Appeal from the Circuit Court of McHenry County. No. 07-MR-40 The Honorable Maureen P. McIntyre, Judge, Presiding.
The opinion of the court was delivered by: Justice Birkett
JUSTICE BIRKETT delivered the judgment of the court, with opinion.
Presiding Justice Jorgensen and Justice Bowman concurred in the judgment and opinion.
Plaintiffs, Jerry and MaryLou Byrd (Byrds), brought an action for administrative review of the decision of the Illinois Department of Revenue (Department) that the Byrds' gambling winnings for tax years 1999, 2000, 2001, and 2002 are taxable income under Illinois law and that their gambling losses for those years are not deductible under Illinois law. The Byrds contend that the Department erred in finding that they were not engaged in gambling as a trade or business for those tax years but were recreational gamblers and, as such, not entitled to a deduction for gambling losses. The Byrds alternatively raise various constitutional challenges to the tax scheme in Illinois that permits deduction of gambling losses for individuals who gamble as a trade or business but not for those who gamble for recreation. For the reasons stated below, we confirm the decision of the Department.
The following is a sketch of the relevant facts, which will be set forth in greater detail below. The Byrds, who are married, gambled at several casinos during tax years 1999, 2000, 2001, and 2002. Most of their gambling occurred at Hollywood Casino in Aurora and Grand Victoria Casino in Elgin. The Byrds played mostly slot machines, and they accumulated substantial winnings and losses. The Byrds filed Illinois and federal tax returns for years 1999, 2000, and 2001, and a federal return for year 2002. As of the Department's decision in this case, the Byrds had not filed a 2002 Illinois return. After the Department reviewed the Illinois returns, it sent the Byrds a series of original and amended tax deficiency notices (NODs) claiming that the Byrds' reported income on their Illinois returns for 1999 to 2001 improperly excluded their gambling winnings. The Department likewise claimed that the Byrds' Illinois tax liability for 2002 included tax on their gambling winnings for that year. The Byrds challenged the NODs, and the Department ultimately found the Byrds liable for $60,382 in additional taxes. The trial court affirmed the Department's decision, and the Byrds appealed to this court.
A. Treatment Under Federal and Illinois Law of Gambling Winnings and Losses The facts of this case are best understood against the backdrop of federal and Illinois tax law concerning gambling winnings and losses. We begin by delineating that tax scheme.
The parties agree that Illinois tax law has no specific provision for gambling winnings or losses. Nevertheless, as the parties recognize, there are tax consequences for an Illinois taxpayer who incurs gambling winnings or losses. Part of the reason gambling has tax consequences for an Illinois taxpayer though Illinois law makes no specific provision for them is that the Illinois income tax law " 'piggy-backs' onto the federal calculation of income and uses federal taxable income as the premise for tax liability." Rockwood Holding Co. v. Department of Revenue, 312 Ill. App. 3d 1120, 1124 (2000). By virtue of this derivative relationship, Illinois taxpayers can enjoy the benefit of certain federal income tax exclusions or deductions that have no express parallel under Illinois law. See Bodine Electric Co. v. Allphin, 81 Ill. 2d 502, 509 (1980). This scheme works as follows for gambling winnings and losses. The Internal Revenue Code (IRC) (26 U.S.C. §61(a) (2006)) defines "gross income" for purposes of federal taxation as "all income from whatever source derived." Gambling winnings must be reported as gross income on the federal tax return. McClanahan v. United States, 292 F.2d 630, 631-32 (5th Cir. 1961). The only component of gambling winnings that a federal taxpayer may exclude from gross income is the cost of winning wagers, which is nontaxable as the recovery of capital. Shollenberger v. Commissioner of Internal Revenue, 98 T.C.M. (CCH) 667, 669 (2009) (a gambler's "gross income from a wagering transaction should be calculated by subtracting the bets placed to produce the winnings, not as a deduction in calculating adjusted gross income or taxable income but as a preliminary computation in determining gross income"); Hochman v. Commissioner, 51 T.C.M. (CCH) 311, 313 (1985) ("[t]o the extent that the cost of his winning ticket is included in the payoff which [the taxpayer] receives at the cashier's window on a winning race, *** [the taxpayer] has only recovered his capital, and is entitled to exclude the amount of that winning ticket from his gross receipts in order to arrive at gross income within the meaning of [the IRC]"). The cost of a wager that did not result in a win is considered a loss and is not excluded from gross income. Shollenberger, 98 T.C.M. (CCH) at 669. As one treatise has noted:
"The cost of placing a winning bet or wager isn't a deductible loss, but is rather a tax-free return of capital. The amount of income from a winning bet or wager is the full amount of the winnings less the cost of placing that winning bet or wager." 33A Am. Jur. 2d Federal Taxation §13258.1 (2005).
