DFS Players, Operators Brace For Impact Of Latest IRS Tax Ruling

Will DraftKings and FanDuel pass the cost along to the players if DFS is taxed like sports betting?
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Building on a July 23 memorandum that declared daily fantasy sports (DFS) to be a form of gambling and thus subject to a federal tax, last Friday the IRS published another memo, dated Sept. 14, that confirmed “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 Section 165(d).

With the IRS doubling down on its assertion that, yes, for tax purposes, DFS is gambling, it’s probably time for DFS players and operators to transition from viewing this as an “if” to approaching it as a “when.”

Over the summer, DraftKings CEO Jason Robins declared that the first memo “has no force of law and is non-binding.”

That sort of defiance, which seems tenable when you have one strike against you, gets tougher to rely on when the count goes to 0-2.

While some industry insiders believe it will still be several years before the new federal taxation of DFS can be imposed, the feeling increasingly is that this is coming and the DFS community needs to brace for its impact.

DFS-playing CPA weighs in

Both a certified public accountant and a highly successful DFS player and analyst, Justin Van Zuiden is uniquely qualified to assess what these memos mean for winning DFS players, losing DFS players, and operators.

“Basically what the IRS has said is that a daily fantasy entry fee qualifies as a wagering transaction, and that essentially puts them on the same level as most sports betting operators,” Van Zuiden told US Bets. “Sports betting operators have to pay this 0.25% excise tax to the government on each wagering transaction — or in this case, for DFS operators, it would be each entry fee. That obviously adds up.”

A likely scenario is that DFS operators will transfer that cost, or at least part of it, to the players, in the form of increased rake.

“It’s not really noticeable if it’s a tenth of a percent or two tenths of a percent, or if it’s only on certain contests like the [DraftKings] Millionaire Maker or something like that,” Van Zuiden said. “But 0.25% of all their entry fees is not small potatoes. So I think you’ll see them do something, whether it’s cutting back on certain costs or trying to bump the rake up a little bit.”

Would players notice if the Millionaire Maker rake increased? It’s already just about the highest rake seen in the business. For this coming Sunday’s contest, entries are $20 and capped at 222,000, which means there will be $4.44 million ponied up if it fills. The prize pool is $3.775 million. That leaves DraftKings collecting a rake of $665,000, or 14.98% of the prize pool.

There’s a case to be made that the DFS giants, DraftKings and FanDuel, could eat the cost of the new federal taxes — instead of passing them on to consumers — and be just fine. For smaller DFS companies, especially ones that don’t have rapidly growing legal sports betting arms, the taxes might present a greater challenge.

Will winning players benefit at tax time?

While a fraction of a percent of expected value is a concern for anyone who takes their DFS play seriously, the more immediate question for many DFS players is how this IRS ruling impacts their personal taxes.

“If you’re a losing player,” Van Zuiden said, “this pretty much eliminates any ability to deduct a net loss. If I deposited $50,000 and I walked away with $40,000 of it left at the end of the year and I had a $10,000 loss, I don’t see any way under this ruling that I can deduct that net loss. From a tax perspective, if it’s treated as a gambling activity, you’re only allowed to deduct expenses up to the extent of your earnings — so basically, you’re going to be capped at a zero if you have a loss.

“For winning players, it might be more complicated. For example, if you had a winning player who made a significant sum of money, under the old guidance it was presumed that that money would be subject to self-employment tax. Basically, the IRS is saying you’re operating as a business, so you file it as a Schedule C, and you pay self-employment tax, which is essentially the Social Security and Medicare tax that the employer would have to pay.

“Now, if it ends up getting governed under essentially the gambling rules, then those winnings have a separate tax form that are not subject to those Social Security and Medicare taxes. So to me, that is a win for a winning player.”

But Van Zuiden, a content provider for RotoGrinders, is part of a subset of the DFS community with additional factors to weigh.

“If you have a second source of income from whatever DFS content provider you’re working for, then what happens if you’ve got earnings on that?” he asks. “Under the old rules, I’d file DFS and content earnings together under the same umbrella. So now what happens with that? The IRS has fumbled through this for so many years that it’s a giant gray area, and I think that they’re going to need to clarify a few more of these details after these rulings settle in.”

Not enough skill to pay the bills

The IRS ruling stems from its determination that DFS should not be characterized as a “game of skill” — even though the agency doesn’t deny that there is skill involved.

In the Sept. 14 memorandum, the agency’s Office of Chief Counsel writes, “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.”

For IRS purposes, a game of partial skill may as well be a game of complete chance.

“It doesn’t surprise me that this is the end result,” Van Zuiden said. “I think from a tax perspective it makes the most sense just because you don’t have to have a separate set of rules. In my opinion, this is probably where it will end up. I don’t think there’s enough hardline evidence to get it reversed. I think there is skill involved, but it’s a high hurdle to try to challenge the IRS on it.”

The good news for the DFS community: This appears unlikely to dramatically impact the legality of the game. In states that have already determined sports betting to be legal, or are clearly working toward legalizing and regulating traditional Las Vegas-style sports gambling, it shouldn’t matter that the IRS views DFS as gambling. In those states where FanDuel Sportsbook or DraftKings Sportsbook are accessible, there’s no logical reason their DFS sites and apps wouldn’t be.

One key consideration, however: The excise tax on a DFS entry could be as high as 2% in states without legalized sports betting. That’s a harder amount for the operators to absorb or pass along to the players without it having a noticeable effect on their bankrolls.

Photo by Leonid Sorokin / Shutterstock.com

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