40
      Itemized deductions generally are disallowed to the extent
of 3 percent of AGI over a threshold amount for a taxpayer whose
income exceeds that amount, sec. 68(a), and certain itemized
deductions, classified as “miscellaneous itemized deductions”,
are disallowed to the extent they do not exceed 2 percent of
total AGI, sec. 67(a). But these disallowance rules do not apply
to gambling losses. See secs. 67(b)(3), 68(c)(3); H.R. Conf.
Rep. 99-841 (Vol. II), at II-34 (1986), 1986-3 C.B. (Vol. 4) 1,
34; Whitten v. Commissioner, T.C. Memo. 1995-508.
                               - 35 -

bets in determining gross income); McKenna v. Commissioner, 1

B.T.A. 326, 332-333 (1925); Hochman v. Commissioner, supra

(offsetting the cost of each of a casual gambler’s winning bets

against his proceeds from that bet in determining his gross

income).   These cases suggest that the Orrs may have overstated

their gross income and gambling losses by equal amounts by

treating the gross proceeds of winning bets as gross income and

treating the cost of making those bets as losses.   Equal

overstatements of gambling gross income and losses would not

change the net gambling loss disallowed under section 165(d), and

would increase the deductible gambling loss dollar-for-dollar with

the overstatements.   Since even an itemized deduction for net

gambling losses is not limited by sections 67(b)(3) and 68(c)(3),

such overstatements would not change taxable income.   Since a

professional gambler’s allowable gambling-loss deduction is

claimed above the line, the overstatements would not change AGI.41

We thus lose nothing by accepting the statement on the Orrs’

return that they had $909,058 in “gambling winnings”, the same

amount of gross income, and $1,113,766 in gambling losses from

their gambling business.


     41
      Nothing suggests that the Orrs have any tax item whose
treatment would be affected by the amount of their gross income
as such. The extent to which the Orrs would be taxable on their
Railroad Retirement Board and Social Security benefits may depend
in part on their “modified adjusted gross income”, which, like
AGI, would not be affected by equal overstatements of gambling
gross income and losses.
                                 - 36 -

V.   Substantial Understatement Penalty

     Section 6662(a) generally imposes a 20-percent penalty,

described in the section’s title as the “accuracy-related

penalty”, on underpayments of tax attributable to certain

circumstances, including, under section 6662(b)(2), a “substantial

understatement of income tax.”    Section 6664(a) defines an

“underpayment” for relevant purposes not simply as a lack of

payment but, in relevant part, as an excess of the correct tax

over the sum of (A) the amount shown as tax on the return and (B)

amounts not shown as tax on the return but previously assessed or

collected.   Since the Orrs paid only a small amount of tax before

filing the return and reported on the return that no tax was due,

the majority of their correct tax liability for the year was an

“underpayment” under section 6664(a).     (This is true regardless of

the precise amount of their omitted retirement benefits, which, as

we discuss later, remains to be determined.)    Section 6662(d)

provides that a substantial understatement of income tax is, with

exceptions not relevant here, the excess of the correct tax

required to be shown on the return over the tax shown on the

return, but only if that excess is greater than the greater of (1)

$5,000 and (2) 10 percent of the correct tax.42    Since the Orrs’


     42
      Sec. 6662(d)(2)(B) provides that a portion of an
understatement attributable to a position which, although
ultimately determined to be erroneous, is or was supported by
“substantial authority”, or has a “reasonable basis” and was
                                                    (continued...)
                                - 37 -

income tax for 2004 as properly determined without the deduction

for net gambling losses exceeds $5,000 (regardless of the precise

amount of the omitted retirement benefits), and the tax shown on

the return was zero, they have a substantial understatement of

income tax for the year.   It is undisputed that the entire

underpayment is attributable to the substantial understatement.

     Section 6664(c) provides that no penalty shall be imposed

under section 6662 with respect to any portion of an underpayment

if it is shown that there was a reasonable cause for such portion

and that the taxpayer acted in good faith with respect to such

portion.

