COMMISSIONER OF INTERNAL REVENUE, PETITIONER V. ROBERT P. GROETZINGER No. 85-1226 In the Supreme Court of the United States October Term, 1985 The Solicitor General, on behalf of the Commission of Internal Revenue, petitions for a writ of certiorari to review the judgment of the United States Court of Appeals for the Seventh Circuit in this case. Petition for a Writ of Certiorari to the United States Court of Appeals for the Seventh Circuit TABLE OF CONTENTS Opinions below Jurisdiction Statutes involved Questions presented Statement Reasons for granting the petition Conclusion Appendix A Appendix B Appendix C Appendix D OPINIONS BELOW The opinion of the court of appeals (App., infra, 1a-20a) is reported at 771 F.2d 269. The opinion of the Tax Court (App., infra, 21a-37a) is reported at 82 T.C. 793. JURISDICTION The judgment of the court of appeals (App., infra, 38a) was entered on August 21, 1985. On November 9, 1985, Justice Stevens extended the time within which to petition for a writ of certiorari to and including January 18, 1986. The jurisdiction of this Court is invoked under 28 U.S.C. 1254(1). STATUTES INVOLVED The relevant portions of Sections 56, 57, 62, 162 and 165 of the Internal Revenue Code of 1954 (26 U.S.C. (1976 ed. & Supp. I 1977)), as in effect for the tax year at issue, are set out in a statutory appendix (App., infra, 39a-41a). QUESTION PRESENTED Whether a full-time gambler who wagers solely for his own account, and who thus does not hold himself out as offering goods or services to others, is engaged in a "trade or business" for federal income tax purposes. STATEMENT 1. Since February 1978 respondent has been engaged full time in pari-mutuel wagering on dog races. He has had no other profession or employment during this period (App., infra, 22a). Apart from his gambling winnings, his only source of income has been interest, dividends and proceeds from the sale of investments (id. at 4a, 23a). Respondent had previously been employed by a truck manufacturer in Peoria, Illinois (id. at 22a). He had done market research there for 20 years, until his job was terminated (ibid.). During 1978, the tax year in issue, respondent devoted about half his waking hours to gambling at tracks in Florida and Colorado (App., infra, 22a). He went to the track six days a week. When not at the track, he spent much of his time studying racing forms, racing programs, and other materials in order to decide what bets to place. He devoted 60 to 80 hours a week to these various gambling endeavors (ibid.). He never placed bets on behalf of others, sold tips to other bettors, or collected commissions for placing bets. He gambled solely for his own account (id. at 23a). In 1978, respondent had gambling winnings of $70,000 and gambling losses of $72,032, for a net gambling loss of $2,032 (App., infra, 23a). He received income from other sources in the amount of $6,498, representing interest, dividends, capital gains, and salary earned before losing his job (ibid.). On his 1978 federal income tax return, respondent reported as income only the $6,498 received from non-gambling sources. He did not report any gambling income, nor did he deduct any gambling losses (ibid.). On audit, the Commissioner determined that respondent's $70,000 of gambling winnings had to be included in his gross income, and that a deduction should be allowed for his gambling losses to the extent of his gambling gains. See 26 U.S.C. 165(d). The Commissioner further determined that a portion of respondent's gambling-loss deduction was an "item of tax preference" subject to minimum tax. See 26 U.S.C. (1976 ed.) 56(a). Under the law as it stood in 1978, "items of tax preference" were defined to include certain itemized deductions, but to exclude deductions "attributable to a trade or business carried on by the taxpayer." See 26 U.S.C. (1976 ed. & Supp. I 1977) 57(a)(1) and (b)(1)(A), 62(1). The Commissioner determined that respondent's gambling activities during 1978 did not constitute a "trade or business," and hence that a portion of his gambling losses were "adjusted itemized deductions" subject to minimum tax. See 26 U.S.C. (Supp. I 1977) 57(a)(1). In so concluding, the Commissioner relied on the fact that respondent wagered solely for his onw account and thus did not hold himself out to others "as engaged in the selling of goods or services." Deputy v. du Pont, 308 U.S. 488, 499 (1940) (Frankfurter, J., concurring). Based on this conclusion, the Commissioner determined that respondent was liable for minimum tax of $2,142, resulting in a total tax deficiency (reflecting ancillary adjustments) of $2,522 (App., infra, 24a). 