Appeal from a Decision of the United States Tax Court. Tax Ct. No. 15221-87.
Thomas Tang, Stephen Reinhardt and Charles Wiggins, Circuit Judges. Opinion by Judge Tang.
Petitioners Preben Norgaard and Sandra Norgaard reported gambling winnings on their 1983 tax return. They also declared offsetting gambling losses on their tax return for that year. The Internal Revenue Service ("I.R.S.") audited and disallowed the loss deductions. A deficiency notice for the tax owed was mailed to the Norgaards, as well as for a fraud penalty, and a penalty for substantial understatement of income tax due. The taxpayers contested the imposition of the deficiency and penalties in the tax court. The tax court held that the Norgaards had failed to substantiate the losses, that they were negligent, and liable for the penalty for substantial understatement. The Norgaards appealed. We affirm the tax due determination, but reverse the penalty assessments.
FACTUAL AND PROCEDURAL BACKGROUND
Preben and Sandra Norgaard, at all relevant times, lived in San Diego, California. Preben was employed by his father as a residential property manager in San Diego at the Mission Hills Apartments. The Norgaards reported this income for 1983 in the amount of $15,790. Mr. Norgaard did not have a personal checking account, but paid personal expenses with checks drawn on the Mission Hills' business checking account. He withdrew additional money from the account to support his gambling activities.
During 1983, Mr. Norgaard placed wagers at the Hollywood Park racetrack in Inglewood, California and at the Del Mar racetrack in Del Mar, California. He frequently attended the races with his father and brothers and had season tickets to the racetrack for approximately fifteen years. During the course of 1983, Preben Norgaard won five bets amounting to a total of $29,958. The racetracks sent informational W-2G forms on these bets to the I.R.S. indicating the amount of the winnings and the amount withheld for taxes. Mr. Norgaard deposited one of his large gambling wins, a check for $10,958 in the Mission Hills account.
On the Norgaards' joint tax return for the 1983 tax year, the Norgaards reported gambling income from the racetrack in the amount of $29,958. The Norgaards also reported offsetting losses in the amount of $29,958. The I.R.S. audited the Norgaards and requested that they substantiate their gambling losses. At the first interview, Mr. Norgaard presented $34,106 worth of losing wagering tickets to Revenue Agent Neil Stein. At the second interview, an additional $7,352 worth of losing tickets was presented.
The I.R.S. disallowed $29,216 of the claimed $29,958 gambling losses and assessed a tax deficiency in the amount of $6,805.37. The I.R.S. also assessed additions to tax for fraud, 26 U.S.C. § 6653(b), or alternatively, for negligence, 26 U.S.C. § 6653(a), and for substantial understatement of income tax due, 26 U.S.C. § 6661.*fn1 The Norgaards petitioned in the tax court to contest the deficiency and additions to tax. The I.R.S. conceded the fraud penalty at trial.
At trial, the Norgaards proceeded pro se. Mr. Norgaard produced losing racetrack tickets totaling $57,526. The tickets were clean and untorn indicating that they had not been salvaged from the ground. The tickets were for the most part sequentially numbered. Myers v. Commissioner, T.C. Memo 1976-191, 1976 T.C. Memo 191, 35 T.C.M. (CCH) 823, 826 (1976). The Norgaards contend that they also produced a contemporaneous record of the wagers in the daily programs from the racetrack. The record does not reflect that Mr. Norgaard presented these daily programs to the trial court nor did the tax court enter them into evidence. The Norgaards introduced evidence of nineteen cancelled checks drawn on the business account for the property he managed. Most of the checks had the notation "Que Sera," which indicated to Preben that the money was to be used for wagering. Some of the checks also bore notations such as "supplies/locks." Mr. Norgaard testified that these notations indicated that he reimbursed himself for purchases made on behalf of his employer. Mr. Norgaard also testified that he was not "religious" about writing "Que Sera" on the checks representing gambling stakes. Mr. Norgaard testified that he kept all of his winnings, daily programs, and losing tickets in a brown bag, which he produced at trial. The record does not reflect that either the bag or the tickets were offered into evidence. He testified also that it was his practice to receive his winnings for large wins in the form of checks and to deposit those checks in his bank account.
Mr. Norgaard testified he calculated his claimed losses by using a "bankroll" method. He compared the withdrawals during 1983 for his gambling activities from the Mission Hills account with the deposits made to the same account. At the end of 1983, he determined that those withdrawals were greater than the deposits and that the brown bag in which he kept his winnings contained no money. Therefore, he concluded that his gambling losses exceeded his winnings for 1983.
The tax court found that Mr. Norgaard, his brothers and his father, had saved some of their gambling tickets. However, the tax court held that the Norgaards had failed to meet their burden of proof to substantiate their claims for gambling losses. It found that Mr. Norgaard did not keep a daily log or other contemporaneous record of his gambling winnings, gambling losses, or amounts that he wagered in 1983. The tax court found that the losing tickets introduced had only slight evidentiary weight because the only corroboration was Mr. Norgaard's statement that he purchased each one. The court found that, on at least ten race dates, the aggregate dollar amount of gambling tickets presented to the I.R.S. exceeded the amount of tickets presented at trial. The tax court concluded that it had no way of knowing whether Mr. Norgaard purchased the tickets or "picked up the discarded stubs of disheartened bettors." Additionally, the tax court found that Mr. Norgaard reported only those winnings which were reported to the I.R.S. via the W-2G forms. He admitted to additional wins, but had no idea how large those wins were. The tax court concluded that Mr. Norgaard had established neither his true gambling income nor the relation of his losses thereto, and thus the court could not apply the rule of Cohan v. Commissioner, 39 F.2d 540, 543-44 (2d Cir. 1930) which allows for an approximation of the taxpayer's loss deduction. Thus, the claimed gambling losses were denied in full.
The Norgaards were found liable for the additions to tax for negligence under 26 U.S.C. § 6653(a)(1) and (a)(2) (1983). Finally, the tax court held that the Norgaards were liable pursuant to 26 U.S.C. § 6661(a) (repealed 1989), for additions to tax because of the substantial understatement of the tax due in 1983.
The Norgaards appeal the disallowance of their gambling losses as well as the additions to tax because of negligence ...