Daily fantasy sports giants DraftKings and FanDuel spent several years in a mostly successful state-by-state effort to convince legislatures that their product did not constitute gambling, a la sports betting that was mostly outlawed in all but Nevada.
Then the U.S. Supreme Court in 2018 threw out a 26-year-old federal law that banned that sports betting, and suddenly the distinction hardly seemed to matter. The two DFS giants almost immediately began to dominate the sports betting space while maintaining those DFS products.
But last week, the status quo potentially was upended when the IRS published a 10-page memorandum declaring that DFS is gambling and therefore subject to a federal tax.
The memo contrasts traditional season-long fantasy sports leagues – such as the Rotisserie League baseball competition my current league launched in 1984 – to DFS, which does not tend to feature merely friends and work colleagues pooling money and then paying it all out to the most successful owners six months later.
“For contests involving guaranteed prize pools, a typical DFS operator will set the prize pool such that it retains a commission ranging from 6% to 14%,” the memo notes.
“A DFS operator may try to differentiate taxable wagers from non-taxable entry fees into skill-based contests. In state courts and state legislature discussions of DFS, the issue of DFS’s legality within each state typically turns on whether DFS is a game of skill or a game of chance (that is, gambling) under the state’s laws.
Skill vs. chance question doesn’t matter to IRS
“While these state rules are helpful context, the statutory language does not differentiate whether an activity involves skill, chance, or some combination of the two. Most importantly, whether DFS is a game of skill for state gambling statute purposes is not relevant for determining whether DFS is wagering for federal excise tax purposes.
“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.”
Daily fantasy sports previously has banked on the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA), which exempted fantasy sports from a federal definition of gambling.
DFS was in its infancy at the time, of course. But this memo concludes that UIGEA is not relevant to the issue of the taxability of DFS revenues.
Sportsbooks already pay an 0.25% federal tax on revenues, although the American Gaming Association recently began lobbying for a repeal of that tax and a pair of Congress members have introduced a bill to eliminate it.
The AGA estimates that the federal government collected $33 million by this tax in 2019.
DraftKings CEO Jason Robins – whose company could be on the hook for $20 million or more per year if the memo grows teeth – scoffed at the memo in a quarterly conference call with gaming analysts last week.
“We have been involved in in audit with the IRS for many years, and this was a memo that has no force of law and is non-binding,” Robins said. “In our view, the analysis is deeply flawed. It has been confirmed in courts throughout the country that DFS is not wagering, and legislatures have affirmed that. We believe that the arguments at the federal level are incredibly strong.”
Big deal – or no big deal?
Still, not all insiders are as convinced that the memo is a non-starter.
“This is one of the most significant events in the evolution of sports betting in the United States that has happened in a long time,” said Kate C. Lowenhar-Fisher, a Nevada-based gaming attorney at Dickinson Wright PLLC.
But in a series of tweets, renowned gaming law attorney Daniel Wallach questioned the logic of the memo.
“The core issues are two-fold: (1) are DFS entry fees “wagers”? and (2) are DFS contest operators engaged in “the business of accepting wagers” through their acceptance of entry fees to compete in contests? The answer to both questions is ‘no’ (IMO).
“First, there is no independent definition of ‘wager’ under the Internal Revenue Code. And to confuse matters, the Treasury Regs provide a completely meaningless circular definition of the word ‘wager,’ essentially defining a ‘wager’ as a ‘wager.’ Essentially meaningless.
So, how, then, does the IRS attorney arrive at a definition of the word ‘wager’? She relies entirely on a single Random House dictionary definition, ignoring more than one century of case-law on that issue. This is the linguistic equivalent of forum-shopping.”
Wallach said that the real definition of a wager is that there are two sides, with each winning or losing depending on the result of the bet. But, he adds, “DFS companies are indifferent to the result.”
That’s significantly different from sportsbooks, which can actually lose money on occasion when bettors have an unusually good day – it happened on Monday, when 20 out of 21 MLB/NBA/NHL favorites all won.
That was a major loss for the books, because multi-game “parlay bets” – which overall produce double-digit profits for sportsbooks – tend to include numerous favorites all packaged into one bet. As long as one of the favorites lose, the house wins.
Ultimately, this phrase from the IRS memo is worth noting: “This Generic Legal Advice Memorandum responds to your request for assistance. This advice may not be used or cited as precedent.”
Who sought the analysis is unknown, setting off a flurry of social media speculation among gaming industry insiders as to the identity of the requesting party.
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