2. Respondent sought redetermination of the deficiency in the Tax Court. That court rejected the Commissioner's contention that, "to be engaged in a trade or business, one must hold himself out to others as offering goods or services." App., infra, 25a (footnote omitted). The Tax Court held, rather, that the proper inquiry "requires a broader examination of all the facts involved in each case" in order to ascertain whether the taxpayer's profit-seeking endeavors are "sufficiently regular, frequent, active and substantial to constitute a trade or business" (id. at 37a). The court noted that respondent during 1978 was engaged "full-time in pari-mutuel wagering on dog races, had no other employment during that period, * * * and devoted an extraordinary amount of time and effort to his gambling with a view to earning a living from such activity" (id. at 24a-25a). The Tax Court concluded that respondent was thus engaged in the "trade or business" of gambling, that his gambling losses were "attributable to a trade or business carried on by (him)," and that his gambling-loss deduction was not an "item of tax preference" subject to minimum tax. Id. at 24a & nn. 7 and 8 (quoting 26 U.S.C. (1976 ed.) 56(a), 62(1)). The court of appeals affirmed (App., infra, 1a-20a). It observed that "(t)he determination of what constitutes a 'trade or business' under * * * the Internal Revenue Code has proven to be most difficult and troublesome over the years," and it noted that "neither judicial precedent nor the relevant statutory language * * * provides a clear basis for resolving this issue" (id. at 5a, 8a). The court decided that "the term 'trade or business' * * * should be construed broadly," and it agreed with the Tax Court that the offering of goods or services should not be "an absolute prerequisite to a finding that a taxpayer (is) engaged in a 'trade or business'" (id. at 7a, 13a). The court stated that "the inquiry should concentrate on whether certain activities of a taxpayer can fairly be characterized as a livelihood, occupation or means of earning a living," and it held that respondent's gambling activities constituted a "trade or business" by this standard (id. at 13a). The court noted (id. at 7a) that its holding conflicted with decisions of the Second, Third and Sixth Circuits, each of which has held, on substantially identical facts, that a full-time gambler who wagers solely for his own account is not engaged in a "trade or business" for tax purposes because he does not offer goods or services to others. See Gajewski v. Commissioner, 723 F.2d 1062 (2d Cir. 1983), cert. denied, No. 83-1715 (Oct. 1, 1984); Noto v. United States 598 F. Supp. 440 (D. N.J. 1984), aff'd mem., 770 F.2d 1073 (3d Cir. 1985) (Table); Estate of Cull v. Commissioner, 746 F.2d 1148 (6th Cir. 1984), cert. denied, No. 84-1310 (June 10, 1985). REASONS FOR GRANTING THE PETITION The question whether a taxpayer must hold himself out as offering goods or services to others in order to be deemed engaged in a "trade or business" for tax purposes has arisen most frequently in cases involving gamblers and investors in securities. The courts of appeals have struggled unsuccessfully with this question for many years, and they are now squarely in conflict upon it. We are frank to admit that the revenue impact of this question is extremely difficult to gauge, and that its importance has been diminished, for years after 1982, by amendments to the minimum-tax provisions that furnish the context of the present case. The issue continues to arise under numerous other sections of the Internal Revenue Code, however, and the disarray in the lower courts has reached the point where it is impossible for the Commissioner to administer the tax laws in a consistent manner nationwide. 1. The question whether a full-time gambler is engaged in a "trade or business" was first litigated in the context of the "self-employment tax." See 26 U.S.C. 1401 et seq. That tax, which is the analogue for self-employed persons of the Social Security tax paid by those employed by others, is imposed on the net earnings "derived by an individual from any trade or business carried on by (him)" (26 U.S.C. 1402(a)). The Commissioner in the early 1970s took the position that full-time gamblers were engaged in a "trade or business" by virtue of the regularity of their profit-seeking endeavors, and hence that they were liable for self-employment tax. In Gentile v. Commissioner, 65 T.C. 1 (1975), the Tax Court rejected the Commissioner's position. Speaking through Judge Tannenwald, the court found no merit in an "expansive reading of the term 'trade or business,'" concluding that those words connote something more than "an individual's everyday efforts to earn a living, characterized by continuity, regularity, and profit motive" (65 T.C. at 3, 4). Rather, the court accepted the taxpayer's "oft-cited definition of carrying on a trade or business as that which 'involves holding one's self out to others as engaged in the selling of goods or services.'" Id. at 5 (quoting Deputy v. du Pont, 308 U.S. at 499 (Frankfurter, J., concurring)). Under that definition, the Tax Court held (65 T.C. at 6), a gambler who wagered solely for his own account could not properly be held liable for self-employment tax: Upon stepping up to the betting window, (the taxpayer) was not holding himself out as offering any goods or services to anyone. (His) use of his own resources to wager and his dedicated studies of the activities on which he wagered are akin to the management and investment of one's own estate and the study of market reports in order to do so more knowledgeably. Noting that personal investment activities are "clearly not within the bounds of a trade or business" (65 T.C. at 6, citing Higgins v. Commissioner, 312 U.S. 212, 218 (1941)), the Tax Court ruled that personal gambling activities are similarly outside that term's scope. The Commissioner acquiesced in Gentile, announcing that he would thenceforth follow the Tax Court's decision that a gambler who wagers solely for his own account is not engaged in a "trade or business." 