"C plays a slot machine that takes $5 tokens. He makes ten 'pulls.' He loses nine times, but on the tenth pull, he wins $100. The amount of his winning income is $95-the $100 win, less the cost of the $5 winning token. The $45 spent on losing tokens is a gambling loss." Id.
While gambling losses are not excluded from gross income, they are deductible under federal law with certain restrictions. How this deduction figures in the computation of federal tax depends on whether the gambling was recreational or rather in the nature of a trade or business. Gambling losses that qualify as trade or business losses are recorded on Schedule C of the federal tax return and are deducted from the taxpayer's "gross income" or "total income" in determining "adjusted gross income." 26 U.S.C. §62(a)(1) (2006) (calculation of adjusted gross income takes into account "deductions *** which are attributable to a trade or business carried on by the taxpayer"); 26 U.S.C. §162 (2006) ("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 ***."); Torpie v. Commissioner, 79 T.C.M. (CCH) 2064 (2000). As such, they are an "above the line" deduction. LaPlante v. Commissioner, 98 T.C.M. (CCH) 305, 307 (2009). Gambling losses not qualifying as trade or business losses do not figure in the calculation of total or gross income. Id. Rather, they are factored later, and thus are a "below the line" deduction. Id. Losses in casual gambling are among the itemized deductions taken from adjusted gross income to arrive at "taxable income." Id.; see 26 U.S.C. §63(a) (2006). This is a less favorable deduction than if those losses were deducted in the determination of gross or total income, as they would be in the case of a professional gambler.
LaPlante, 98 T.C.M. (CCH) at 307. Regardless, however, of whether the taxpayer is a professional or a casual gambler, "Losses from wagering transactions shall be allowed only to the extent of gains from such transactions." 26 U.S.C. §165(d) (2006).
As the parties agree, the Illinois Income Tax Act (Act) (35 ILCS 5/101 et seq. (West 2008)) has no specific provision for gambling winnings and losses. By virtue, however, of the Act's carryover of income figures from the taxpayer's federal return, the Act incorporates for state tax purposes the federal tax treatment of gambling winnings and losses. The incorporation is not wholesale, however. The starting figure for computing income tax under the Act is the taxpayer's "base income," which is "an amount equal to the taxpayer's adjusted gross income." 35 ILCS 5/203(a)(1) (West 2008). "[A]djusted gross income" is in turn defined as the "amount of *** adjusted gross income *** properly reportable for federal income tax purposes for the taxable year under the provisions of the Internal Revenue Code" (35 ILCS 5/203(e)(1) (West 2008)). Thus, the Act takes federal adjusted gross income as the "starting point" for calculation of state income tax. Bodine, 81 Ill. 2d at 510. "To the extent that federally allowed deductions enter into the computation of this figure, they are relevant under the *** Act." Id. However, the carryover of federal adjusted gross income does not create a set of Illinois deductions parallel to the federal deductions. Id. Rather, section 203(a)(2) of the Act (35 ILCS 5/203(a)(2) (West 2008)) provides that adjusted gross income as carried over from the federal return may be modified by the addition of certain amounts. Some of these are add-backs of amounts deducted from federal gross income to reach adjusted gross income. For instance, section 203(a)(2)(D) (35 ILCS 5/203(a)(2)(D) (West 2008)) provides for an add-back in "[a]n amount equal to the amount of the capital gain deduction allowable under the Internal Revenue Code, to the extent deducted from gross income in the computation of adjusted gross income." Also added back is (unsurprisingly) an amount equal to the amount of tax imposed under the Act "to the extent deducted from gross income in the computation of adjusted gross income for the taxable year." 35 ILCS 5/203(a)(2)(B) (West 2008). Section 203 provides no add-back, however, for trade or business losses deducted from federal gross income to reach federal adjusted gross income. If section 203 does not specify a certain add-back, it does not exist in the Act. See 35 ILCS 5/203(h) (West 2008) ("Except as expressly provided by this Section there shall be no modifications or limitations on the amount of income, gain, loss or deduction taken into account ***."). Thus, a deduction for gambling losses by professional gamblers is sub silentio incorporated into the concept of adjusted gross income under the Act.
