Mr. and Mrs. Au erroneously deducted gambling losses to offset other income, in violation of Code §165(d). Code §165(d) only allows gambling losses to be deducted to the extent of gambling winnings.
The IRS sought to impose the 20% accuracy-related penalty under Code §6662 for the understatement of tax. The taxpayers objected, claiming that they deducted the losses only because their tax preparation software allowed them to do it – thus, they had reasonable cause which is an exception to the 20% penalty.
The Tax Court rejected the reasonable cause claim. This is not the first time it has done so. See, for example, Parker v. Comm., T.C. Memo 2010-78 (June 21, 2010). That case involved the TurboTax tax preparation software, and this defense is often referred to as the “TurboTax Defense.”
In the Au’s case, the Court found that the taxpayers did not provide evidence of a mistake in the software instructions, nor of a thorough effort by the taxpayers to determine their correct tax liability. This seemingly leaves the door open to the successful use of the TurboTax Defense if a taxpayer can actually prove up a mistake in tax preparation software or its instructions.
To be fair (to TurboTax), the opinion did not indicate whether the software used was TurboTax or some other company’s software. I am sure that TurboTax does not appreciate the colloquial use of the term “TurboTax Defense” since it implies that their tax preparation software makes mistakes. Perhaps they may take some comfort in the credo that there is no such thing as bad publicity, or does that only apply to celebrities?
Au v. Commissioner, T.C. Memo. 2010-247