1980-2 C.B. 1, 4 n.39. This taxpayer victory, however, threatened to turn pyrrhic when Congress amended the Code in 1976 to include "excess itemized deductions" among the "items of tax preference" subject to minimum tax. Tax Reform Act of 1976, Pub. L. No. 94-455, Tit. III, Section 301(c)(1)(A), 90 Stat. 1550 (amending 26 U.S.C. 57(a)(1)). Since gambling losses would be "itemized deductions" if gambling were not a "trade or business," a gambler's assessment of the costs and benefits of being in a "trade or business" for tax purposes became somewhat complicated. Consistently with his acquiescence in Gentile, the Commissioner after 1980 took the position that a full-time gambler was not engaged in a "trade or business" and hence that his gambling losses could generate liability for minimum tax. The Tax Court, in a reviewed decision, then proceeded to overrule Gentile in Ditunno v. Commissioner, 80 T.C. 362, 371 (1983). The Ditunno court concluded that the goods-or-services requirement adopted in Gentile was "overly restrictive" and that "(t)he proper test of whether an individual is carrying on a trade or business requires an examination of all the facts involved in each case" (80 T.C. at 366-367 (emphasis and footnote omitted)). The taxpayer there, while "us(ing) his own money to gamble solely on his own account," was nevertheless "an active gambler (who) devot(ed) his full time to gambling activities" (id. at 372). The regularity, continuity and extensiveness of those activities in the majority's view established a "trade or business" and thus immunized the gambler from minimum tax (id. at 371-372). Judge Tannenwald, the author of Gentile, dissented in an opinion joined by three other judges. He contended that the majority had "allowed their hearts to prevail over their minds in order to alleviate the arguably inequitable application of the minimum tax to full-time gamblers" (id. at 372). The Commissioner was prevented from appealing Ditunno because it was a "small tax case." See 26 U.S.C. 7463(a) and (b). The Commissioner has regularly appealed subsequent Tax Court decisions adhering to Ditunno, however, and these appeals have produced a conflict among the circuits. In Gajewski v. Commissioner, 723 F.2d 1062 (1983), rev'g 45 T.C.M. (CCH) 967 (1983), cert. denied, No. 83-1715 (Oct. 1, 1984), the Second Circuit reversed the Tax Court and held that a gambler who wagers solely for his own account is not engaged in a "trade or business." The words "trade or business," the court observed, are "commonly viewed as meaning a commercial activity in which a person seeks to earn a livelihood by furnishing goods or services to others for a price" (723 F.2d at 1066). It concluded that the goods-or-services requirement not only describes "the universal characteristic of a businessman or trader in a free enterprise society," but also offers a standard that is "administratively workable and fair to taxpayers" (id. at 1066-1067). Because the taxpayer there "gambled only for his own account and did not operate a bookmaking service or place wagers for others," the Second Circuit held that he was not engaged in a "trade or business" and that his gambling losses were items of tax preference" subject to minimum tax (id. at 1067). The Sixth Circuit reached the same result on substantially the same facts in Estate of Cull v. Commissioner, 746 F.2d 1148 (1984), rev'g 45 T.C.M. (CCH) 691 (1983), cert. denied, No. 84-1310 (June 10, 1985). It agreed with the Second Circuit that the offer of goods or services is an appropriate "minimum standard for determining whether a taxpayer is engaged in a trade or business," and it held that a full-time gambler who wagers solely for his own account is not so engaged (746 F.2d at 1152 (citing 723 F.2d at 1066)). Accord, Noto v. United States, 598 F. Supp. 440 (D. N.J. 1984), aff'd mem., 770 F.2d 1073 (3d Cir. 1985) (Table). The Eleventh Circuit, on the other hand, has affirmed a Tax Court decision adhering to Ditunno on facts substantially identical to those here. Nipper v. Commissioner, 47 T.C.M. (CCH) 136 (1983), aff'd mem., 746 F.2d 813 (1984) (Table). We declined to seek certiorari in Nipper, owing in part to the fact that the Eleventh Circuit did not write an opinion. We subsequently opposed the taxpayer's petition in Estate of Cull, acknowledging the Eleventh Circuit's conflicting judgment but concluding that "the case law in this area (was) not sufficiently developed to warrant this Court's review." 