Wednesday, September 27, 2017

Treasury/IRS Finally Recognize Reality

A mere 22 years ago, I wrote a law review article arguing, among other things, that the tax reporting and withholding rules for horse-race betting were punitive and irrational. (For those so inclined, you can find it at 49 Tax Lawyer 1 (1995).)

At the time, the only horse racing insiders with an audience much larger than the seven people who read law review articles and who were making the same case were Andy Beyer and Steve Crist. But, whatever our logical merit, the US Treasury, which writes the regulations that the IRS then enforces, continued on its boneheaded merry way.

Here's what was wrong: the Treasury regulations provided for mandatory IRS reporting any time a bet returned at least $600 at odds of 300-1 or higher. And for mandatory withholding whenever those 300-1 bets produced winnings of $5,000 or more. Where the regulations erred was in treating the winning bet (say, a $2 Pick Six ticket) as a separate entity, and not as part of a larger bet that included all the losing tickets on the same event. So, for example, if someone bet $500 on the Pick Six, with 250 separate $2 tickets, and had one winner, and had the sole winning ticket, returning, say, $75,000, then that winner was subject to withholding, because the IRS treated it as getting $75,000 for $2, odds of 37,499-1, rather than what it really was, $75,000 for $500, or actual odds of 149-1.

Withholding was imposed at 28% -- roughly $21,000 in the case of our $75,000 winner. And in some states, state income tax withholding was added in on top of that. Even without any state tax, though, our happy $75,000 winner would be taking home only $54,000. A nice payday, but a lot less than what she thought she won.

As the popularity of complex exotic wagers -- Pick 4/5/6 bets, superfectas and such -- has grown in this century, the amount of money locked up in withholding has also grown, to perhaps $1 billion a year, as estimated by the National Thoroughbred Racing Association (NTRA). As the late Sen. Everett Dirksen used to say, a billion here, a billion there, pretty soon you're talking about real money. And in the little corner of the economy that's horse racing, $1 billion is pretty close to 10% of total annual handle. To be sure, horseplayers can get some of that withheld money back the next year, when they file their tax returns, either by deducting losses as an itemized deduction on Schedule A of their 1040 or by treating their gambling as a trade or business on Schedule C, The documentation of those losses is easier now, since most serious horseplayers use online accounts that generate a precise record of all their betting -- no more shoeboxes full of losing tickets, many with heel prints on them -- but it still (1) leaves out those bettors who don't itemize deductions and (2) decreases "churn," the ability to recycle wins into more wagering.

Now, finally, thanks in large part to the untiring efforts of Alex Waldrop and others at the NTRA, and to the more than 1,700 comments sent to the Treasury by us ordinary horseplayers, sanity has prevailed. New regulations, published in the Federal Register today and scheduled to become effective in 45 days, on November 11th, take the sensible step of treating all a bettor's wagers on the same opportunity -- say, a Pick Six pool on a given day -- as a single bet. In our example above, the $75,000 winning ticket on a total bet of $500, that would mean the odds would indeed be calculated at 149-1 and the bettor would not face any withholding. So our hypothetical bettor would go home with $75,000, not $54,000, and would most likely put a good chunk of that extra money right back into the parimutuel pools.

So, from November 11th on, the tax environment for horserace (and greyhound and jai alai, if you care) bettors will move one step closer to fairness. It's still not all the way there, for reasons explained in my 1995 article, but every little bit helps. Thanks to all the folks at the NTRA who made this happen, and to David Bergman of the Treasury's legal staff, who wrote the new regulation. Now, all we have to do is wait for those Pick Six carryover days with a positive expectation (when the amount of the carryover exceeds the takeout on new money) -- and actually pick winners.

Sunday, September 24, 2017

Claiming Jail Has Its Day(s) in Court

Most US racing jurisdictions impose some sorts of limits on what an owner can do with a horse that she just claimed. In almost all states, the new owner can't transfer ownership of the just-claimed horse -- except in another claiming race -- for at least 30 days, to avoid possibilities of collusion. In some states, like New York, the owner must run the horse back, if it runs in the first 30 days after the claim, for a price higher than the price at which she claimed it. And in many states, the owner may not enter the horse in a race at another track, or in another state, for the balance of the race meet at which it was claimed or for some specific period, usually 30 or 60 days.

