Posts Tagged ‘DFS’

IRS: DFS Is Wagering (Gambling)

Monday, October 19th, 2020

In February 2014, I wrote a post titled, “Taxes and Daily Fantasy Sports: The Duck Test.” I concluded:

So daily fantasy sports have at least some element of luck. Then from a tax standpoint they sure look to be a form of wagering activity. There’s a prize, chance, and consideration. The Duck Test again: If it looks like a duck, walks like a duck and quacks like a duck, it might just be a duck.

On Friday, the IRS released a second Chief Counsel Memorandum dealing with Daily Fantasy Sports. An IRS attorney asked the question, “Does the amount paid by a daily fantasy sports player to participate in a daily fantasy sports contest constitute an amount paid for a wagering transaction under §165(d) of the Internal Revenue Code?” The Chief Counsel’s Office conclusion was:

The amount paid by a daily fantasy sports player to participate in a daily fantasy sports contest constitutes an amount paid for a wagering transaction under §165(d).

The Chief Counsel’s office opinion is basically what I wrote over six years ago:

DFS transactions meet the definition of wager as interpreted by the Tax Court and State courts because there is an uncertain event (such as the live performance of individual players), winnings if the event resolves in participant’s favor, and consideration is lost if the event does not resolve in participant’s favor. Each DFS transaction is a pay to play competition with predetermined winnings for a certain number of participants. The outcome of the competition turns on the overall statistical performance of live professional players assembled into the fantasy team. The winning participant receives a return of his or her initial bet along with wagering gains, while the losing participant walks away empty handed. This is consistent with the courts’ interpretation of the term “wager.”

The IRS Chief Counsel memorandum also correctly notes that the fact that DFS is skillful wagering is a blind alley. “DFS transactions are similar to poker and other wagers in which a player’s skill is a component of the game but it does not dictate the outcome. As such, the argument that DFS transactions are excluded from wagering as a game of skill are unpersuasive.”

There are some obvious conclusions from this. First, DFS sites have been issuing Form 1099-MISC’s, not W-2G’s, to participants. We can expect the IRS to pressure the sites to switch (and expect the sites to fight this). Second, expect the sites to come under pressure to register as gambling sites in “grey market” states or to leave such states.

Both DraftKings and FanDuel, the two leading DFS sites, have expanded into sports betting (which is clearly gambling) and have registered appropriately in states where they act as sports books. In those states, DFS being considered wagering/gambling won’t matter. However, just like Nevada did years ago some other state or states are going to also consider DFS to be gambling.

For DFS players, there is both good and bad in this memorandum. The good is that you can deduct losses (to the extent of winnings). If DFS were a skill contest, you couldn’t; however, if DFS is a wagering activity losses are explicitly allowed up to the amount of winnings. That’s good. The bad is that for professional DFS players, you might not be able to take business expenses in a year that you lose money. The Tax Cuts and Jobs Act (passed at the end of 2017) specifically disallows a professional gambler from taking business losses.

For the DFS sites, this is a continuation of the bad news coming from the IRS. Like the first Chief Counsel memorandum, I expect the DFS sites to bury their head in the sand and fight this. Unfortunately, while DFS clearly involves substantial skill to be a consistent winner, that is completely irrelevant as far as whether or not it is a wagering (gambling) activity. The only way around this for the DFS companies is for Congress to change the law.

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Burying Your Head in the Sand

Monday, August 17th, 2020

One of my favorite sayings (and I am not the one who came up with it) is “The Tax Code Giveth, The Tax Code Taketh Away.” It’s not fair, but we have to live with it as it is, not how we want it to be. Only Congress can change the Tax Code because it’s law.

Last week, I reported on the IRS releasing a Chief Counsel Memorandum where the IRS concludes that Daily Fantasy Sports (DFS) companies are liable for the Excise Taxes on Wagering. (Back in 2015 I came to the same conclusion as the IRS.) Per published reports, Jason Robins, the Chief Executive Officer of DraftKings, disagrees. The Wall Street Journal notes [pay link]:

“This was a memo that has no force of law, is nonbinding and [in] our view is deeply flawed in its analysis,” Mr. Robins told analysts. “Our position continues to be, which we believe has been reaffirmed through state legislatures and courts throughout the country, that [daily fantasy sports] is not wagering.”

