A major shake-up for the daily fantasy sports (DFS) industry is looming after the decision by the Internal Revenue Service (IRS) that the entry fees for the competitions must be subjected to federal excise tax, threatening to affect large DFS and sports book operators such as DraftKings and FanDuel.

An internal memorandum from the Office of Chief Counsel of the IRS released August 7 concluded that a DFS operator is liable for the excise tax on wagers and the occupational excise tax related to each person accepting those wagers, besides registering with the IRS the persons taking wagers. For daily fantasy sports, wagers are the fees each person pays to enter competitions.

IRS Will Apply Excise Taxes in Audits

Despite the memo having no legal power, its implications can be disastrous for the industry as it shows the position the IRS will hold in audits. And the tax rate varies depending on whether the wagers are legal in the state they are being accepted.

Currently, legal sports wagering is subjected to an excise tax of 0.25% on the wager and an annual occupational excise tax of $50 for each person taking the wagers, but if wagers are considered illegal, excise tax jumps to 2% of the amount wagered and the annual occupational tax jumps 10 times, to $500.

As the excise tax is applied to the wagered amount, the tax compared to the revenue goes much higher, as some gaming experts consider 2% tax on the handle to equate to roughly 20% tax on the revenue. On top of that, there potentially could be large penalties for the operators for late payments for the taxes they did not pay previously.

One of the two DFS operators that could be hugely affected by the IRS memo, Boston-based DraftKings, took a defensive stance against the conclusions from the internal document. In the conference call after the release of the company’s second quarter financial results, DraftKings CEO Jason Robins disputed the assertion.

Insisting on the notion that DFS is not wagering, Mr Robins outlined the memo has no force of law, is of a non-binding nature and was deeply flawed in its analysis on the subject. DraftKings’ CEO pointed out state legislatures and courts throughout the country affirmed his position, while acknowledging that there could be no expectations related to what a potential resolution related to an IRS audit would look like.

Unlike DraftKings, fellow DFS operator FanDuel took a measured response, confirming the company was aware of the issue and would be looking forward to working with the IRS. FanDuel did not go into details regarding potential financial implications of the memo.