IRS Takes Aim at DFS but Customers Could Be Collateral Damage

IRS Takes Aim at DFS but Customers Could Be Collateral Damage
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The percolating issue raised by the IRS now opining twice in a matter of a few months on the essence of daily fantasy sports has implications for both operators and the playing public.

Is DFS a contest of skill or a game of luck?

That is, in large part, a determining consideration in whether DFS operators are found to owe Uncle Sam millions of dollars in taxes — either going forward or even reaching back into the past.

The central tax issue is whether DFS companies are subject to a gambling excise tax that can range from a fairly modest .25% to a far more substantial full 2%, depending on the jurisdiction in which the business has been conducted.

In July, the IRS issued a memo saying that that daily fantasy DFS companies — in the IRS’ opinion — have been engaged in a gambling enterprise and as such, were subject to the same excise tax as any other gambling business, like a casino or a sports wagering company. Late last week, the IRS doubled down on that that initial opinion with still another memo in which the IRS further parries the contention that DFS can claim an exemption based on the argument that daily fantasy is a contest of skill.

The latest IRS memo argued: “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.”

To put some of this in perspective, a couple of notes.

First, an opinion issued by the IRS is not binding on the taxpayer in itself. However, that’s not to say it is insignificant or should be taken lightly. To the contrary, it is a shot across the bow alerting the taxpayer (in this case, DFS companies) that further action could be coming.

Second, depending on how strong the DFS companies feel about all this, the enforcement of the aforementioned IRS opinion could be delayed substantially by legal action.

“This feels like it was a long time in coming,” said tax attorney Brad Polizzano, a senior manager with Baker Tilly US, who is familiar with tax issues involving gambling. “Sometimes, the Service (IRS) looks at an issue that it gets around to sooner or later and in this case, it’s certainly later — but it has let it be known that it considers DFS to be gambling.”

DFS Strongly Disagrees with IRS Opinion

And should that opinion be enforced, the excise tax would come into play. The DFS industry, which has always looked at the Unlawful Internet Gambling Enforcement Act as the guide for the legality of the games, has made it clear it strongly disagrees with the IRS opinion.

DraftKings CEO Jason Robins said at the time of the initial opinion in the summer that it was “deeply flawed in its analysis.”

Robins also said: “Our position continues to be, which we believe has been reaffirmed to state legislators and courts throughout the country, that DFS is not wagering.”

Sources knowledgeable about the DFS industry agreed with Robins and observed that the other DFS heavyweight, FanDuel, is “linked arm-in-arm” with DraftKings in contesting the IRS opinion.

Currently, there are far more questions than answers about all this, not the least of which is what does it all mean for DFS customers? In the end, probably nothing good if the IRS opinion is enforced.

“So, the question out there is how is the IRS going to enforce it?” Polizzano said. “Are they going to now just expect these operators to remit the tax going forward or are they going to go back and examine all these DFS sites in an audit and try to figure out how to quantify how much tax should be paid? If they haven’t been filing and paying, there’s no statute of limitations.

”The IRS can go back for however long. Depending on whether there’s enough money involved, will the operators put a stake in the ground and say, ‘We still think it’s a game of skill and it’s not subject to the tax,’ and then they could end up in tax court over this.”

Cost Likely Passed on to Players

For individual DFS players/taxpayers, there might be a few consequences.

For starters, if the DFS companies have to pay more in taxes, it is quite likely that becomes a cost passed on to customers in the form of higher rake. Already, DFS rake Is substantially higher than the vigorish paid by bettors in straight-up sports wagering.

As it stands, daily fantasy is not an easy game to beat on a consistent basis because the pool of payers in these peer-to-peer contests has become increasingly sophisticated and, as mentioned, the rake has crept higher and higher in the short history of the DFS phenomena.

Also at issue is how DFS players will themselves be required to account for any income from playing DFS should they be so fortunate as to have a net gain at the end of a calendar year.

DFS Companies Use Form 1099

So far, the documenting standard has been for some major DFS companies to send their customers a year-end Form 1099 that reflects a net figure of winnings-minus-entry fees with the entire year considered one “session.” The triggering figure for the 1099 has been a gain of $600.

It is significant that the DFS companies issue customers a Form 1099 rather than a W-2G. The latter is documentation that gamblers often receive as a result of hitting a jackpot on, say, a slot machine (different circumstances are associated with varying triggering payout thresholds). Obviously, since DFS companies insist that their product is not “gambling” they would be (and have been) reluctant to issue a document (the W-2G) that would be a tacit admission otherwise. Hence, the Form 1099.

All this does affect DFS players/taxpayers. For instance, if they have a reportable daily fantasy gain on DFS website A (assume $1,000) but have also recorded and even journaled losses on DFS website B for $500, how is that handled? If the DFS player/taxpayer conducts his DFS activity as a legitimate ongoing business, the handling of the tax issue is different than if it’s merely a hobby that’s done in spare time to make a few extra bucks.

All along, the treatment of DFS in terms of federal taxation has been a bit murky. The contentions arising over the excise tax are certainly significant. And while it appears on the surface to be a battle above the level of the average DFS player, there are ramifications that are certain to ripple from the industry's corporate suites down to the weekend daily fantasy player who’s just trying to put together a winning lineup.