How much New Mexico tax refund could Texas residents receive after casino winnings, partly documented losses, and an incorrectly allocated Texas business loss?

Plain-English summary

Raul and Antonieta Arizpe were entitled to a $6,397 New Mexico refund after substantiating part of their gambling losses, but not the full $11,252 withheld by the casino. Their return had misallocated both New Mexico gambling income and a Texas business loss, and most claimed gambling losses lacked records.

The Arizpes were full-year Texas residents in 2004. Antonieta Arizpe played slot machines at Sunland Park Racetrack/Casino in New Mexico, sometimes using a rewards card that tracked wins and losses.

The casino issued Forms W-2G showing $187,535 of winnings and withheld $11,252 of New Mexico income tax. Their return reported $186,535 of gambling winnings and claimed the same amount as gambling losses, while also assigning a $22,215 loss from Arizpe's El Paso sales business to New Mexico.

Those entries produced zero New Mexico tax and a claim for all withholding.

All New Mexico casino winnings were allocated here

Section 7-2-11(A)(5) required a nonresident's gambling winnings to be allocated to New Mexico when they arose from a source in the state.

The casino's $187,535 figure controlled because the Arizpes did not explain the $1,000 lower amount on their return. All of the casino winnings therefore entered the New Mexico allocation calculation.

The Texas business loss did not belong in New Mexico

Antonieta Arizpe operated a vitamin and fashion-jewelry business from her El Paso home. Its 2004 expenses exceeded receipts by $22,215.

She offered no reason to apportion that Texas business loss to New Mexico. The decision removed it from the New Mexico column of Schedule PIT-B.

Only documented gambling losses were allowed

Section 165(d) allowed gambling losses as an itemized deduction up to gambling winnings, but the taxpayer had to substantiate them. Records could include a gambling diary, tickets, canceled checks, credit or bank records, and casino statements.

The Sunland Park win/loss statement reliably documented $90,506.75, rounded in the conclusions to $90,507, based on rewards-card play. Arizpe produced no evidence of losses from sessions when she did not use the card.

The remaining $96,028 claimed gambling-loss deduction was therefore disallowed.

The Department could not offset on speculation

After those adjustments, the decision calculated New Mexico tax of $4,855 against $11,252 withheld, leaving a $6,397 overpayment.

The Department theorized that Arizpe must have won additional jackpots below the casino's withholding threshold. But it offered no evidence of the casino's actual threshold, likely unreported amounts, or bank activity.

Section 7-1-29(C) permitted offset against tax for which the refund recipient was liable. The Department could audit suspected income, but it could not retain the established refund based solely on an unsubstantiated theory.

Result: protest GRANTED IN PART and DENIED IN PART. The Department was ordered to refund $6,397 plus applicable interest.

What this means for you

Nonresidents gambling in New Mexico

New Mexico-source gambling winnings can be allocated to the state even when the gambler lives elsewhere.

Frequent casino patrons

Use a consistent tracking method and keep independent records. A rewards-card statement covered only the play recorded with that card.

Taxpayers deducting gambling losses

Winnings and losses must be reported and substantiated under the applicable rules. A belief that total losses equaled winnings did not replace documentation.

Taxpayers with businesses in another state

Do not allocate an out-of-state business loss to New Mexico without a supported allocation or apportionment basis.

Refund claimants facing an offset

The agency may investigate suspected additional liability, but this decision required evidence before using that liability to retain an otherwise established refund.

Common questions

Q: How much did the casino report as winnings?
A: $187,535.

Q: How much gambling loss was substantiated?
A: $90,506.75, stated as $90,507 in the conclusions.

Q: Why were the remaining losses disallowed?
A: Arizpe had no records for gambling sessions when she did not use the rewards card.

Q: What happened to the Texas business loss?
A: The $22,215 loss was removed from the New Mexico allocation.

Q: What refund was ordered?
A: $6,397 plus applicable interest.