     The Orrs argue that they had reasonable cause for omitting

the retirement benefits because Orr had diminished mental capacity

on account of her depression.   They further argue that if their

deduction of net gambling losses was in error (and it was, as we

have explained), Orr’s diminished mental capacity and unsuccessful

attempts to understand the law constitute reasonable cause.     As

discussed earlier, Orr’s husband was too ill to be expected to

ensure that the Orrs’ joint return was filed correctly.   The



     42
      (...continued)
adequately disclosed to the IRS, is not taken into account in
determining the existence of a “substantial understatement”.
Neither party argues that this rule is relevant. We need not
consider it because we decide that the Orrs are excepted from any
substantial-understatement penalty on the ground that they had
reasonable cause for and acted in good faith with respect to each
of their errors. See sec. 1.6662-3(b)(3), Income Tax Regs.
                               - 38 -

record does not indicate that anyone else had a duty to ensure the

return was correct:   there was no agent or guardian, for example.

Thus, we consider the reasonableness of the actions taken to

ensure the return was correct only in the light of Orr’s own

diminished mental capacity.

     The IRS argues that Orr’s attempts to understand the law were

not sufficient, and her mental capacity was not sufficiently

diminished to constitute reasonable cause.43    In support, it argues

that she was “able to carry out her gambling trade or business”

during 2004 and that one would generally be expected to be

familiar with the tax laws relating to one’s business.     It further

argues that Orr’s mental state was sufficient that she “could

adequately carry on her personal affairs”,     “take care of her

ailing mother and husband”, and “keep accurate business records of

her gambling enterprise as well as two other business

enterprises”; and that Orr’s implicit contention that she was a

novice in tax law research was undermined by her work for H&R

Block and her “familiarity with” TurboTax.




     43
      The IRS has the burden of production with respect to the
penalty, which has been met. See sec. 7491(c). Because we
affirmatively find that Orr suffered from diminished mental
capacity that constituted reasonable cause for the errors, we
express no view on which party had the burden of proof.
                               - 39 -

     The IRS did not contend that Orr acted in bad faith separate

from the argument that she did not have reasonable cause.44    The

kinds of activities Orr conducted in connection with filing the

return--doing legal research and discussing her situation with the

IRS, tax advisers, and colleagues--tend to indicate that she was

honestly attempting to file it correctly.   Her transactions are

consistent with a good-faith mistake:   she simply claimed a

deduction for an actual business loss, which, were it not for a

special rule, normally would be deductible.   She described the

transactions on her return clearly, as a business of “gambling” in

which she incurred “gambling losses”, making no attempt to hide

the tax issue, and enabling the IRS to easily determine whether an

examination would be appropriate.    Moreover, Orr’s omission of

some or all of the Orrs’ retirement benefits appears to be

essentially an “isolated computational or transcriptional error”

that “generally is not inconsistent with reasonable cause and good

faith.”   Sec. 1.6664-4(b)(1), Income Tax Regs.   Consequently, we

infer that if Orr’s mental capacity was sufficiently diminished

that she would have honestly understood her objectively flawed


     44
      The IRS concludes the section of its brief addressing the
accuracy-related penalty by stating that “petitioners in bad
faith and without reasonable cause tried to circumvent the
limitations of § 165(d)” but does not specifically explain why it
believes they acted in bad faith. If Orr’s mental capacity was
not sufficiently diminished for her to have believed that she had
done enough to ensure her return was correct, it would follow
that she did not act in good faith. But if that were the case,
she would not have reasonable cause for her errors, either.
                               - 40 -

efforts to file a correct return to be adequate (a point we

address later), she acted in good faith.