84-1310 Br. in Opp. at 8-9. We noted that the question of a full-time gambler's trade-or-business status was then pending before the Seventh Circuit in the instant case, and we suggested that "it will be time enough for the Court to consider the issue when and if a court of appeals renders a published opinion in a taxpayer-gambler's favor" (84-1310 Br. in Opp. at 9 & n.8). The Seventh Circuit in the instant case has brought about the condition to which we referred. The circuits are thus squarely in conflict. This case presents an appropriate vehicle by which the conflict may be resolved. 2. On the merits, we think that the competing arguments are fairly evenly matched, but that the balance tips against the decision below. There is certainly some intuitive appeal to the Seventh Circuit's construction of the phrase "trade or business" to mean "a person's occupation, livelihood or means of earning a living" (App., infra, 11a). On the other hand, common sense is not affronted by the Second Circuit's stance either, since the term "trade or business" is "commonly viewed as meaning a commercial activity in which a person seeks to earn a livelihood by furnishing goods or services to others for a price" (Gajewski, 723 F.2d at 1066). The goods-or-services test, of course, cannot furnish a comprehensive definition of a "trade or business" for tax purposes, since that term also requires a taxpayer to engage in commercial activity with regularity and with the intent to earn a profit. However, as one component of the overall inquiry, the goods-or-services requirement does seem to offer an appropriate minimum standard that embodies the distinction between a "trade or business" and other activities (such as investment activities) engaged in for profit. As the Second Circuit has observed (id. at 1065-1066), the goods-or-services test, first articulated in Justice Frankfurter's concurring opinion in Deputy v. du Pont, 308 U.S. at 499, has an impressive pedigree, and it had received widespread acceptance by courts before Ditunno was decided. And while this Court has not explicitly endorsed that test, the Court approved it by implication in Snow v. Commissioner, 416 U.S. 500, 502-503 (1974). See Gajewski, 723 F.2d at 1065; Estate of Cull, 746 F.2d at 1152; Ditunno, 80 T.C. at 374 & nn. 4, 5 (Tannenwald, C.J., dissenting). The Seventh Circuit's expansive reading of "trade or business" to mean a person's "occupation" or "means of earning a living" also seems at odds with the established rule that a taxpayer's management of his investments cannot be a "trade or business," however extensive and continuous those activities might be. In Higgins v. Commissioner, 111 F.2d 795 (1940), aff'd, 312 U.S. 212 (1941), the Second Circuit had held that an investor's management of his $10 million securities portfolio was not a "trade or business," reasoning that, "(b)y the common speech of men, a person who does nothing beyond looking after his own investments and receiving the income from them is not conducting a trade or business" (111 F.2d at 796). This Court unanimously affirmed, noting that the result would be the same "(n)o matter how large the estate or how continuous or extended the work required" (312 U.S. at 218). This Court rejected the taxpayer's argument that the "extent, continuity, variety and regularity" of his investment activities should be dispositive (id. at 216). In rejecting that argument, the Court explicitly distinguished an earlier decision that had defined "business" as "'a very comprehensive term (that) embraces everything about which a person can be employed'" (id. at 217, quoting and distinguishing Flint v. Stone Tracy Co., 220 U.S. 107, 171 (1911)). Applying Higgins, the lower courts have repeatedly held that personal portfolio management is not a "trade or business," even where a taxpayer devotes his full time to such endeavors and derives all his income from his investments. E.g., Moller v. United States, 721 F.2d 810 (Fed. Cir. 1983), cert. denied, No. 83-1485 (June 18, 1984). The decision below seems inconsistent with this well-settled rule. Securities management may be called the "occupation" of a full-time investor no less than gambling is the "occupation" of a full-time gambler. See App., infra, 11a. In deeming gamblers to be in a "trade or business," moreover, the court of appeals held dispositive the very factors -- "the continuity, repetition and extensiveness of (the) activities and * * * the good faith intent of the taxpayer to make a profit" (id. at 13a) -- that this Court in Higgins found insufficient to indicate a "trade or business." See 312 U.S. at 216, 218. The court of appeals sought to reconcile its holding with Higgins by emphasizing what it called "the 'personal' nature of investment activities" (App., infra, 14a (quoting Higgins, 312 U.S. at 218)). But we fail to see how playing the horses (or playing the dogs) is any less "personal" than playing the stock