First, state law and state courts do not change federal tax law. A state can call an activity a non-gambling contest but it can still be considered wagering (gambling) under federal law. We have a dual system of taxation in the United States, and state tax law and federal tax law differ in numerous respects.

Second, some states have concluded that DFS is gambling. For example, Nevada did so. Of course, a company executive will put the most positive light on something.

So I’m going to assist Mr. Robins with some information about the Federal Tax Code. Back in 2014, I wrote:

[T]here are plenty of IRS and Tax Court rulings on [what wagering/gambling is], and all say basically the same thing. For something to be gambling, three elements must be present:
1. A prize;
2. Chance; and
3. Consideration.

Clearly daily fantasy sports have elements 1 and 3. There’s a prize and there’s a cost to enter each event. Is there chance?

Gambling does not have to be 100% chance to be considered gambling. For example, poker is considered gambling under US tax law yet there’s plenty of skill involved with it. (Indeed, I’d argue that skill predominates over luck; however, there’s absolutely an element of luck in poker.) Let’s look at what’s involved with a daily fantasy sports contest. You generally select a team to play in a day’s events. Let’s say you selected Carlos Boozer and Shane Battier for today’s NBA daily fantasy sports contest. Those players scored 8 and 3 points, respectively. On the other hand, had you selected Taj Gibson and Chris Bosh you would have done far better; they scored 20 and 28 points. Yet before a single game who know what each player will score? If you had selected NBA star Lebron James you would normally do quite well; however, he didn’t play today.

The IRS Chief Counsel memorandum notes that there can be skill and the ‘contest’ can still meet the definition of a wagering activity:

In [Revenue Ruling 57-521], the contest participant’s own skill was the only factor involved in winning the puzzle game and there was no chance element at all. In contrast, DFS participants merely select a lineup for their simulated teams and have no ability to exercise control or influence over the actions of the players participating in the game and who earn the participants their fantasy points. DFS participants may be educated on the sports games, players, expected weather conditions, and other factors. Regardless of how educated a DFS participant is, their chosen player(s) may perform poorly that day, become injured, not play in a given game, or be affected by uncontrollable circumstances such as weather and officiating. The existence of chance indicates that DFS contests are distinguishable from the type of contest described in Rev. Rul. 57-521. We conclude that the “skill” involved in selecting fantasy players is similar to the skill involved in selecting winners of individual professional sports games, horse races, or other traditional sports gambling activities.

In my view, and the current state of the Federal Tax Code, it’s quite clear that a DFS contest is a wagering activity. It meets the specifications of wagering. There is consideration, there is a prize, and there is an element of chance (luck). Bluntly, Mr. Robins can educate the world on the skill needed to be a winner in DFS (and he is absolutely correct on the skill needed); however, under the Tax Code this is clearly gambling (wagering). Basically, Mr. Robins’s argument is irrelevant.

The only way this changes is to change the Federal Tax Code. That would require Congress to add a new section to the Tax Code specifically stating that DFS is not a wagering (gambling) activity.

If I were an auditor of a DFS firm, I would be insisting DFS companies either pay the wagering excise taxes or add a reserve for them. To put it in sports terms, the Pittsburgh Pirates have a better chance of winning the 2020 World Series than the DFS companies do of not having to pay the wagering excise taxes.

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IRS: DFS Sites Liable for Excise Tax on Wagering

Thursday, August 13th, 2020

Back in 2015, I asked and answered the question on whether the DFS sites were liable for the excise tax on wagering. I came to the conclusion they were. In late July, the IRS came to the same conclusion: DFS sites are liable for this tax.

The IRS legal opinion (which cannot be cited, but does give the IRS’s reasoning) notes that clearly DFS entry fees are wagers, and that DFS events are wagering pools. The opinion cites Tschetschot v. Commissioner and also notes the dictionary definition of a wager.