     Section 1.6664-4(b)(1), Income Tax Regs., interprets

“reasonable cause” for purposes of section 6664 in relevant part

as follows:

     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. * * * Generally, the most
     important factor is the extent of the taxpayer’s effort
     to assess the taxpayer’s proper tax liability.
     Circumstances that may indicate reasonable cause and
     good faith include an honest misunderstanding of fact or
     law that is reasonable in light of all the facts and
     circumstances, including the experience, knowledge and
     education of the taxpayer. * * *

     We have found tax compliance failures resulting from mental

illness, including severe emotional disturbance, to be due to

reasonable cause and not inconsistent with good faith. In Ruckman

v. Commissioner, T.C. Memo. 1998-83, we found reasonable cause for

an omission of income from a joint return where the spouse who

handled the couple’s finances was undergoing extensive treatments

for cancer and the other, who had long relied on her to handle

their finances, was “undoubted[ly] impact[ed] [by] having a spouse

battling a life-threatening illness”.   She, similarly to Orr,

testified that “I didn’t know that I wasn’t capable of what I was

trying to do.”   In Gray v. Commissioner, T.C. Memo. 1982-392, we

found reasonable cause for omissions of income from a joint return

(some of which omissions the taxpayers were unable to explain as
                               - 41 -

other than simply accidental) where one spouse became totally

disabled and required hospitalization periodically throughout the

year, placing a “significant emotional drain” on the other, who

read various publications in the course of taking what she

described as “great care” to file the return.   See also Kees v.

Commissioner, T.C. Memo. 1999-41.   (Some of the foregoing cases

address former section 6653, Additions to Tax for Negligence and

Fraud, a precursor to the current accuracy-related and fraud

penalties that was also subject to a reasonable-cause exception.)

     We are satisfied that Orr suffered from diminished mental

capacity that impaired her ability to file a correct tax return,

and that she was not sufficiently aware of this diminution for us

to find bad faith from her failure to do something more than she

did (such as her failure to hire a tax adviser).    Orr gave

undisputed testimony that her employer had granted her early

retirement for permanent disability on account of her depression.

She also stated, and we accept, that the fact of her disability

was certified by a doctor.   Her mother, for whom she had been

caring, had recently died; two of her brothers also had recently

died; and her husband had an illness, believed to be terminal,

which continued to require her care.    Her conduct of her

“businesses”, discussed later, corroborates that she did not

understand how far her mental capacity had diminished.   We have in

the past accepted evidence less extensive than what Orr presented
                                - 42 -

to establish diminished mental ability as reasonable cause for

penalty purposes.   See Ruckman v. Commissioner, supra (in which we

excused the couple from a penalty in part on the basis of the

“undoubted impact” upon the spouse who prepared the return of

having a spouse battling a life-threatening illness); Gray v.

Commissioner, supra.

     We noted earlier that in her pretrial memorandum Orr asserted

that the issue in this case was whether “To allow or disallow

gambling losses above the line” and that Orr believed that an IRS

publication’s statement that a net gambling loss was not

deductible did not apply to a professional gambler.      Informal IRS

guidance is not itself law, but a reasonable misunderstanding of

its discussions of law can be relevant to whether a taxpayer

should be excused from a penalty.45      See Gray v. Commissioner,

supra.    Because Orr did not explain which publication she used or

how it contributed to her error and because other evidence

suffices to establish reasonable cause, we do not consider her use

of the IRS publication.




     45
      It is well established that an ambiguity or error in
informal guidance, such as IRS form instructions and informal
publications, “cannot affect the operation of the tax statutes or
* * * [a taxpayer's] obligations thereunder.” See Weiss v.
Commissioner, 129 T.C. 175, 177 (2007). We have also held more
broadly that interpretations of tax law in these informal
materials are not authoritative. See Green v. Commissioner, 59
T.C. 456, 458 (1972).
                               - 43 -

     The IRS’ argument that Orr’s handling of her businesses

indicates that her mental ability was not so diminished as to

prevent her from filing a correct tax return is misplaced.    None

of Orr’s businesses had a reasonable potential for profit.    The

fact that she thought they did tends to show that her mental

capacity was diminished, and the fact that she persisted in them

tends to show that she did not know how far her mental capacity

had diminished.