The sum of these limits, which vary a bit from state to state, is usually referred to as "claiming jail," or just "jail." Racetracks and state racing commissions impose the limits, which have their origin more than a century ago in England and the US, in order to prevent raids on the horse population at a track by aggressive claiming owners who then move the horses elsewhere, depleting the horse population available for racing at the original track. Owners who race in more than one jurisdiction may not be happy with the rules, but, by and large, they accept them as part of the bigger picture of the claiming game. If you want to claim horses, then you play by the rules.

Enter Jerry Jamgotchian, the litigation-happy California-based owner who seems to think rules were made for the little people, not for him. Starting in 2011, Jamgotchian has spent years and, probably, hundreds of thousands of dollars, challenging the claiming-jail rules in Kentucky, Pennsylvania and Indiana. Last year, he was soundly rebuffed by a unanimous Kentucky Supreme Court, and the US Supreme Court declined to hear his appeal. Then in August this year, a federal district court in Pennsylvania agreed, upholding that state's claiming-jail rule. But just last week, Jamgotchian finally got a win. The federal district court in Indiana said that state's claiming-jail system violated the Commerce Clause of the US Constitution. So now there's an apparent conflict among the courts and, who knows, this arcane bit of racing regulation may yet make it to the Supreme Court. Can't speak for the rest, but I'm pretty sure Justice Sonia Sotomayor, who looked pretty happy in the "Judge's Chambers" (named for American League home-run leader Aaron Judge) at Yankee Stadium, wouldn't mind spending a day at Belmont.

So how did the three courts arrive at two different results? In each of the cases, Jamgotchian had claimed one or more horses and wanted to race it elsewhere before the relevant race meet ended. And in each case, there was a rule that said no you can't, at least without the stewards' permission. But there were differences, both in the specific facts of the cases and in the wording of the claiming rules in each state. Let's look at each of the cases in a bit more detail, in the order in which they were decided.

In the Kentucky case, Jamgotchian v. Kentucky Horse Racing Commission (488 S.W. 3d 594 (KY 2016), for the legal nerds out there), Jamgotchian had claimed a well-bred filly named Rochitta (Arch-Lady Ilsley by Trempolino) for $40,000 (plus $2,400 tax) at Churchill Downs on May 21, 2011. Something of a bargain, despite the filly's less than stellar career on the race track (one win in 15 starts, earnings of $44,416), since she'd been a $160,000 Keeneland September yearling and went on to be sold as a broodmare prospect in England for $480,000.

But the Kentucky claiming rule provided that:

Unless the Stewards grant permission for a claimed horse to enter and start at an overlapping or conflicting meeting in Kentucky, a horse shall not race elsewhere until the close of entries of the meeting at which it was claimed. 810 Ky. Admin. Regs. (KAR) 1:015 Sec. 6.

In fact, there are no overlapping or conflicting race meetings in Kentucky, as only one track at a time has the right to operate, using dates granted by the Commission. So the rule effectively bans a horse from racing anywhere other than the track at which it was claimed until the end of the meet.

In reality, Rochitta did not race again until after the end of the 2011 Churchill Downs spring meet, showing up in the starting gate next on July 8, 2011, at Presque Isle Downs in Pennsylvania. From there her career continued its downward trajectory, with stops at Mountaineer and Tampa Bay Downs before a subsequent owner realized he had a filly worth a whole lot more in the auction ring than on the track. But while Jamgotchian still owned Rochitta, and while she was still in claiming jail at Churchill, the owner attempted to enter her in a minor stakes at Penn National and in a claiming race at Presque Isle. It's not clear from the Kentucky Supreme Court opinion whether Rochitta was actually entered and then scratched or whether the entries were aborted earlier in the process. In any event, the disgruntled Jamgotchian filed a complaint in court in Kentucky in July, 2011, claiming his constitutional rights were being trampled on. Despite Rochitta's eventual move to the greener pastures of a breeding farm, the case dragged on, as they tend to do, through a trial court decision in November, 2012, an appellate court decision in February, 2014, and finally the Kentucky Supreme Court ruling in May, 2016. The US Supreme Court denied certiorari, , effectively dismissing the final appeal, in November, 2016. All three Kentucky courts held that the state's claiming-jail rule was valid, and that Jamgotchian had suffered no loss of constitutional rights.