Citations and references

Statutes:

• NMSA 1978, §§ 7-2-1 et seq. — New Mexico personal income tax
• NMSA 1978, § 7-2-11(A)(5) — allocation of nonresident gambling winnings
• NMSA 1978, § 7-1-10(A) — duty to maintain records permitting accurate tax computation
• NMSA 1978, § 7-1-11(C) — duty to make records available for inspection
• NMSA 1978, § 7-1-29(C) — offset of a refund against established tax liability
• NMSA 1978, § 7-3-3(D) — withholding from winnings subject to federal withholding
• 26 U.S.C. § 165(d) — gambling loss deduction limited to winnings
• 26 U.S.C. § 3402(q)(5) — slot-machine winnings and federal withholding

Other authority cited:

• IRS Publication 529, Miscellaneous Deductions
• Lyszkowski v. Commissioner, T.C. Memo 1995-602

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Raul & Antonieta Arizpe
• Decision PDF: D&O 05-14

Original ruling text

BEFORE THE HEARING OFFICER
OF THE TAXATION AND REVENUE DEPARTMENT
OF THE STATE OF NEW MEXICO

IN THE MATTER OF THE PROTEST OF
RAUL M. AND ANTONIETA M. ARIZPE NO. 05-14
TO DENIAL OF REQUEST FOR REFUND
OF 2004 PERSONAL INCOME TAX ISSUED
UNDER LETTER ID NO. L0642431488

DECISION AND ORDER

A formal hearing on the above-referenced protest was held on July 13, 2005, before

Margaret B. Alcock, Hearing Officer. The Taxation and Revenue Department ("the Department")

was represented by Peter Breen, Special Assistant Attorney General. The taxpayers, Raul and

Antonieta Arizpe, were represented by Antonieta Arizpe. Based on the evidence and arguments

presented, IT IS DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. The taxpayers were full-year residents of Texas in tax year 2004.

2. During 2004, Ms. Arizpe spent a substantial amount of time playing the slot

machines at Sunland Park Racetrack/Casino (“the Casino”) in Sunland Park, New Mexico.

3. The Casino issues patrons a rewards card that enables them to enter various

drawings and obtain a small percentage of cash back on money spent at the casino.

4. To participate in the rewards program, the patron must insert the card, which

keeps track of the patron’s wins and losses, into the slot machine before starting to play.

5. Ms. Arizpe used her rewards card during some, but not all, of her visits to the

Casino.

6. The Casino issued Forms W-2G for tax year 2004 showing that Ms. Arizpe won

$187,535 playing the slot machines, from which the casino withheld New Mexico income tax in

the amount of $11,252.

7. Ms. Arizpe believes she lost as much as she won during 2004, but was able to

document only $90,506.75 of her gambling losses. This is the amount shown on a “Win/Loss

Statement” the Casino issued based on Ms. Arizpe’s use of her rewards card. There is no record

of losses that might have been incurred when Ms. Arizpe played without using the card.

8. In February 2005, the Arizpes had their 2004 personal income tax returns

prepared by an H & R Block office in El Paso, Texas.

9. The income reported on the Arizpes’ 2004 federal income tax return consisted of

wages, taxable interest, taxable refunds, and “other income,” which included $186,535 of Ms.

Arizpe’s gambling winnings from the Casino.

10. Offsetting the Arizpe’s income was a $22,215 loss from Ms. Arizpe’s sole

proprietorship (a sales business located in El Paso, Texas) and a number of itemized deductions

reported on Schedule A, including $186,535 of gambling losses.

11. The Arizpes’ 2004 New Mexico personal income tax return (“PIT-1”), which was

also prepared by H & R Block, contained two errors: first, it failed to allocate Ms. Arizpe’s

gambling winnings to New Mexico as required by NMSA 1978, § 7-2-11(A)(5); second, the

return apportioned the entire $22,215 loss from Ms. Arizpe’s Texas business to New Mexico.

12. As a result of the erroneous allocation and apportionment of income, the Arizpes

reported zero personal income tax to New Mexico and requested a refund of the entire $11,252

of tax withheld from Ms. Arizpe’s gambling winnings by the Casino.

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13. On April 23, 2005, the Department sent the Arizpes notice that their claim for

refund was being denied “because you have provided insufficient substantiation of claimed

gambling income and loss.”

14. On May 2, 2005, the Arizpes filed a written protest to the Department’s denial of

their claim for refund.

DISCUSSION

The issue to be decided is whether the Arizpes are entitled to the $11,252 refund claimed on

their 2004 New Mexico personal income tax return. The Department stated the following reasons

for denying the refund: (1) the Arizpes failed to properly allocate and apportion their income on

Schedule PIT-B to their New Mexico return; and (2) they failed to document the gambling losses

taken as an itemized deduction on their federal income tax return, which served to reduce the

federal adjusted gross income used as the starting point for calculating New Mexico tax. In

addition, the Department maintains that Ms. Arizpe had additional winnings that were not reported

by the Casino and argues that this justifies denying any refund of taxes due to the Arizpes.

