This is the third article in a four-part series about paying taxes on daily fantasy sports.
Part 1: Daily Fantasy Sports And Taxes: Dissecting The 1099s
Part 2: Daily Fantasy Sports And Taxes: Gambling or Not Gambling?
So far we have covered some basic tax consequences for amateur DFS players. What if the DFS player is playing full-time? Is it considered a trade or business? Are taxes reported differently?
Let’s first look at the standard of whether one could be considered a professional DFS player. Then we will look at how one would report as such, and whether the gambling/not gambling characterization makes a difference. (Hint: It does.)
Professional vs. amateur DFS status
The professional versus amateur status is a facts-and-circumstances determination. There is no IRS guidance or court cases that acknowledge a professional DFS player. So we look to other similar types of professionals for guidance.
In Commissioner v. Groetzinger, 480 U.S. 23 (1987), the Supreme Court of the United States established the professional gambler standard:
If one’s gambling activity is pursued full-time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business….
Despite receiving other forms of income in 1978, Mr. Groetzinger was held to be a professional gambler for the year because he spent 60 to 80 hours per week at dog races gambling solely for his own account. Gambling was his full-time job and livelihood. Notably, Mr. Groetzinger had a net gambling loss in 1978. Thus, actual profit is not a requirement for professional gambler status.
In addition to the test above, the U.S. Tax Court and state courts often apply the following non-exhaustive nine-factor test found in IRS regulations to determine if the activity is a trade or business or merely a hobby:
- Manner in which the taxpayer carries on the activity;
- The expertise of the taxpayer or his advisers;
- The time and effort expended by the taxpayer in carrying on the activity;
- Expectation that assets used in the activity may appreciate in value;
- The success of the taxpayer in carrying on other similar or dissimilar activities;
- The taxpayer’s history of income or losses with respect to the activity;
- The amount of occasional profits, if any, which are earned;
- The financial status of the taxpayer; and
- Elements of personal pleasure or recreation. (Note the irony for this factor: Gambling for pleasure weighs against professional gambler status!)
Although DFS play is not definitively considered gambling at this time, the Groetzinger and nine-factor tests above are useful guidance in determining whether one is a DFS professional. The burden of proof is on the professional to prove such status.
“You know it when you see it” could be a good gauge when evaluating the professional versus amateur question. Is the player paying for living expenses with DFS income? Does the DFS player regularly study concepts and models in an effort to profit over the long-term? Ultimately, does the player treat DFS as a livelihood?
Of course, there are a lot of players who operate in a gray area. Because the professional status is a facts-and-circumstances determination, a DFS player should consult a tax professional to discuss his or her specific situation.
Reporting winnings and losses
A professional DFS player reports winnings, losses and expenses on Schedule C of Form 1040 as a trade or business. As discussed last time, a DFS player may deduct “ordinary and necessary” expenses incurred in connection with DFS play.
Net income reported on Schedule C is also subject to self-employment tax. This tax is in addition to any income taxes imposed upon a professional DFS player.
Self-employment tax is a Social Security and Medicare tax that is similar to those taxes withheld from the pay of most wage earners. Self-employment tax includes what would be both the employer and employee’s share of Social Security and Medicare tax and equals 15.3% of net income.
The Social Security portion of the tax (12.4%) is capped at $118,500 of earned income for 2015. A taxpayer may, however, deduct one-half of self-employment taxes paid.
Does it matter for the professional DFS player that reports on Schedule C if DFS play is considered gambling for tax purposes?
Last time we noted that hobby losses and expenses are deductible only to the extent of hobby winnings. If one is a professional DFS player, and DFS is not considered gambling, there is no limitation on deducting DFS losses and expenses. Put another way, if a DFS professional has a net loss for the year, that loss may be used to offset other income that year or in other years.
If one is a professional DFS player, and DFS is considered gambling, the limitation of deducting gambling losses only to the extent of gambling winnings still applies, but there is no limitation on deducting the “ordinary and necessary” expenses incurred with the DFS play.
Based on the above considerations, tax law proves more advantageous for DFS professionals if the activity is not considered gambling.
Next time, we will jump over to the operator’s perspective and discuss some interesting tax issues DFS operators could face.
Disclaimer: Nothing contained in this article is specific tax advice, as each person’s situation is different. Consult a tax professional to discuss particular facts and circumstances.