In the Pennsylvania case, Jamgotchian v. State Horse Racing Commission (2017 WL 3713395, U.S. Dis. Ct. M.D. PA), Jamgotchian had claimed two horses, Super Humor for $25,000 at Presque Isle on August 29, 2016, and Tiz a Sweep for $25,000 at Presque Isle later in the meet, on September 8, 2016.

Pennsylvania's claiming jail rule, 58 Pa. Code Sec. 163.255, provides that:

If a horse is claimed . . . . nor may it race elsewhere until after the close of the meeting at which it was claimed. The Commission has the authority to waive this section upon application and demonstration that the waiver is in the best interest of horse racing in the Commonwealth.

Unlike Kentucky, Pennsylvania does have overlapping or conflicting race meetings. Penn National, near Harrisburg, and PARX (formerly Philadelphia Park) both race essentially year-round, and the Presque Isle meet in Erie, in late summer, competes with both of them.  Penn National and PARX do divide their racing year into several different "meetings," so claiming jail is not a year-long sentence, but it still can keep a horse on the grounds for a considerable period.

After the claims, Jamgotchian requested a waiver for Super Humor, which was granted by the Pennsylvania Commission, and for Tiz a Sweep, which the Commission deemed moot, since the Presque Isle meet had ended before the Commission ruled on the request. Nonetheless, Jamgotchian filed suit in October, 2016, in federal court in Pennsylvania, making much the same arguments he had raised in Kentucky. On August 29, 2017, the district court, in a relatively brief opinion, rejected his claims that the claiming-jail rule violated the Commerce Clause of the US Constitution. Thus far, no appeal has been filed in that case (checked Westlaw September 24, 2017).

Enter Indiana. In Jamgotchian v. Indiana Horse Racing Commission (2017 WL 4168488, U.S. Dist. Ct. S.D. Ind.), decided just this past Wednesday, September 20th, there were three claimed horses involved.

In a brazen violation of the claiming-jail rule, Jamgotchian claimed Majestic Angel for $25,000 at Indiana Grand on June 16, 2016 and then, without receiving permission from the Indiana stewards, entered the horse for a July 17 allowance/optional claimer at Mountaineer in West Virginia, while the Indiana Grand meet was still in progress, and in which she finished second. Only after the fact did the Indiana stewards become aware the the horse had been moved from Indiana Grand in violation of the claiming-jail rule.

Jamgotchian's other Indiana claims were Found a Diamond, a three-year-old filly haltered for $30,000 on August 3, 2016, and Tiz Dyna, claimed for $25,000 on August 11, 2016. In both cases, Jamgotchian asked the Indiana stewards for permission to race outside Indiana, and in both cases the stewards said no.

Indiana's claiming-jail rule, 71 Ind. Admin. Code 6.5-1-4, Sec. 4(h), provides that:

No horse claimed out out of a claiming race shall race outside of the state of Indiana for a period of sixty (60) days without the permission of the stewards and racing secretary or until the conclusion of the race meet.

Indiana has only one thoroughbred track, Indiana Grand, which in 2016 had a meet that stretched from April until the end of November, so, except for horses claimed in the last two months of the meet, the jail sentence was effectively 60 days. That's similar, in practical terms, to the Kentucky rule, since no Kentucky race meet, except the Turfway winter meet, lasts longer than 60 days.

Once again Jamgotchian had his lawyers file suit, despite his somewhat unclean hands stemming from the Mountaineer entry for Majestic Angel. And this time, mirabile dictu, the federal court agreed with him, holding that the ban on claimed horses' being able to race outside Indiana, even if only for 60 days, was a Commerce Clause violation. Once again, it's too early to know if there will be an appeal, this time by the state. But, although both cases were filed in federal court, their appeals would go to different federal appellate courts, in the Indiana case, to the 7th Circuit in Chicago, and in the Pennsylvania case to the 3rd Circuit in Philadelphia. So it's entirely possible that the two different results will hold up on appeal, in which case the US Supreme Court -- or at least the Justices' law clerks -- might have to learn a little about horse racing.