The IRS opinion notes some obvious realities about skill and chance in DFS:

DFS participants may be educated on the sports games, players, expected weather conditions, and other factors. Regardless of how educated a DFS participant is, their chosen player(s) may perform poorly that day, become injured, not play in a given game, or be affected by uncontrollable circumstances such as weather and officiating. The existence of chance indicates that DFS contests are distinguishable from the type of contest described in Rev. Rul. 57-521. We conclude that the “skill” involved in selecting fantasy players is similar to the skill involved in selecting winners of individual professional sports games, horse races, or other traditional sports gambling activities.

The DFS tax rate is 0.25% on legal (authorized) wagers and 2% on any non-authorized wagers. If a DFS site operates only in states that authorized the wagers, they’ll owe 0.25% of the wagers collected; otherwise, they will owe 2%.

There’s a corollary to this that I’ve mentioned on several occasions. If DFS is a wagering activity for one aspect of tax law, it almost certainly it is for other aspects of tax law. The DFS sites have been issuing Form 1099-MISC’s as “skill contests.” It’s quite likely that DFS games are gambling and that W-2Gs should be issued instead of 1099-MISC’s.

Finally, I should point out that this legal opinion is just the IRS’s opinion. A DFS site, if audited on this issue, could appeal the decision into the courts. It’s possible, of course, a court could rule differently than the IRS legal opinion (though I doubt it).

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New York DFS & Gambling: It’s the Constitution

Wednesday, February 12th, 2020

There’s a quick way of doing many things that, in the long-run, doesn’t work so well; there’s a slower way of doing those same things that will always work. That’s true in tax, and it’s true for a legislature that’s trying to raise money.

Back in 2016, the New York state legislature amended a law so that DFS could be legalized. Almost immediately, a lawsuit was filed that said the new law violated the New York Constitution. The New York Supreme Court (which is the original trial court) ruled that the law was unconstitutional (as it relates to DFS). Both sides appealed the ruling, and last Friday a decision from the Appellate Division was released. That decision mostly upheld the original ruling.

The key points within that ruling are (1) that gambling only needs an element of chance and (2) it is not the job of the courts to look at the “…wisdom of the Legislature’s enactment of laws, but on whether the NY Constitution prohibited the Legislature from enacting such laws.”

This ruling is not good news for those who would like to see DFS or online gambling in New York state. It will take amending the New York constitution–and that’s a much harder road to go than simply passing a law. It also takes far more time. But if the constitution is amended, the law would be clearly constitutional (and legal).

I expect this decision to be appealed to the New York Court of Appeals (New York’s highest court), and it’s likely the case will be taken up (there was a dissent, and the case is about a constitutional question–the kind of case that appeals to higher courts). The problem, though, is that the plain language of the state constitution is quite specific about how to add more gambling. And it’s by amending the constitution. While a stay on enforcing this ruling may be granted (allowing DFS contests to continue in New York), unless the New York state constitution is changed the future of DFS (and online gambling) in New York looks quite bleak.

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Here We Go Again…

Tuesday, October 30th, 2018

A few years ago I penned a post titled “Taxes and Daily Fantasy Sports: The Duck Test.” To remind everyone,

If it looks like a duck, walks like a duck and quacks like a duck, then it just may be a duck.

The duck test came up yet again yesterday in Albany, New York. The New York legislature passed a law legalizing Daily Fantasy Sports (DFS), even though the New York state constitution specifically prohibits gambling. The New York legislature statutorily said, “DFS isn’t gambling.” Yesterday, Judge Gerald Connolly said the legislature was wrong.

Last year a lawsuit was filed seeking a ruling on whether DFS is New York was legal. (The case is titled White, et. al., v. Cuomo, et. al.) Yesterday, the ruling came out. (My thanks to Legal Sports Report who published the ruling. LSR is a vital resource for anyone interested in sports betting in the United States. But I digress….) The issue is the same one I raised back in 2014.

Unfortunately, many states look at just an element of chance to determine if something is gambling. And there’s no doubt that daily fantasy sports have such an element. [emphasis in original.]

In this case, Judge Connolly ruled that based on the New York constitution if there’s a contest with an element of chance, a prize, and consideration and the constitution doesn’t state that activity isn’t gambling, it is gambling. Gambling is prohibited by the New York constitution, so the constitution will need to be amended in order for DFS to be legalized.