Allocation and Apportionment of New Mexico Income. Payment of New Mexico

personal income tax is governed by NMSA 1978, §§ 7-2-1, et seq. New Mexico is among the

majority of states that use the federal income tax system as the basis for calculating state income

taxes. As reflected on the Department’s 2004 PIT-1, New Mexico taxable income is calculated by

starting with the taxpayer's federal adjusted gross income, deducting the taxpayer's itemized

deductions and federal personal exemption, and making certain adjustments reflected on Schedule

PIT-ADJ. The amount of tax is then drawn from the tax rate table or tax schedule. When a

taxpayer has income that is taxable both within and without New Mexico, NMSA 1978, § 7-2-11

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allows the taxpayer to file Schedule PIT-B to allocate and apportion certain categories of income

between New Mexico and non-New Mexico sources. The percentage of total income allocated

or apportioned to New Mexico is then applied to the tax previously calculated to determine the

tax due.

Gambling Income. Subsection (A)(5) of § 7-2-11 states as follows: “gambling winnings

of a nonresident shall be allocated to this state if the gambling winnings arose from a source

within this state.” There is no dispute that all of Ms. Arizpe’s gambling winnings came from a

casino located in New Mexico. For this reason, the entire $187,535 the Casino reported to the

Department as Ms. Arizpe’s 2004 winnings must be allocated to New Mexico on Schedule PIT-

B of the Arizpes’ 2004 New Mexico income tax return.1

Business Losses. Ms. Arizpe is engaged in the business of selling vitamins and fashion

jewelry. Although she sells her products nationwide, the business is operated out of her home in

El Paso, Texas. Because the 2004 expenses for the business exceeded its receipts, the Arizpes’

2004 federal income tax return reported a $22,215 loss. The entire loss was then apportioned to

New Mexico on Schedule PIT-B to their New Mexico return. At the administrative hearing, Ms.

Arizpe had no explanation for why losses attributable to her Texas business were apportioned to

New Mexico. Accordingly, the Arizpes’ 2004 Schedule PIT-B should be corrected to remove the

$22,215 loss from the New Mexico column.

Gambling Losses. 26 U.S.C. § 165(d) allows taxpayers to deduct their gambling losses as

an itemized deduction on Schedule A to their federal Form 1040, up to the amount of any gambling

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In the absence of any explanation for the $1,000 discrepancy between the $186,535 of gambling winnings
reported on the Arizpe’s 2004 return and the $187,535 of gambling winnings reported by the Casino, the
amount reported by the Casino will control for purposes of this protest.

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winnings reported. Taxpayers must be prepared, however, to provide documentation to support the

winnings and losses reported. In Publication 529 (“Miscellaneous Deductions”), the Internal

Revenue Service sets out the types of documentation needed, which may include a diary of

winnings and losses, wagering tickets, canceled checks, credit records, bank statements, or

statements provided directly by the gambling establishment.

New Mexico law also requires taxpayers to keep documentation to support the amounts

reported on their tax returns. NMSA 1978, § 7-1-10(A) requires every person to "maintain books

of account or other records in a manner that will permit the accurate computation of state

taxes...." NMSA 1978, § 7-1-11(C) states that taxpayers “shall upon request make their records

and books of account available for inspection at reasonable hours to the secretary or the

secretary's delegate.” After reviewing the Arizpes’ 2004 New Mexico income tax return, the

Department asked them to provide documentation to support the $186,535 of gambling losses

included in their itemized deductions. No documentation was provided, and the Arizpes’

requested refund of $11,252 was denied.

At the July 13, 2005 administrative hearing, Ms. Arizpe produced a 2004 “Win/Loss

Statement” that she had obtained from the Casino. The statement shows gambling winnings of

$60,751.00 and losses of $90,506.75. The statement was limited to wins and losses recorded

when Ms. Arizpe used the rewards card issued by the Casino. Ms. Arizpe did not present any

evidence to substantiate losses she may have incurred without using the card. When called as a

witness, the Department’s protest auditor stated that he was familiar with the Win/Loss

Statements issued by the Casino and believed the statement produced by Ms. Arizpe was reliable

evidence of the losses shown.

