The IRS vs. Daily Fantasy Sports - Part IV

May We Have the Check Please?

Is DFS a wagering pool? We believe it is.

Is the IRS's puzzle ruling irrelevant? Yes

If so, only one question remains. How much would a DFS operator owe the IRS? There are two possibilities

  1. State Authorized Wagers. There shall be imposed on any wager authorized under the law of the State in which accepted an excise tax equal to 0.25 percent of the amount of such wager.

  2. Unauthorized Wagers. There shall be imposed on any wager not described in paragraph (1) an excise tax equal to 2 percent of the amount of such wager.

There is quite a difference between the two, so let’s start with our favorite topic: definitions. What do authorized and unauthorized mean? 

Daniel Wallach covered this in his Twitter storm, taking the position that “authorized” does NOT mean expressly permitted by statute. 

To support his position, Wallach also cited some IRS language, arguing that legal means authorized. 

There are two problems with that approach. 

First, the Supreme Court summarily rejected it. In Murphy v. National Collegiate Athletic Association, 584 U.S. ___ (2018), the Supreme Court noted:

The concept of state “authorization” makes sense only against a backdrop of prohibition or regulation. A State is not regarded as authorizing everything that it does not prohibit or regulate. No one would use the term in that way. For example, no one would say that a State “authorizes” its residents to brush their teeth or eat apples or sing in the shower. We commonly speak of state authorization only if the activity in question would otherwise be restricted.

Second, legal commentary made in other contexts took an opposite view.

For example, Rob Rosborough, a litigation partner based out of New York, published a paper on the DFS litigation in New York. He stated (bold emphasis added):

And when a group of plaintiffs challenged New York’s 2016 Interactive Fantasy Sports (IFS) law that authorized DFS in New York for the first time, the courts held that the law violates the constitutional ban because DFS contests involve a material degree of chance. 

It is pretty clear that Rosborough does not think DFS was “authorized” before the enactment of the IFS law. Whether or not it is authorized even today is also a question mark, as two courts concluded that the IFS law is unconstitutional at the state level, but we’ll have a separate write-up for that.

Even Wallach himself doesn’t believe legal means authorized. In a piece he co-authored with Rob Rosborough, he took this position:

Once a form of gambling is authorized, the Constitution gives the Legislature power to regulate the details of wagering. That’s why the constitutional provisions authorizing the state lottery, pari-mutuel betting on horse races and casino gambling include the phrase “as may be authorized and prescribed by the legislature,” meaning that it’s up to lawmakers to “authorize and prescribe” how wagering on those constitutionally-permitted forms of gambling will work.

Wait - there is more. Wallach also authored a paper titled “Daily Fantasy Sports and PASPA: How to Assess Whether the State Regulation of Daily Fantasy Sports Contests Violates Federal Law” (behind a paywall but a free preview may be available through Google Books). In it, he stated:

These definitions suggest that the term “authorize” does not merely mean “to permit” or “to allow.” Rather, according to the plain and ordinary meaning of the word “authorize,” there must be an affirmative granting of formal approval or permission to allow the conduct in question (Norberto, 373 F. Supp. at 156).

That view is, of course, consistent with the Supreme Court position. 

This is precisely the problem in our country, folks. People take whatever position is convenient at the time, and then turn around and take the exact opposite position in a different context when it suits them.

Again, the IRS should take note. Legal does NOT mean authorized. There is strong support for that position based on the Supreme Court decision in Murphy as well as all the legal commentary made in different contexts. What does that mean? That means that there are a lot of places where DFS is not authorized, and in those places, a 2% excise tax should apply. Example: our home state, California. Even if we assume DFS is legal in California, DFS is NOT authorized in California. As far as we are concerned, there is no affirmative granting of formal approval or permission to allow DFS in the state of California.

What if legal actually meant authorized as Wallach is arguing now (conflicting with his earlier position)? We certainly don’t think that is right, but let’s follow that line of reasoning for a moment. Let’s assume, arguendo, legal means authorized. Now we are back to square one. How do we determine whether or not DFS is legal, and under what standard? The excise tax provision makes reference to state law, so if we take the view that one needs to start with the statute, the relevant law is the state law. 

Again, we are in California, so let’s see. The California Penal Code does not define gambling, but makes it a crime to engage in bookmaking, pool-selling and other activities. Remember how we argued that DFS is a wagering pool? Thus, DFS might be pool-selling under the California Penal Code. 

Critically, the California Penal Code also makes it a crime to:

  • Occupying any building, room or other enclosed space for the purpose of recording bets;

  • Receiving, holding or forwarding money or other items of value that are being wagered in a bet; or

  • Recording or registering bets. 

All of these three provisions make reference to bets or wagers on “unknown or contingent event whatsoever.”

Remember - DFS is not a game. It is a claim on contingent events. Thus, even if legal means authorized, we believe the legal status of DFS in California is on shaky ground in the first place. 

We’ll finish with another Wallach position. In his paper, he said (bold emphasis added):

While the definitions of [other betting, gambling, or wagering scheme] also vary from state to state, generally a “bet” or “wager” occurs whenever a person stakes or risks something of value on the outcome of a contest or contingent event, in the hope of winning more money than was risked. This would seem to encompass most real-money DFS contests, since contestants are risking something of value (in the form of an entry fee) on the outcome of either a contest (the DFS contest) or a future contingent event (the performances of a group of real-world athletes who the DFS participant drafts for his or her fantasy team) in the hope that those performances will accumulate more points than the mythical teams put together by a participant’s competitors and thereby enable to him or her to win a prize. 

This sentence belonged to a section titled DFS Contests Are A ‘Betting, Gambling Or Wagering Scheme.”

We rest our case. 

Bottom line: We don’t think legal means authorized. We also don’t think that DFS’s legal status under state law is fully vetted. DFS is not a game, but a claim on contingent events. Those two observations may significantly impact what the excise tax check looks like for DFS.