market, provided that the taxpayer in each event is playing solely for his own account. /1/ 3. The tax issue that gave rise to the instant litigation -- whether gambling losses may generate liability for minimum tax -- has been resolved legislatively for years after 1982. Congress amended the Code in 1982 to provide explicitly that gambling-loss deductions are to be excluded from the minimum-tax base. See Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, Tit. II, Section 201(a), 96 Stat. 411, 414 (codified at 26 U.S.C. 55(b)(1)(B) and (e)(1)(A)). /2/ The question whether a full-time gambler is engaged in a "trade or business," however, continues to arise in a variety of frequently-recurring tax contexts. Because of the way the minimum tax worked in 1978, incorporating a cross-reference to Section 62(1), the narrow statutory question presented here is whether gambling losses are "attributable to a trade or business carried on by the taxpayer" for purposes of determining his "adjusted gross income" under Section 62(1). See 26 U.S.C. (Supp. I 1977) 57(a)(1) and (b)(1)(A). The question whether gambling losses are deductibel in determining adjusted gross income -- that is, whether they are trade-or-business ("above the line") or itemized ("below the line") deductions -- continues to affect a variety of computations on an individual's tax return, such as calculation of the floor beneath his deductions for medical expenses (26 U.S.C. 213(a)) and casualty losses (26 U.S.C. 165(h)(2)). As the court of appeals noted, moreover, the term "trade or business" appears in some 60 different sections of the Internal Revenue Code. See App., infra, 5a-6a n.4. The question whether a full-time gambler is engaged in a "trade or business" is thus relevant in a variety of tax contexts apart from Section 62(1), e.g., in determining the deductibility of a gambler's home-office expenses (26 U.S.C. 280A(c)(1) ) and in determining his liability for self-employment tax (26 U.S.C. 1401, 1402(a)). It is virtually impossible for the IRS to estimate the net revenue impact of the question presented. As the history of litigation in this area shows, being in a "trade or business" may help or hurt a particular taxpayer depending on the facts of his particular case -- depending, for example, on whether he has "net earnings" from gambling on which self-employment tax might be due (26 U.S.C. 1402(a)). Although the revenue impact is thus unpredictable, the question is important in a practical, day-to-day administrative sense, because it affects some of the most basic calculations people make in filling out their tax returns. The Commissioner does not have the option to bring litigation concerning this question to an end simply by abandoning his current position. As we have shown, either of the two alternative positions that the Commissioner might take (and, historically, at different times has taken) will prove advantageous to some gamblers, and disadvantageous to others, depending on their particular facts. Litigation concerning this question, therefore, will necessarily continue until the existing conflict among the circuits is resolved. Given the manifold and diverse tax consequences that hinge on whether a taxpayer is engaged in a "trade or business," the disarray in the lower courts now prevents administration of the tax laws in a sensible and consistent manner nationwide. CONCLUSION The petition for a writ of certiorari should be granted. Respectfully submitted. CHARLES FRIED Solicitor General ROGER M. OLSEN Acting Assistant Attorney General ALBERT G. LAUBER, JR. Assistant to the Solicitor General JONATHAN S. COHEN BRUCE R. ELLISEN Attorneys JANUARY 1986 /1/ Courts applying Higgins in the portfolio-management context have generally distinguished between passive "investors" and active "traders," holding that the latter may qualify for "trade or business" treatment while the former may not. See App., infra, 13a-16a (discussing cases); Moller v. United States, 721 F.2d at 813. Some courts have sought to reconcile this dichotomy with the goods-or-services test by reasoning that, "(a)lthough the occupation of (a) professional investor who invests for his own account may be similar in some respects to that of a professional gambler, the former does offer goods to others in the sense that he buys and sells securities" (Gajewski, 723 F.2d at 1067 n.8). /2/ This exclusion was accomplished by providing that "alternative minimum taxable income" should be reduced by "alternative tax itemized deductions" (26 U.S.C. 55(b)(1)(B)), and by defining "alternative tax itemized deductions" to include deductions for losses described in Section 165(d), that is, "(l)osses from wagering transactions * * * to the extent of the gains from such transactions." See 26 U.S.C. 55(e)(1)(A), cross-referring to 26 U.S.C. 165(d). The amendments respecting gambling losses were added in conference, and the Conference Report does not explain the reason for their addition to the bill. See H.R. Conf. Rep. 97-760, 97th Cong., 2d Sess. 475 (1982). APPENDIX