IRS: DFS Entry Fees Should be Subject to Federal Excise Tax

The industry of daily fantasy sports (DFS) is facing a significant threat to its very existence, a comprehensive analysis of recent developments outlines. And that threat comes from the internal revenue service (IRS) which came up twice for the last 4 months with statements that DFS represents wagering and should be subjected to federal excise tax on wagers.

IRS Considers Entry Fees Wagering Transactions

Last week the IRS released PLR 202042015, in which it determined that amounts players pay to enter DFS contests constitute a wagering transaction under the meaning of Section 165 (d) from the Internal Revenue Code. According to the provision, losses from wagering transactions may be deducted but only to the extent of the gains from these transactions. In other words, the IRS concluded that DFS entry fees are gambling expenses.

The IRS conclusion threatens the existence of DFS operators like DraftKings and FanDuel which in some states, including New York, operate on the premises that DFS is a game of skill rather than a game of chance. The IRS stated that DFS transactions meet the definition of wager as interpreted by the Tax Court due to the uncertainty of an event, this event being the selected players’ performance.

The legality of the position of DraftKings and FanDuel that DFS is a game of skill is still for the Court of Appeals to rule, as a sequence of events that was triggered in 2015 by New York Attorney General Eric Schneiderman, who issued a cease-and desist order and forced DFS operators to temporarily suspend allowing players from the state, was followed by lawsuits and appeals and the final outcome is now heading for the highest state court.

Game of Skill or Game of Chance

And while the industry waits for the Court of Appeals to rule whether it is one or the other, the IRS has already decided it was irrelevant from the point of view of the federal excise tax on wagers. In its 2020-009 Internal Memo the IRS shocked the DFS industry, suggesting the entry fees for the contests should be subjected to a federal excise tax ranging from 0.25% to 2% per wager.

In the memo the Service defended the position that contestants’ entry fees meet the criteria for wager according to Section 4421(1)(A) and (B) of the Internal Revenue Code, and regardless of the outcome of the ongoing battle between operators and states whether DFS is a game of skill or a game of chance, entry fees should be taxed.

“…the statutory language in IRC §§ 4401 and 4421 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.”

IRC Internal Memo 2020-009

If the IRC decides to enforce its memo position and impose the excise tax on DFS wagers in full, many small operators would cease to exist while the big boys would have to pay tens of millions of dollars annually.