The Act does not in the same respect incorporate a deduction for losses by casual gamblers. The starting point for the Act is federal adjusted gross income, but the itemized deduction for losses incurred in casual gambling comes later on the federal return and applies against adjusted gross income to calculate taxable income. See 26 U.S.C. §63(a) (2006); LaPlante, 98 T.C.M. (CCH) at 308. Thus, the deduction appears too late in the computation of federal tax to be carried over onto the Illinois return. Moreover, though section 203 of the Act provides for certain deductions from adjusted gross income, it does not explicitly allow a deduction of losses by casual gamblers. The omission is decisive. See 35 ILCS 5/203(h) (West 2008) (no modification of adjusted gross income unless expressly permitted in section 203); Bodine, 81 Ill. 2d at 509 (Act makes no express provision to "allow a State taxpayer to compute a net operating loss on a State tax return").
To summarize, a deduction for losses incurred in professional gambling is carried over onto a taxpayer's Illinois return, and the Act does not require that the deduction be added back in computing Illinois tax. By contrast, a deduction for losses incurred in casual gambling is not carried over onto the Illinois return and the Act itself does not provide for such a deduction. This tax scheme is the context for the Byrds' claims in this case.
The relevant facts are not disputed. The Byrds filed Illinois and federal income tax returns for tax years 1999, 2000, and 2001, and a federal return for tax year 2002. As of the Department's decision in this case, the Byrds had not filed a 2002 Illinois return. On each of the four federal returns in question, the Byrds reported wages, gambling winnings, and gambling losses. The Byrds reported the winnings as part of their gross income. The Byrds claimed the gambling losses not as trade or business losses, but as itemized deductions taken from adjusted gross income. The Byrds' federal tax returns showed the following figures for the four years at issue:
Tax Wages Gambling Adjusted Gambling Year Winnings Gross Income*fn1 Losses*fn2 1999 $209,195.12 $739,034.84 $207,141.30 $739,034.84 2000 $259,441.32 $530,710.00 $788,432.00 $528,635.00 2001 $250,508.18 $47,450.00 $295,351.00 $47,450.00 2002 $270,598.42 $132,585.00 $400,224.00 $132,585.00 All four returns claimed to state gambling winnings as reported on Internal Revenue Service Form W-2G. A casino must submit Form W-2G to the IRS whenever it makes a payout of $1,200 or more from a slot machine. See Treas. Reg. §7.6041-1 (____). The Department acknowledges in this appeal that the Byrds' gambling winnings reported on their federal returns accurately reflect the gambling winnings reported to the IRS on Form W-2G.
The Byrds' Illinois returns for years 1999-2001 each required them to carry over their federal adjusted gross income as the starting point for calculation of Illinois tax. See 35 ILCS 5/203(a)(1), (e) (West 2008). The Byrds reported the following adjusted gross income for those years:
Year Gross Income 1999 $207,141.30 2000 $250,901.00 2001 $259,797.00 Between 2002 and 2005, the Department issued NODs to the Byrds for underreporting their income on their Illinois returns. For tax years 1999 and 2001, the Department issued an original NOD and one amended NOD. For tax years 2000 and 2002, the Department issued an original NOD and two amended NODs. The NODs claimed that the Byrds failed to report the following income to Illinois and that they owed the following additional tax (including interest).
Original NOD: 1st Amended NOD: 2nd Amended NOD: Tax Omitted income/total Omitted income/total Omitted income/total Year tax deficiency tax deficiency tax deficiency 1999 $739,042 / $26,232 $3,288,589 / $159,902 ------2000 $528,635 / $18,230 $1,582,687 / $68,625 $3,672,687 / $159,517 2001 ????*fn3 / $1,644 $1,351,957 / $52,857 ------2002 $400,224 / $14,276 $1,907,187 / $70,129 $1,272,992 / $46,948
According to the original NODs, the Byrds owed a total deficiency of $60,382. According to the amended NODs, the Byrds omitted $9,586,225 in total income and owed $419,224 in total deficiency.
The parties appear to agree as to why the amended NODs show vastly greater amounts of unreported income than the original NODs. According to the parties, the original NODs were based on simple discrepancies between the Byrds' adjusted gross income as reported on their federal returns and as represented on their Illinois returns. The gambling winnings reported on the federal returns were based on the W-2G forms submitted by the casinos that the Byrds patronized during the relevant years. As noted, a casino must issue a W-2G form whenever a slot machine makes a payout of $1,200 or more.
