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The IRS issued a new memo Friday, 7/23 outlining federal excise taxes applicable to Daily Fantasy Sports (“DFS”) betting websites such as DraftKings and FanDuel. The proposed excise tax(es) and occupational tax(es) would be equal to a .25 percent in states where contests are legal and would be levied upon the operators of the games rather than the persons using and betting on the website with a 2% potential rate increase in states where betting is illegal as well as a $500 occupational tax.

Within Memo 2020-009, the IRS argues that wagers, or bets, paid by customers to DFS operations are taxable transactions as stipulated by IRC code sections referenced along with support from Treasury Regulations and a few cited court cases. The issued memo is nonbinding in court currently, but it does shed light on the IRS’s position moving forward if and when any DFS companies are audited. From my experience within the IRS, no one in the tax profession should be surprised if there are “random” audits assigned to one or both of these companies sooner than later, or even audits currently ongoing related to the release of this memo.

The IRS’s internal, non-binding memo stipulates daily sports betting companies should have to pay excise tax(es) on the specific entry fees paid by online betters who utilize the sports betting functions provided by companies such as DraftKings and FanDuel. According to the IRS, the entry fees are “wagers”. They are subject to excise tax(es) even more so because there is a percentage of the entry fees required from customers to participate under the tax code and its provisions referenced in IRC 4401 & 4411.

The IRS contends that the main difference between fantasy sports and daily fantasy sports is in specific regards to the entry fees charged by DFS operators to customers. Daily fantasy sports take a portion of the customer’s paid entry fees outside of the winnings paid to the customer. Because a portion of the entry is kept by the DFS operator, the IRS now stipulates that a portion of the entry fee retained by the DFS operator is to be taxable, subject to excise tax. On top of that, the IRS also stipulates the DFS operators are required to register under IRC code section 4412 with excise tax rates determined under IRC 4401(a), depending on the legality classification of DFS operations within the state borders.

IRC 4401 generally imposes a percentage tax on every wager. IRC 3285 is a predecessor to IRC 4401. This tax is imposed on the person (or operator) who is engaged in the business of accepting “wagers,” and the percentage amount depends on whether the wager is authorized by the state in which the wager is accepted or is unauthorized. IRC 4421(a) defines wager as any wager with respect to a sports event or a contest placed with a person engaged in the business of accepting such wagers. So, it depends on what your definition of a wager is, right? Apologies, Mr. Clinton.

Per the IRS newly released memo – yes. Yes, DFS operators are subject to excise taxes based on the definition and interpretation of the definition of “wager.” Per the IRS’s analysis cited within the memo, the IRS states in part, A DFS entry fee is also a wager placed in a wagering pool as described in IRC § 4421(1)(B) and Treas. Reg. § 44.4421-1(c)(1). The DFS entry fee is the wager. The entry fees are placed in a common fund with the other participants’ DFS entry fees – this is the wagering pool. The successful bettor (or bettors) receive the pool proceeds, subject to the DFS operator’s commission. The game involves each selected fantasy player’s performance in a real sports event. Finally, the DFS operators derive profit from their operation of DFS by retaining a commission or taking a fee (the rake) from every participant who participates, meaning the wagering pool is conducted for profit.”

According to Fox Business, DraftKings CEO Jason Robins says the IRS’s non-binding memo is “deeply flawed.” FanDuel leadership has indicated it looks forward to cooperating with the IRS and other state regulating agencies. Per Bloomberg Tax analysis, “An IRS Chief Counsel Memorandum said those companies must pay tax on every wager—the entry fee—they accept as well as an annual occupational tax on each person accepting those wagers. Those taking wagers must also register with the IRS.” Bloomberg also added, “In 2018 DFS, or daily fantasy sports to most, generated more than $3.2 billion in entry fees and about $335 million in revenue.”

Another consideration is the fact that the IRS claims the “wagers” not “revenues from the wagers” would be taxable at a 2% excise tax rate as well as the $500 occupational tax. Therefore, companies such as DraftKings and FanDuel would be required to pay a .2-.25% tax on “the handle” or the amounts wagered and not the (net) revenues derived from the “wagers.” Moreover, both companies could be subject to late penalties, fines, and interest as imposed by the IRS if prior year taxes were not paid as well as newly compiled state tax notices, assessments, penalties, and interest.

Legally, per the rendered memo, it appears that the IRS is at odds with prior federal court rulings, specifically Humphrey v. Viacom from 2007 where “…the court’s ruling in Humphrey v. Viacom held that entry fees for fantasy sports were outside the definition of a bet or a wager though that case focused on traditional, season-long fantasy games. Per further research, DFS companies were also ensconced in legal battles in New York state in which an appeals court ruled that fantasy sports contests are illegal gambling… those are additional concerns but ultimately allow New York state to implement the higher outlined tax rates within the newly released IRS memo…” per Bloomberg.

Ultimately, if these companies are operating in states like California or New York or have “customers” betting within these more liberally taxed states, even more tax notices and assessments are almost guaranteed, especially if and when the IRS issues federal tax assessments regarding this concern. These types of states will always want their tax shares too!

All in all, the daily fantasy sports betting contest between DFS operators and the IRS will be ongoing and likely come to a head during the 2021-2022 tax season with an almost guaranteed court case related to the IRS’s newly released memo, and it’s directives. Presuming the IRS doesn’t already have a particular court case docketed. I don’t presume.

So… to whom are you placing your fantasy bet? The IRS? Or DFS operators? Maybe we can make a friendly bet on DraftKings or FanDuel? Aww… we better not! Gambling can be addictive. Plus, you never bet against the house!

Author: Dustin Wells

Dustin is an Enrolled Agent with the Strothman and Company Tax team and has been with the Firm since 2019. He has nine years of experience working for the Internal Revenue Service before transitioning his career into public accounting. Utilizing his IRS experience he specializes in assisting clients with tax representation at the federal, state, and local levels in addition to his tax preparation and planning work.
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