     We reject the IRS’ argument that Orr’s ability to keep

financial records for her businesses indicates a high degree of

sophistication.   As discussed earlier, all of these records were

very simple.   The records indicate Orr’s ability to accurately

report the amounts of what she understands to be her income and

deductions--which, generally, she did.   But they do not indicate

an ability to adequately address the legal issue of whether a

professional gambler may deduct net gambling losses.

     We reject the IRS’ argument that Orr’s care for her ailing

mother and husband, or her ability to “carry on her personal

affairs” meant that she did not have reasonable cause for the

errors on the return.   Nothing suggests that Orr’s care for her

mother and husband reflected a degree of sophistication relevant

to tax return preparation rather than simply hard work.   Her

ability to care for them suggests at most that she may have had

the ability to perform periodic tasks, such as filing a tax return
                                 - 44 -

every year, which she did.     As discussed earlier, Orr’s handling

of her affairs did not reflect any degree of sophistication.     Her

employer had found her unable to do her job.    Her “businesses”

were illogical.    (The parties did not elaborate on the Orrs’ sales

of shares, but, as discussed earlier, these appear not to reflect

any particular skill or judgment.)     Tamberella v. Commissioner,

139 Fed. Appx. 319, 323 (2d Cir. 2005), affg. T.C. Memo. 2004-47,

which the IRS cites for the proposition that carrying on one’s

personal affairs indicates a lack of reasonable cause, is

distinguishable.   In Tamberella, we held and the Court of Appeals

for the Second Circuit affirmed that a taxpayer did not have

reasonable cause for an omission of income from his return on the

ground of mental incapacity.    We found that he had been

hospitalized for mental illness on two occasions--10 days near the

beginning of the year before the year at issue and 5 weeks a few

years after the year at issue--but that there was no evidence that

he suffered from any mental incapacity in the interim.      We also

found that during the tax year at issue he had represented himself

in an arbitration proceeding and settlement negotiations through

which he obtained a large employment-related award.    Mental

incapacity did not actually prevent that taxpayer from complying

with his tax obligations.    He was just trying to use mental

incapacity from an irrelevant period as an excuse for not

complying.
                                - 45 -

      The fact that Orr once prepared tax returns at H&R Block does

suggest that she had more relevant knowledge and experience than

the average taxpayer.   But we infer that her skills deteriorated

with time and with her overall mental capacity.   By the time she

prepared her 2004 return, she was neither able to determine the

correct treatment herself nor recognize that she was unable to do

so.   We note, moreover, that Orr’s way of addressing an issue she

found difficult would have been very roughly correct even for a

tax expert:   she consulted others in her industry, IRS employees,

accountants, a lawyer, and a law librarian, and considered these

people’s advice in the light of her own experience, research, and

analysis.    Orr should have made a greater effort to find someone

able to help her with her particular tax issue, but we find her

diminished mental capacity to be reasonable cause for this

omission.

      We reject the IRS’ argument that Orr’s “familiarity with

TurboTax” “undermines her contention that she is a novice in tax

law research.”   Nothing about Orr’s use of TurboTax suggests

special knowledge of tax law or tax law research.

      We have found before that taxpayers with substantial tax and

financial experience can become unable to prepare their returns

correctly.    In Gray v. Commissioner, T.C. Memo. 1982-392, the

spouse who prepared the return had for many years prepared returns

reporting the taxpayers’ farming activities.   In Ruckman v.
                               - 46 -

Commissioner, T.C. Memo. 1998-83, the spouse who prepared the

return had for many years maintained financial records for and

consulted with an accountant for the preparation of returns

reporting the taxpayers’ trucking activities.   (While those

taxpayers apparently had not prepared tax returns professionally,

the limited record before us does not show Orr’s experience to be

much greater than theirs.)   We accepted the distress Gray suffered

as a result of her husband’s becoming totally disabled and

requiring hospitalization from time to time throughout the tax

year, and the distress Ruckman suffered as a result of undergoing

extensive cancer treatments, as being reasonable cause for their

tax compliance problems.   We similarly accept as reasonable cause

for Orr’s significant but apparently isolated compliance problems

her diminished mental capacity associated with depression which

made her unable to work, her gambling problem, her recent loss of

multiple family members, and her responsibility of caring for her

ailing husband.