During discovery, however, the Byrds tendered documents that purported to record all payouts (not just those of $1,200 or more) that the Byrds received from Hollywood Casino and Grand Victoria Casino, where the Byrds gambled the most during the relevant years. These casinos had issued the Byrds "players cards" that enabled the casinos to electronically record the Byrds' activity at slot machines. The documents tendered during discovery included year-end reports from Hollywood Casino and Grand Victoria Casino. The reports, which were admitted into evidence at the administrative hearing and are part of the appellate record, contain year-end figures based on activity recorded by use of the players cards. These reports show columns for "coin in," "coin out," and "jackpots." The "coin in" totals reflect all sums the Byrds paid into the slot machines. The reports show separate totals for the "coin out" and "jackpots." While no one from the casinos testified at the administrative hearing, plaintiff Jerry Byrd testified that the "coin out" and "jackpots" totals are exclusive of each other and must be combined to determine the total sums paid out to the Byrds from the slot machines. (The "jackpots," notably, comprise more than those payouts that qualify for reporting via Form W-2G, for several of the jackpots are below the $1,200 minimum.) When combined, the "coin out" and "jackpots" columns for each year exceed the aggregate W-2G payouts for that year. Based on the casino reports, the Department issued amended NODs claiming markedly higher levels of unreported income and tax deficiencies than in the original NODs.
The Byrds contested the amended NODs, and the case proceeded to a hearing before an administrative law judge (ALJ) on April 19, 2006. The parties stipulated to the authenticity of a large body of documents including: (1) the Byrds' federal tax returns for 1999-2002, and their Illinois returns for 1999-2001; (2) W-2G forms from Hollywood Casino, Grand Victoria Casino, Harrah's Casino in Joilet, and Rio Suite Hotel & Casino in Las Vegas; (3) year-end reports from Hollywood Casino and Grand Victoria Casino; (4) records of ATM and credit card transactions at the casinos; and (5) records of markers, or lines of credit, extended to the Byrds by the casinos.
The sole witness at the hearing was Jerry Byrd. Jerry testified that he has been employed in the graphic arts field for 38 years and that his current position is manager of a graphic arts firm. Jerry held that same position during tax years 1999 to 2002.*fn4 Jerry testified that, during the tax years in question, his wages from his managerial position ranged between $210,000 and $250,000 per year. (Jerry's W-2 forms for these years show wages between $209,195 and $270,598.) During this period, the Byrds' "primary income" came from Jerry's employment. His wife, MaryLou, did not work outside the home.
Jerry testified that he was first exposed to gambling in 1998 on a golf trip to Las Vegas. Jerry testified that, from 1999 to 2002, he and his wife frequented casinos and played mostly slot machines. The Illinois casinos they patronized most were Grand Victoria Casino and Hollywood Casino. Jerry testified that he and his wife went to Grand Victoria Casino on a weekly and sometimes daily basis. (Jerry did not say how often he or his wife went to Hollywood Casino.) The Byrds played mostly slot machines. Jerry explained that Grand Victoria Casino and Hollywood Casino each issued Jerry and his wife "players cards" that enabled the casinos to electronically record the Byrds' activity at slot machines. Jerry testified that the players cards allow him to keep careful records of his gambling activity. Jerry explained that there is no electronic recording of activity at table games in casinos. Patrons are not allowed to take notes while paying table games. Rather, casino employees monitor the tables and give a patron a win-loss tally when he leaves a table. Jerry testified that this tally is just "an estimation" and is not for tax purposes. Jerry further noted that W-2G forms are not issued for table winnings.
Jerry identified the reports from Hollywood Casino and Grand Victoria Casino showing yearly totals of "coin in," "coin out," and "jackpots" from their slot machines for the years in question. The records from Grand Victoria identify each date the Byrds had gaming activity at the casino. According to these records, the Byrds were active at Grand Victoria on 97 separate dates in 1999, 68 dates in 2000, 51 dates in 2001, and 53 dates in 2002. The records from Grand Victoria do not record dates of activity. The reports from both casinos, however, show yearly totals of money the Byrds paid into slot machines (the "coin in" totals) and money dispensed to them (the "coin out" and "jackpots" totals combined). As reported, these yearly totals were:
Grand Victoria Grand Victoria
Year Casino - Casino - Net
Money In Money Out 1999 $2,059,377.00 $1,955,457.00 -$103,920.00 2000 $1,438,681.00 $1,324,079.00 -$114,602.00 2001 $503,494.90 $473,627.40 -$29,867.50
2002 $777,316.70 $759,419.40 -$17,897.30 Total $4,778,869.60 $4,512,582.80 -$266,286.80*fn5