[toc]This is the final 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?
Part 3: Daily Fantasy Sports And Taxes: File As A Professional Or Amateur?
In the final installment of this mini-series of posts on DFS tax issues, we look at a few interesting tax issues that DFS sites may face.
As mentioned, the Internal Revenue Service has not commented to date on whether or not it considers DFS games as gambling for tax purposes. We have discussed why this is significant for players. It is also significant — perhaps even more so — for the DFS sites.
Federal wagering excise tax
The Internal Revenue Code imposes an excise tax on “wagers.”
What is an excise tax?
An excise tax is a tax on the sale or purchase of a particular good or activity. You may have heard of special taxes on gasoline or hotel rooms.
A person in the business of accepting a “wager” must pay a tax to the federal government based upon the following:
- For accepted wagers authorized under state law, the tax is 0.25 percent of the wager amount.
- For all other wagers, the tax is 2 percent of the wager amount.
Is it possible that this excise tax applies to DFS entry fees? Let’s consider the definitions provided in the law and regulations:
“Wager” has three alternative definitions under the law. We discuss each in turn.
Any wager with respect to a sports event or a contest placed with a person engaged in the business of accepting such wagers.
Sports event is defined to include “every type of sports event, whether amateur, scholastic, or professional, such as horse racing, auto racing, dog racing, boxing and wrestling matches and exhibitions, baseball, football, and basketball games, tennis and golf matches, track meets, etc.”
Contest is defined to include “any type of contest involving speed, skill, endurance, popularity, politics, strength, appearances, etc., such as a general or primary election, the outcome of a nominating convention, a dance marathon, a log-rolling, wood-chopping, weight-lifting, corn-husking, beauty contest, etc.”
DFS formats that enable customers to construct lineups of players performing in only one game, such as the Super Bowl, could arguably fall within this definition of “wager.” “Sports event” and “contest” appear to refer to a single competition or game.
What about DFS formats that enable customers to construct lineups of players performing among several games? Of course, this is the industry standard. Let’s look at the second definition.
Any wager placed in a wagering pool with respect to a sports event or a contest, if such pool is conducted for profit.
Wagering pool is defined to include “any scheme or method for the distribution of prizes to one or more winning bettors based upon the outcome of a sports event or a contest, or a combination or series of such events or contests, provided such wagering pool is managed and conducted for the purpose of making a profit.”
The key question here: Does betting on the “outcome” of a combination or series of sporting events or contests include paying an entry fee on the outcome of several individual player performances among several games?
On the surface, it seems like the answer could be yes. One good starting point for this analysis is to consider the IRS’s discussion of “wagering pool” in this Private Letter Ruling.
Any wager placed in a lottery conducted for profit.
I won’t post the entire definition of a lottery. You can read it here.
The definition focuses on a game of choosing numbers or symbols with the winning numbers drawn from a receptacle. Without going into it more, it seems a stretch to say the typical DFS games would be considered a lottery.
The IRS has not issued any formal guidance on this issue. At some point the IRS could decide to audit a DFS site and assert that the site should be collecting and remitting federal excise tax. On top of that, the IRS could assert that the higher 2 percent tax rate applies if DFS activity is not explicitly authorized under state law.
One would suspect that if DFS sites have to pay the federal wagering excise tax, the sites will pass the tax down to the end user, making the games even more difficult for DFS players to earn a profit.
Informational reporting requirements
We have discussed possible methods to compute winnings on Form 1099-MISC if DFS is not considered gambling. What if DFS is considered gambling? Then we look at the Form W-2G reporting requirements.
The tax law requires withholding on payments of gambling winnings on wagers placed in a “wagering pool” if the winnings exceed $5,000. For these rules, there is no definition for a “wagering pool.” If the “wagering pool” definition for the federal excise tax is used, DFS play may look like gambling for information reporting purposes.
Who cares? The DFS sites could be held responsible for the tax that should have been withheld when paying out DFS winnings. In addition, the IRS could impose penalties for failure to timely furnish Forms W-2G.
Some states have their own gambling withholding requirements, as well. For example:
- Connecticut requires withholding on gambling winnings if the winnings are paid to a Connecticut resident
- Illinois requires withholding on gambling winnings if the winnings are paid to an Illinois resident
- Michigan requires withholding for Michigan income tax whenever regular withholding is required
What is the likelihood the IRS or a state tax agency will seek to impose gambling withholding requirements retroactively if DFS is considered gambling? Your guess is as good as mine.
This is far from the last word on DFS and taxes. As the industry transitions towards regulation, stakeholders need be mindful of the current uncertainties in the tax law as applied to DFS and fantasy sports in general.
A sound tax policy is critical to keep the DFS industry sustainable for both operators and players going forward.
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.