Do the claiming-jail rules have some sort of (very limited) impact on interstate commerce? Of course they do. Is that impact discriminatory to the extent of being a Constitutional violation? Hardly. But, as any lawyer knows, nothing is certain when you go into court. The Indiana decision thus raises the prospect that, if it is not overturned, as it should be, on appeal, a fundamental element of the legal structure that has governed claiming races for over a century will be abolished. I would hope that, if there is an appeal in the Indiana case, the entire racing industry, especially the lawyer-heavy NTRA, will join in on the side of preserving this particular piece of the status quo. Without it, the Michael Gills and Jerry Jamgotchians of the world could quickly destroy the claiming game as we know it.

Legal nerds please continue. The rest of you can probably stop here.

First, as described above, the claiming-jail rules, and the attendant circumstances of actual race meetings in a particular state, are all a little different. And in law, the facts matter.

For comparison, the New York claiming-jail rule, 9 NYCRR 4063.3, reads as follows:

If a horse is claimed . . . . nor shall such horse race elsewhere until after the close of the meeting at which such horse was claimed.

At NYRA tracks, most race meetings are six to 10 weeks long. The longest, the Aqueduct winter meet, is about three months, so that is the maximum "jail" term for a claimed horse, and it's at the meet that has the greatest difficulty in maintaining a horse population large enough to provide something approaching full fields on race days. Preserving the horse population at a track is by far the strongest justification for the jail rules.

Now, on to the legal reasoning. Jamgotchian's lawsuits all raised the issue of the "dormant" or "negative"  Commerce Clause, something that a few of us remember from law school, but that hardly any lawyer pays much attention to in real life.

Article I, Sec 8, cl. 3 of the US Constitution gives Congress the power to regulate commerce "among the several states." By implication, if Congress has the power to regulate interstate commerce, then the individual states don't have that power, and if they try to set up restrictions on interstate trade, then those restrictions are invalid. See, e.g., Dep't of Revenue of Ky. v. Davis, 553 U.S. 328 (2008). Lots of cases on this issue, most involving some sort of protectionism that favors in-state business and disadvantages out-of-state competitors. E.g., New Energy Co. of Indiana v. Limbach, 486 U.S. 269 (1988).

The claiming-jail rules certainly impose some kind of burden on interstate commerce. Without them, an aggressive claiming owner, named, perhaps, Michael Gill, could simply raid a track, claim dozens of horses, and ship them out of state. See Gill v. Delaware Park LLC, 294 F. Supp. 2d 638 (Dist. Ct. D. Del. 2003). The result of such a raid would be that the track from which the horses were claimed would have a sharp and sudden reduction in its horse population, with the result that the size of its fields, the quality of its racing and, eventually, its betting handle and the state tax revenue derived from that handle would surely decline. It's to avoid these consequences that most states have some sort of claiming-jail rule.

The Kentucky Supreme Court opinion, by far the longest and best-reasoned of the three claiming-jail cases, sets out a number of reasons why the dormant Commerce Clause does not apply to claiming jail.

First, the claiming-jail rule is really, the court points out, part of an implicit contract. In exchange for the right to claim horses, the buyer agrees to abide by the rules, including not transferring ownership of the claimed horse for 30 days, and not racing outside the claiming track for a period without the permission of the stewards or the racing commission. If you want a horse, you can buy one other than through the claiming process -- though it might cost you more, since the seller will want compensation for the possible purse the horse might have earned in the race. 

Second, the Kentucky court pointed out that the claiming-jail rules don't discriminate between in-state and out-of-state residents; everybody's subject to the rules if they claim a horse. 

Third, the court asked whether the rule imposed any incidental burden on interstate commerce. To be sure, it did, if of a brief and fleeting nature, since horses were all released from "jail" within a short period after the claim. In cases of such incidental burdens, the court looked at whether the benefits of the rule -- maintenance of the horse population at a track and the consequent support of state tax revenues from racing as well as support of the industry -- outweigh those incidental burdens. The Kentucky court concluded that they did. The Indiana federal court, after an extremely brief and cursory analysis, reached the opposite conclusion.

