The IRS vs. Daily Fantasy Sports - Part I

Why the IRS is Right and Daily Fantasy Sports is Wrong

The daily fantasy sports (DFS) industry received some news a couple of months ago when the IRS issued a memorandum (PDF) and stated that DFS positions are wagers that need to be taxed. Bloomberg was quick to cover it, pointing out that tax consequences could be “business-destroying”. Jason Robins, CEO of DraftKings was asked a question on it in the Q2 Earnings Call and this is how he responded:

This was a memo that has no force of law, is nonbinding and our view is deeply flawed in its analysis. And our position continues to be, which we believe has been reaffirmed through state legislatures and courts throughout the country, that DFS is not wagering. And we believe that the arguments at the federal level are incredibly strong and that many courts and legislatures have affirmed that.

Daniel Wallach, a sports gambling attorney, clearly took issue with the IRS position, firing up a series of Twitter posts. He then covered the issue on Episode 56 of Conduct Detrimental, a sports law podcast (the 10-minute discussion starts at 15:46). His co-host, Dan Lust opened the discussion by saying “This could mean a lot to bettors,” arguably revealing his real views on DFS. The IRS should take note. 

The tone got rather harsh over the next ten minutes, with Dan Lust declaring that the IRS has “no familiarity with the substance they are commenting on”, and the IRS should ask them and people in the gambling community what qualifies as a wager. In our view, it is actually the pro-DFS crowd that has no familiarity with the substance, and if you want to understand why, please read on. 

The IRS issued another memorandum in October and doubled down on its position. Forbes chimed in. Daniel Wallach took issue with the IRS's position again.

Bloomberg covered it again and unfortunately missed the mark on a critical piece. Specifically, it included  this quote from Daniel Wallach:

Every state attorney general opinion has concluded DFS is a game of skill.

We are not sure what happened here, but the statement is clearly incorrect. One boutique law firm, Vela Wood, actually tracks this stuff. It shows 13 negatives, 4 mixed and 4 positive opinions. Quite a far cry from every state attorney general opinion concluding DFS is a game of skill, isn’t it?

So there you go. This is how we deviate from the truth. It may have been an honest mistake. That said, it appears that the Bloomberg author didn’t fact-check it, Wallach tweeted it without correcting it, and we are now left with the readers of this piece thinking all state attorney generals that have opined on this issue concluded that DFS is a game of skill. That is simply false. Relentlessly seeking the truth and calling out inaccuracies and incorrect statements when others are not is what we do, and you can be absolutely certain that we will continue to do just that. 

***

Now for the main event. Is the IRS position a big problem for the DFS? Or is it yet another legal nuisance the industry can handle?

The answer depends on how you look at it. There is certainly a path for the IRS to prevail on the argument. There might be millions of tax dollars at stake here, as the taxes would be calculated as a percentage of gross fees, not profits. The more important question is what that path looks like. We believe a proper resolution of this case really comes down to the legality of DFS, which has never been fully vetted. More specifically, a proper resolution will likely come down to the question of whether DFS is a game of skill. 

Some of you may know our position on this, most of you probably don’t. Are you ready? Here it is, in a picture: 

Here it is, in five words:

DFS is not a game

Shocking? Yes. The only conclusion that logic dictates? Yes.

The problem, at its core, has always been definitional. A seemingly simple question for which the answer eluded us for centuries. Literally. That question is:

What is gambling? 

You could shake your head and say “What is so controversial about the definition of gambling? It is the prize/chance/consideration framework.” 

You would be right IF the activity was a game.

The proper definition of gambling is, and honestly has always been this:

Gambling = Chance games & entertainment claims

That’s it. It is a two-step process, really. 

Step 1: Determine whether the activity is a game or a claim.

Step 2a: If a game, measure where the game lies on the skill vs. chance spectrum. If enough skill exists (however that boundary may be defined), the activity is not gambling.

Step 2b: If a claim, measure where the claim lies on the entertainment vs. purpose spectrum. If enough purpose exists - we are talking valid economic purpose here -  the activity is not gambling.

Give credit to the DFS industry for tricking everybody into thinking DFS is a game. The result?  We have been applying the wrong test to DFS all along. Everybody was taking the blue pill

Daily fantasy sports games? That is the biggest fantasy of all. It is not a game. Therefore, whether or not DFS involves skill is completely irrelevant. 

If you are in the mood for reading while your favorite coffee is brewing, check out our New York amicus brief. In that brief, we characterized DFS as a market. Subsequently, we refined that characterization and started using the word “claims”, which is the more technically correct term. Other than that labeling upgrade, that brief is what contains the proper DFS narrative. 

Right around the time we submitted the brief (March 2016), the then-New York Attorney General Eric Schneiderman decided to settle with the DFS operators. Arguably, that settlement changed the trajectory of DFS, resulting in more sports gambling, inaccurate statements and wrong legal opinions. 

If you are short on time, or provocative thought experiments are your thing, we’ll leave you with this question.

Which “game” were you not able to play during the pandemic? 

Monopoly remained an all-time favorite. Playing “doctor” was natural for kids. Video games, in moderation, can be beneficial and bring families together. Basketball was largely stopped to enforce social distancing, but there were still some options: certain parks, your backyard hoop, etc. 

DFS, on the other hand, was the only “game” that had to come to a full stop (if the underlying sports had stopped). How is this possible? Isn’t the whole point of a game to momentarily disconnect from life and have some fun?

We know this sounds crazy, but ... DFS is not a game. We’ve been saying this for a while now, and the fact that DFS had to stop during a pandemic reveals the true colors of DFS. It’s not a game. It is simply a contingent claim on sports performance.

This insight has substantial implications, one of which is this: the IRS is right, and DFS is wrong. DFS is gambling, and therefore subject to the excise tax. Viewed in that light, the IRS memo can be seen perhaps as the beginning of another legal battle where the courts continue to try to sort through the question of what is gambling. Yes, this is a taxation issue; however one the proper resolution of which requires understanding why DFS is gambling.

Over the next few days, we will publish Part II, III, IV and V where we analyze three main concepts that we feel are central to this debate: 

  • Definitional Matters: defining wagers & distinguishing between traditional wagers and wagering pools; 

  • Previous IRS positions: analyzing an IRS ruling on a puzzle contest; and  

  • Excise Tax Calculations: determining the right amount of the excise tax, i.e. 0.25% vs. 2%. 

In addition, we are offering an annotated version of the first IRS memo in our Full Court Press Legends collection on the Thinkific platform. Legends is where we dive deeper into court decisions, legal arguments, and everything else that resides at the intersection of sports, money and law. We cover quite a bit here already, but if you want even more analysis, be sure to check it out.