The business of daily fantasy sports (DFS) has been on an uphill trend over the past decade and has sure earned some attention from the Internal Revenue Service (IRS). On Friday, October 16th the IRS published PLR 202042015 stating that the amounts paid by an individual to participate in DFS (also known as an entry fee) are considered a wagering transaction. A wager, as defined in the PLR, “requires two or more parties with mutual rights in respect to money wagered, has a chance to win or lose in the outcome of an uncertain event.” DFS activities, argued otherwise by companies such as DraftKings and FanDuel, are deemed as a game of chance in the eyes of the IRS. While there is a lot of research that goes into their consideration, the overall outcome is dependent upon the live performance of the professional players that make up an individual’s fantasy team. With the IRS’s conclusion of a DFS entry fee as a “wager,” we have since seen potential costs and benefits falling in the laps of the individuals and DFS companies.
Section 165(d) grants a taxpayer the ability to deduct losses from wagering transactions to the extent of their gains from like transactions *. In addition, based on the support above, the IRS has allotted taxpayers the ability to deduct their entry fees paid against any fantasy winnings. While this is surely in favor of the individual, we have caught wind of the negative implications this will have in DFS companies. The IRS published Memo 2020-009 suggesting that the entry fees paid by individuals leave an excise tax liability for the DFS companies under Section 4401. Historically, excise taxes have been applied to all wagers when it comes to sports betting. Yet, with the new clarification of the entry fees for DFS, they now fall under this umbrella. Currently, excise tax ranges from 0.25% to 2% per wager depending on is acceptance under its respective states law where it was accepted.
We have since seen some backlash from DFS companies, arguing that DFS is a game of skill versus a game of chance. Their goal in this argument is to alleviate the act of DFS as gambling. While this may see more traction at the varying state levels, the IRS deems the type of game itself as irrelevant when it comes to the determination of whether DFS is wagering for federal excise tax purposes. If the IRS looks to enforce their position in Memo 2020-009 the excise tax liability for DFS companies can peek to tens of millions of dollars for their larger companies and potentially eliminate the smaller companies altogether.
WG Observation: Please note gambling losses are reported as an itemized deduction, therefore, it is possible that a taxpayer utilizing the standard deduction may pay tax on their winnings even though losses were incurred.