Fourth, the Kentucky court looked at other cases on "export embargoes," or state rules that prevented the export from a state of, for example, electricity produced within the state (New England Power Co. v. New Hampshire, 455 U.S. 331 (1982)), cantaloupes that hadn't been processed within the state (Pike v. Bruce Church, Inc., 397 U.S. 137 (1970)), or unprocessed timber (South-Central Timber Dev., Inc. v. Wunnicke, 467 U.S. 82 (1984)). The Kentucky court pointed out how these cases differed from the claiming jail rule:

The differences are those between permanent and temporary, between total and partial, between serious and slight and between inescapable and voluntary. The laws challenged in the Supreme Court cases just referenced forbade export of the article of commerce entirely or forbade it for as long as the would-be exporter failed to do something, such as employ a local processor. Here, Jamgotchian simply had to wait thirty days to transfer his Kentucky-claimed horse, and, only had to wait forty-two days (May 11 to July 1) to race her in another state.

The entire Kentucky Supreme Court opinion, with its careful and lengthy analysis of how the specifics of racing fit into Commerce Clause jurisprudence, is well worth reading. If you don't have access to Westlaw or a similar service, you can find it here. If these cases ever reach the US Supreme Court, I suspect their opinion will look a lot like that of Justice Hughes in Kentucky, where they do know something about horse racing.

Monday, September 11, 2017

Fasig-Tipton's Turf Showcase Sale

With lots of well-heeled European, Middle Eastern and Asian buyers in town for the million-dollar yearlings in Book 1 of the Keeneland September sale -- which started today -- the number two auction company, Fasig-Tipton, tried something new. It held a "turf showcase" yearling sale last night, aimed specifically at foreign buyers, plus those few Americans that actually like turf racing, and featuring yearlings that arguably had turf-oriented pedigrees.

Whatever spin the folks at Fasig-Tipton may put on it -- first time trying a new concept, Keeneland snagged all the best turf pedigrees anyway, etc. -- the sale was by any measure less than a rousing success, failing to pull much cash out of the pockets of those wealthy foreigners. Of 171 yearlings in the catalogue, only 41 (43.3%) were sold, bringing an average price of $68,041 and a median of $52,500. Of the 97 that didn't sell, 71 -- nearly as many as were sold -- failed to meet their reserves (i.e., were "RNA"), and the remaining 26 were scratched from the sale. You can see all the results here. Any time 49% of the horses that go through the ring at an auction fail to sell, as happened last night, that's a sign that someone, usually the sellers, had unrealistic expectations.

Another odd result, given the stated purpose of the sale -- to attract foreign buyers -- was that hardly any of the buyers were in fact foreign. It's impossible to tell for sure, when so many purchases are made by agents, but none of the usual names representing non-US interests showed up in the F-T Turf Showcase results. Nor did the very best American turf pedigrees. There were more War Front babies (4) in the first 20 hips at Keeneland today than in the entire F-T sale (1). Lots of Kitten's Joy, Gio Ponti and Temple City yearlings in both sales, but that just suggests some over-breeding.

Some American buyers may have gotten a good deal, in the absence of serious foreign money. Ahmed Zayat (with, I trust, the advice of my friends Jeff Seder and Patti Miller at EQB) picked up two at the turf showcase, a Real Solution colt for $60,000 and a War Command filly for $75,000. And leading partnership West Point Thoroughbreds snagged a colt by English sire Noble Mission for $85,000. Apart from that, it was the usual mix of owners and agents, and even a pinhhooker, Nick DeMeric, who paid the co-high price of the evening, $250,000, for a Scat Daddy colt. One never sees pinhookers in Book 1 at Keeneland, as they don't have the bottomless bankrolls to compete that other Book 1 buyers seem to possess.

Was the experiment worth it for Fasig-Tipton? My guess would be, probably not. The prices they got, and the buyers they attracted, would be just as likely at the regular F-T yearling sale in October. Credit F-T for trying something new, but not everything new works.