I expect this decision to be appealed, and a stay put on any adverse impacts for DFS in New York…for now. The problem is that the ruling seems right to me. If the New York prohibition against gambling was statutory, DFS could be legalized by statute. Since the New York prohibition is in the state’s constitution, a constitutional amendment appears to be necessary. This does not bode well for the future of DFS in New York.

Additionally, this ruling points out something that should be obvious regarding sportsbetting. The Supreme Court decision in Murphy v. NCAA allows sportsbetting to be legalized state-by-state. In some states, that just means passing a new law. In many states, though, that will mean amending the state’s constitution. Changing a state’s constitution takes a lot more time and effort.

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It’s One 1099 Per Person, Or the Most Stupid and Hilarious Thing I’ve Seen in Some Time

Friday, September 29th, 2017

One of my clients, Barri Brown (all names in this post are fictitious), was missing a 1099 issued by one of the two large Daily Fantasy Sports (DFS) companies. It didn’t show on her Wage & Income Transcript, so she called their accounting department and requested a copy. A few days later they emailed it to her. She forwarded it on to me and I entered it into her return.

And then I took a look at the pdf and saw that it was 18 pages long. I wondered what kind of attachments this company would send on a 1099? Perhaps a breakout of state tax issues (although that didn’t apply to my client). Or perhaps some internal accounting records detailing Ms. Brown’s profits and losses.

How about the 1099s for everyone this company serviced with the last name of Brown? The second page is that of Brett Brown, the third page is Daniel Brown, etc. At least only the last four digits of the social security numbers were shown (but both my client and I know the exact amount of Brett Brown’s DFS income from this site in 2016).

In one way, this is hilarious. Apparently it was easier for that clerk to email the 1099s for all the Browns to my client than to just send the specific 1099. (I have to wonder about how they create their 1099s, but that’s a question for another day.)

In another way, it’s stupid. Hasn’t this company heard of privacy concerns and laws? My client has every right to know her income, but absolutely no right to know Brett Brown’s income (unless Mr. Brown elects to tell one of us).

But my client asked a very good question. “That is HILARIOUS and absurd and maybe illegal?” I’m not an attorney, so I can’t state with certainty whether this was a violation of the law. The reality is that this was almost certainly a stupid error, and there wasn’t the intent to do something illegal.

(Tax professionals fall under the provisions of the Federal Trade Commission Act. If a tax professional were to deliberately do this, it definitely could be a violation of the FTC Act.)

Unfortunately, the data breach at Equifax and this act of stupidity reinforce my belief that businesses need reminders to treat data security very seriously. My client used an Employer Identification Number (EIN) with the DFS company; I strongly recommend that sole proprietors (like my client) do that whenever possible. A stolen EIN (for a sole proprietor) can’t be used to file a personal tax return.

Let me give a helpful hint to those issuing 1099s and sending them out: It’s one to a customer. Barri Brown doesn’t need Steven Brown’s 1099. Luckily for this company, my client is able to laugh this off (as am I). The problem is that if this happened to Ms. Brown, it likely happened to Mr. Nelson and others.

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NY Judge Rules Against DFS Sites

Friday, December 11th, 2015

New York Judge Manuel Mendez granted the New York State Attorney General a preliminary injunction that bans DraftKings and FanDuel from operating in New York. Both sites will appeal, but for now daily fantasy sports (DFS) is gone from the Empire State.

As for legislative solutions, there’s an additional issue raised by attorney Daniel Wallach this morning: The Professional and Amateur Sports Protection Act of 1992. This act banned traditional sports betting in all but four states. Mr. Wallach believes that the law could be read to ban DFS, too:

This decision shouldn’t be a surprise, and I expect it to be upheld on appeal. (Note that I am not an attorney, so please don’t take what I write as legal advice.) As I wrote back in mid-November, I expect more states to ban DFS while some will move to explicitly allow it (by regulating it). Remember that the first instinct of any regulator is to ban anything that’s new. With DFS not only is that an issue, there’s also the dubious legality of it.

UPDATE: DraftKings and FanDuel filed appeals. Both sites received temporary stays against the original injunction until January 4th.

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