VI.   Computation of Retirement Benefits

      The stipulation of facts that the parties submitted jointly

at trial stipulated that the Orrs received and reported Railroad

Retirement Board and Social Security benefits totaling $30,391

(the stipulated retirement benefits):

      4. During the 2004 taxable year, the petitioners
      received retirement benefits of $17,784.00 from the U.S.
      Railroad Retirement Board and $12,607.00 from the Social
      Security Administration.
                                - 47 -

     5. The petitioners failed to report any of the
     retirement benefits on their 2004 federal income tax
     return.

In the Orrs’ reply brief, however, Orr argues that:

     I know retirement funds are taxable and I don’t know why
     I did not include them; I thought I had everything
     listed. I have enclosed a copy of Form 1040 showing I
     DID report $16,470 of which $9,529 was considered
     taxable.”[46]

The Orrs had reported $16,470 on the return’s line entitled

“Pensions and annuities”, and, of this, $9,529 on the return’s

next line, entitled “Taxable amount” (of the “Pensions and

annuities”).   Social Security and certain Railroad Retirement

Board benefits should have been entered on a different line,

entitled “Social security benefits” (with a corresponding line for

“Taxable amount”), on which the Orrs did not enter any amount.

2004 1040 Instructions at 24.   It seems possible, however, that

the Orrs mistakenly entered their Social Security and Railroad

Retirement Board benefits on the line for “Pensions and

annuities”:    these benefits are a kind of pension, in the generic

sense, and, like certain other pensions, they are only partially



     46
      We consider the partial copy of the Orrs’ return enclosed
with their reply brief merely an informal reference to the copy
of the return which the parties had earlier submitted as a joint
exhibit and stipulated to be authentic.

     Orr should not have waited until filing her reply brief to
introduce the retirement-benefits issue. But we consider it
because we conduct proceedings in sec. 7463 “small tax cases”
informally and because the IRS will have a full opportunity to
address the issue in a Rule 155 computational proceeding.
                                - 48 -

taxable.    See, e.g., secs. 72 (annuities, including certain

pensions), 86 (Social Security and Railroad Retirement Board

benefits).    Since the record before the Court does not specify the

source of the amounts they listed on the relevant lines,47 we do

not know whether the $16,470 of “pensions and annuities” they

reported were a part of the $30,391 of stipulated retirement

benefits or are a separate amount of income.

     If the Orrs reported some of the stipulated retirement

benefits on the return, only a part of the stipulated retirement

benefits (and only a part of their taxable portion) would properly

be added to the figures they had listed for “pensions and

annuities” in determining the Orrs’ taxable income, and tax, for

the year.    Alternately, the Orrs may simply have reported on the

return “pensions and annuities” other than the amounts to which

the stipulation refers.

     We decline to adopt paragraph 5 of the stipulation as a

finding of fact.   We may permit a party to contradict a

stipulation “where justice requires”, and “We are not bound by

stipulations of fact that appear contrary to the facts disclosed

by the record.”    Rule 91(e); Estate of Eddy v. Commissioner, 115

T.C. 135, 137 n.4 (2000); see also Jasionowski v. Commissioner, 66

T.C. 312, 318 (1976).   The record before the Court calls paragraph


     47
      Any relevant information returns or payee statements that
the Orrs may have filed with the return, such as IRS Forms 1099,
are not before the Court.
                                 - 49 -

5 into doubt, and we observe that Orr’s diminished mental capacity

makes her more likely than a typical litigant to have failed to

notice--despite exercising care reasonable in her circumstances--

that she had already reported an amount on her return.   Therefore,

we will leave (1) the portion of the Orrs’ “pensions and

annuities”, if any, that is separate from the stipulated

retirement benefits and (2) the portion of the stipulated

retirement benefits that is taxable for the parties to compute

under Rule 155.

     To reflect the foregoing,


                                          Decision will be entered

                                     under Rule 155.
