DraftKings, FanDuel fees deemed taxable in landmark IRS memo

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Daily fantasy sports companies like FanDuel Inc. and DraftKings must pay federal excise tax on their entry fees, the Internal Revenue Service has decided, according to an internal memo that could cause a major shakeup in the industry.

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. DraftKings fell before regular trading Friday.

“This is one of the most significant events in the evolution of sports betting in the United States that has happened in a long time,” said Kate C. Lowenhar-Fisher, a Nevada-based gaming attorney at Dickinson Wright PLLC.

It could mean fantasy sports companies would face millions of dollars in taxes if they haven’t been paying and are challenged by the IRS. The taxes due could be “potentially business-destroying” in some jurisdictions, Lowenhar-Fisher said.

The daily fantasy sports industry generated $3.2 billion in entry fees and about $335 million in total revenue in 2018.

The memo isn’t binding in court but does signal the agency’s position in audits.

DraftKings declined to comment. FanDuel said it is aware of the issue and looks forward to working with the IRS. FanDuel declined to comment on the financial implications of the memo.

DraftKings shares fell as much as 7.4 percent in volatile premarket trading Friday and were down 3.5 percent to $34.80 at 7:39 a.m. in New York. The stock had soared 237 percent this year through Thursday.

Separately Friday, DraftKings reported second-quarter revenue of $71 million, beating the analyst estimate of $66.4 million compiled by Bloomberg. The company said it expects pro forma 2020 revenue of $500 million to $540 million, which it said would mean second-half revenue growth of 22 percent to 37 percent. DraftKings didn’t refer to the IRS memo in its release.

Tax consequences

Daily fantasy sports are online games that let fans — in exchange for an entry fee — compete for cash prizes contingent on the performance of the professional athletes they select in their fantasy lineup.

The memo says the IRS considers the entry fees to meet the definition of a wager under the tax code.

The amount of federal excise tax owed differs based on whether the wagers are legal in the states in which they’re accepted, according to the IRS.

Legal sports wagers are subject to an excise tax of 0.25 percent on the amount wagered and an annual occupational tax of $50 for each person accepting wagers. Illegal wagers are subject to an excise tax of 2 percent on the amount wagered and the annual occupational tax increases to $500 per person accepting wagers.

It’s significant that the tax applies to the wagers themselves, as opposed to revenue, Lowenhar-Fisher said.

“A 2 percent tax on handle can roughly equate to like a 20 percent tax on revenue,” she said, basing the figures on her experience dealing with companies in Nevada. Handle is the amount of money accepted in wagers.

In addition, companies could be looking at large late payment penalties for taxes they didn’t previously pay, she said.

Legal challenges

Gaming attorney Daniel Wallach of Wallach Legal LLC pointed out that the memorandum is at odds with a previous court ruling from the U.S. District Court for the District of New Jersey, which could be something companies use to challenge the IRS.

The court in 2007 ruled in Humphrey v. Viacom that contest fees for daily fantasy sports were outside the definition of a bet or a wager.

The industry was recently at the center of a New York legal battle in White v. Cuomo, when an appeals court ruled that fantasy sports contests are illegal gambling.

Lots of zeros

The IRS in the memorandum notes that the companies can’t get out of paying the tax, even if a state has decided daily fantasy sports are a “game of skill,” as opposed to gambling. The agency notes that some states use this label to decriminalize the activity under state law.

The potential bill won’t be cheap for people who may have been skipping out on those taxes.

“You’re talking about lots of zeros in liability, lots of zeros,” said Marc W. Dunbar, a shareholder at Florida-based law firm Dean Mead.

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