IRS Rules Daily Fantasy Sports Is Gambling, Not Game of Skill

Posted on: October 20, 2020, 10:16h. 

Last updated on: October 20, 2020, 12:56h.

In a memo released last week, the IRS ruled the fees players pay to participate in daily fantasy sports (DFS) are indeed gambling expenses. As such, the endeavor itself should be treated as wagering, not a game of skill.

IRS Daily Fantasy Sports
IRS headquarters in Washington, DC. The agency recently said daily fantasy sports is gambling, not a game of skill. (Image: USA Today)

In PLR 202042015, the IRS addresses the matter of the amount a participant pays to enter a DFS contest constituting “a wagering transaction under Section 165 (d) of the Internal Revenue Code.” The tax agency is clear in its view, stating DFS entry fees are akin to bets.

The amount paid by a daily fantasy sports player to participate in a daily fantasy sports contest constitutes an amount paid for a wagering transaction under Section 165 (d),” according to the IRS.

The ruling is crucial for operators such as DraftKings and FanDuel because it’s the second time in just a matter of months that the IRS targeted the DFS industry.

In August, the agency said DFS providers should pay a 0.25 percent excise on entry fees. That tab would amount to $8 million based on the $3.2 billion DFS players wagered in 2018.

Another Thorny Issue

Although some states are considering ending the practice of allowing deductions of gambling losses, IRS Section 165 (d) allows for such losses to be deducted from federal tax returns.

However, the code has no statutory or regulatory definition for what actually constitutes a wagering transaction.

Due to that ambiguity, a DFS player can claim entry fees as a deduction. However, DFS participants can only get those deductions if they are paying taxes on winnings, too. In other words, a player has to show winnings to qualify for the loss deduction or risk running afoul of IRS regulations.

The IRS ruled that this is applicable across all forms of DFS play, including head-to-head games, cash contests, 50/50 competitions, and guaranteed prize pool games.

Leaning on State Rulings

In its PLR, the IRS cited multiple state court rulings that upheld the definition of a wager as something that “requires two or more parties, having mutual rights in respect to the money wagered, having a chance to win or lose upon the outcome of an uncertain event.”

On that basis, the IRS notes winnings from DFS contests are not prizes or rewards because a prize is a compensation for a performed act and DFS doesn’t meet that standard.

“DFS transactions meet the definition of wager as interpreted by the Tax Court and state courts because there is an uncertain event (such as the live performance of individual players), winnings if the event resolves in participant’s favor, and consideration is lost if the event does not resolve in participant’s favor,” according to the PLR.

As for the game of skill argument, which operators frequently supported to shield these games from being viewed as gambling, the IRS compares DFS to poker, acknowledging that skill is a component, but it “does not dictate the outcome.”

The IRS goes on to compare DFS with horse racing, which has long been considered wagering, noting that a gambler may use skill in the horse selection process, but “chance dominates the outcome of the transactions.”