The IRS vs. Daily Fantasy Sports - Part II

Defining Wagers & Distinguishing Between Traditional Wagers and Wagering Pools

In Part I, we presented a critical insight: DFS is not a game. We also promised that we will analyze three main concepts further. In this post, we’ll cover the first of the three.  

To say that we are sticklers on definitions would be an understatement. We believe that most of the legal confusion at the intersection of sports and money is simply a result of prematurely diving into the analysis before we establish a consensus on definitions. Gaming v. Gambling is a big one - we actually wrote a Supreme Court amicus brief on it. That is a topic we will cover extensively in the future, but for now, let’s focus on some definitions that are relevant in this case.

Commentary by various gambling attorneys primarily honed in on two issues. First, they pointed out the circularity in definitions. Second, they argued that DFS is not a traditional wager. Daniel Wallach’s Twitter coverage is here. Darren Heitner offered similar arguments here. Are they right?

Short answer: 1) The definitions are circular, but that doesn’t make DFS right. 2) DFS is indeed not a traditional wager, but it is a wagering pool, and that’s all the IRS needs to prevail. 

Finally, any analysis that talks about traditional wagers and not wagering pools is not a proper legal analysis at all; it is simply cheerleading for the sports gambling industry. As we also stated in Part I, it is disingenuous to entirely ignore a key provision, and then to accuse the IRS of having “no familiarity with the substance they are commenting on.” 

i) Defining Wagers

With respect to the first issue, we agree that the drafting is not ideal, but disagree that this is a big deal. The circularity in the definitions goes away once we acknowledge that gambling can happen in two ways: i) chance games, or ii) entertainment claims. 

Thus, a contingent claim on athlete performance in the DFS context is gambling, because it only entertains, and does not serve a valid economic purpose. A claim on snowfall in Detroit might also entertain (indeed, at least one gambling operator offered these types of contracts when sports momentarily went away), but these contracts are blessed by the CFTC because they are risk management tools for people whose fortunes are tied to the weather. That’s the difference. Speculation, per se, is not the problem; however, it needs to contribute to greater social good. Neither traditional sports betting nor DFS does so. 

The key observation: we cannot define gambling by looking it up in the dictionary. As far as we know, the dictionary definitions always fall short, either limiting themselves to the prize/chance/consideration framework or otherwise failing to truly capture what gambling is. Some examples:

Random House (the one the IRS is relying on): something risked or staked on an uncertain event or a bet.

Merriam-Webster: the practice or activity of betting: the practice of risking money or other stakes in a game or bet.

Black’s Law Dictionary: Betting; wagering. Results in either a gain or total loss of wager, the money or asset put up. Neither risk-taking nor investing, nor like insurance. Risk taking or speculation takes on substantial short-term risk to potentially get high gain. Investing uses property or assets to potentially increase in worth, securing long-term capital gains. Insurance can prevent financial loss but has no way to gain.

Britannica: the betting or staking of something of value, with consciousness of risk and hope of gain, on the outcome of a game, a contest, or an uncertain event whose result may be determined by chance or accident or have an unexpected result by reason of the bettor’s miscalculation.

The first two are really not helpful. Black’s Law Dictionary comes closer, at least trying to draw a meaningful line between entertainment and purpose, but doesn’t quite get there. Britannica also distinguishes between games and claims by referencing an “uncertain event” (some state laws do this as well, including New York), but fails to draw a meaningful line between claims that are socially beneficial and those that are not.

This has been the problem all along. It is an issue that literally predates the United States of America (more on this later). The proper definition of gambling is out there in bits and pieces, but it was never synthesized into a coherent dictionary definition as far as we are aware. We are confident that our version, “chance games and entertainment claims” does just that. 

Bottom line: the IRS is correct that DFS is gambling, but the support it offers in the memo is not as strong as it could have been. We feel that relying on dictionary definitions to resolve the ambiguity might be risky for the IRS, and we urge the IRS to adopt a more holistic definition of gambling.  

ii) Traditional Wagers vs. Wagering Pools

Treasury Regulations § 44.4401-2(b) provides

A person is engaged in the business of accepting wagers if the person makes it a practice to accept wagers with respect to which the person assumes the risk of profit or loss depending upon the outcome of the event or the contest with respect to which the wager is accepted. 

As mentioned earlier, both Wallach and Heitner make much of this. Is this critical for the IRS?

No, not at all. It is absolutely correct that DFS is a scheme that does not involve a traditional bookmaker. It is also irrelevant. 

Why? Because Treasury Regulations § 44.4421-1 offers three definitions for wagers. Traditional bookmakers accepting wagers is only one way to get caught in the IRS’s net. The second one is wagering pools. The third one is lotteries. 

“Wagering pool” is a defined term in the regulations. Treasury Regulations § 44.4421-1(c)(1) provides

A wagering pool conducted for profit includes any scheme or method for the distribution of prizes to one or more winning bettors based upon the outcome of a sports event or contest, or a combination or series of such events or contests, provided that such wagering pool is managed and conducted for the purpose of making a profit.

In our opinion, this right here is the ballgame for the IRS. Let’s look at this definition more carefully and see why:

  1. Conducted for profit

  2. Any scheme or method

  3. Distribution of prizes

  4. One or more winning bettors

  5. Based upon the outcome of a sports event or contest, or a combination of such events and contests

This definition is tight. Like, really, really tight. Whoever drafted it must have had a lot of foresight. 

  1. Conducted for profit. It is clear that this prong is satisfied for DFS.

  2. Any scheme or method. There is no escaping this in our opinion; clearly, DFS would qualify as a scheme or method. The drafters anticipated human ingenuity and got ahead of it; the word “any” doesn’t leave any wiggle room. 

  3. Distribution of prizes. DFS cannot contest this part of the definition either. 

  4. One or more winning bettors. In our opinion, this prong is certainly satisfied. Maybe DFS argues that their participants are not “bettors,” rather they are just skilled players playing a game, but that argument fails once the proper gambling definition is applied. One can be skillful but still a bettor if the activity is gambling. Also, let’s not forget the fun fact: The podcast where two attorneys criticized the IRS position started with one of the co-hosts saying: “This could mean a lot to bettors.” (Episode 56, Conduct Detrimental, about 16-min mark)

  5. Based upon the outcome of a sports event or contest, or a combination of such events and contests. It is rather critical that this drafting includes both the singular and the plural. Why? Because the DFS industry loves legal maneuvering and argued, in a similar setting, that because the provision at issue (New York State Penal Law) uses the phrase “future contingent event,” i.e. the singular version as opposed to the plural (fast forward to 1:16 in this DFS hearing video from 2015), DFS will stay out of trouble. No such argument will apply here, as the singular and plural are both covered by the definition.

Of course, the DFS industry will come out and say athlete performance is not a sports event, and that somebody rushing 100 yards is not an outcome. This is precisely where Edgewood comes in. That type of argument was already made, and the Edgewood Court summarily rejected it.

This argument is little more than an exercise in semantics and in our view is without merit. The operation constituted a wagering pool, the winner of which was determined by reference to the happenings of a sports event. The particular manner in which such event was used in determining the winner is beside the point.

Bottom line: The IRS doesn’t need to prevail whether or not DFS is a wager under Treasury Regulations § 44.4421-1(a)(1). They may not, but that is not a problem. DFS is a wagering pool under Treasury Regulations § 44.4421-1(a)(2), and the fact that supposedly neutral commentators are not talking about it at all is not only disingenuous but also a clear sign that there is really no credible counter-argument there. For the IRS, on the other hand, the wagering pool angle is a winner and we feel that should be their primary argument.