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Right of Offset. Based on the evidence presented at the administrative hearing, the

Arizpes are entitled to a refund of approximately $6,400 of the New Mexico income tax withheld

by the Casino. This figure is arrived at by adjusting their 2004 PIT-1 as follows:

Line 5 Reported Federal AGI $235,770
Line 7 Itemized Deductions (reduced by (126,334)
$96,028 of unsubstantiated gambling losses)

Line 8 Federal Exemption ( 5,084)
Line 11 New Mexico Taxable Income 104,352
Line 12 Tax on Line 11, from PIT-B 4,855*
Line 17 NM Income Tax Withheld 11,252
Line 22 Overpayment 6,397

*The tax on $104,352, determined from the 2004 tax schedule, is $6,104. This is then
multiplied by 79.541% (NM percentage from PIT-B after allocating $187,535 of gambling
winnings to NM and excluding the $22,215 business loss) to arrive at a tax due of $4,855.

Despite evidence that Ms. Arizpe suffered gambling losses of $90,507 during 2004, the

Department maintains that it is entitled to retain any refund due to the Arizpes as an offset against

unreported income. The Department argues that the Casino only withheld tax from winnings over a

certain dollar amount and theorizes that Ms. Arizpe must have had additional winnings below that

threshold. The Department must do more than theorize, however. The method used by the Casino

to withhold New Mexico income taxes is far from clear. Ms. Arizpe stated her belief that the

Casino withheld tax from jackpots of $1,000 or more. Federal law requires casinos to issue a Form

W-2G to report gambling winnings of $1,200 or more from slot machines, but 26 U.S.C. §

3402(q)(5) specifically exempts slot machine winnings from the general duty to withhold taxes.

See also, Lyszkowski v. Commissioner, Tax Court Memo 1995-602, aff’d without opinion, 79

F.3d 1138 (3d Cir. 1996). New Mexico law limits its withholding requirement to every person

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“who is required by the provisions of the Internal Revenue Code to deduct and withhold federal tax

from payment of winnings that are subject to withholding….” NMSA 1978, § 7-3-3(D).

In this case, the Department did not present evidence to establish the actual threshold

Sunland Park Casino used to withhold New Mexico income taxes from slot machine winnings.

The Department did not present expert testimony or other evidence to establish how much a person

who gambled as frequently as Ms. Arizpe gambled during 2004 was likely to win in jackpots below

the withholding threshold. Nor did the Department audit the taxpayers to examine bank statements

and other records that might indicate whether Ms. Arizpe had an additional $94,000 of income from

such jackpots.2

NMSA 1978, § 7-1-29(C) gives the secretary of the Department discretion to offset any

amount of tax to be refunded “against any amount of tax for which the person due to receive the

refund is liable.” Based on the evidence presented at the administrative hearing, the Arizpes are

liable for tax in the amount of $4,855. If the Department believes there is income that the Arizpes

failed to report, the Department has the right to initiate an audit in accordance with the procedures

set out in the Tax Administration Act. The Department does not have the right to withhold the

Arizpes’ refund based solely on its unsubstantiated hunch that additional taxes may be due.

CONCLUSIONS OF LAW

A. The taxpayers filed a timely, written protest to the denial of their claim for refund,

and jurisdiction lies over the parties and the subject matter of this protest.

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At New Mexico’s top 2004 tax rate of 6.8 percent, this is the approximate amount of unreported income needed
to fully offset the $6,400 refund otherwise due to the Arizpes.

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B. The Arizpes substantiated gambling losses in the amount of $90,507; they failed to

substantiate the $96,028 of remaining losses claimed as a deduction on their 2004 PIT-1, and the

deduction for those losses must be disallowed.

C. The Arizpes are required to allocate the $187,535 that Ms. Arizpe won at the

Sunland Park Racetrack/Casino to New Mexico on Schedule PIT-B to their 2004 PIT-1.

D. The Arizpes may not apportion the $22,215 loss from Ms. Arizpe’s Texas business

to New Mexico on Schedule PIT-B to their 2004 PIT-1.

E. Based on the adjustments set out in Conclusions B, C, and D, above, the Arizpes are

entitled to a refund of $6,397.

For the foregoing reasons, the Taxpayers’ protest IS GRANTED IN PART AND DENIED

IN PART. The Department is ordered to refund the Arizpes $6,397, plus applicable interest. The

balance of the refund requested on the Arizpes’ 2004 New Mexico income tax return is denied.

DATED July 19, 2005.

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