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‘Unauthorized’ Daily Fantasy Play Poised for Scrutiny Beyond Tax

Aug. 17, 2020, 8:45 AM

The IRS’s newly declared position that daily fantasy sports operators like FanDuel Inc. and DraftKings Inc. owe federal excise taxes on their entry fees could lead to more than audits and levies.

Gaming attorneys parsed the wording in the IRS Chief Counsel Memorandum as opening the door to potential criminal cases, by differentiating between tax rates on fees accepted in states where daily fantasy sports are sanctioned and where they’re not. The IRS on its website even describes the two rates in terms of legal versus illegal.

“It’s not a big jump to go from unauthorized to illegal,” said Kate C. Lowenhar-Fisher, a Nevada-based gaming attorney at Dickinson Wright PLLC.

DraftKings shares fell as much as 9.6 percent Friday as CEO Jason Robins told investors that the IRS’s memo is “deeply flawed” and that the legal arguments against it are “incredibly strong.” The company’s position, he said, is that daily fantasy sports is not wagering—meaning it wouldn’t have to bother with the difference between authorized and unauthorized wagers in the first place.

The IRS memo, which isn’t legally binding but signals the agency’s position in audits, said the fantasy sports companies must pay federal excise tax on every wager—every entry fee—they accept. If the wager is accepted in a state in which it is unauthorized, a higher 2% tax rate applies, compared to the 0.25% tax for authorized wagers, the IRS said.

“It really is the the string that can unravel the entire fabric of the current daily fantasy paradigm in the U.S.,” said Marc W. Dunbar, a shareholder at Florida-based law firm Dean Mead. Dunbar handles legal matters and provides lobbying representation for several industries, including gaming.

The next step for the IRS could be asking to see the companies’ books, take a state-by-state look at the wagers that were accepted, and decide whether the appropriate level of excise tax was paid, he said.

If the IRS determines more tax is owed, especially if it assesses the 2% unauthorized rate, and companies write a check to cover those amounts, they could essentially be admitting to accepting illegal wagers, said Radney Wood, a partner at Vela Wood in Austin, Texas, who represents a dozen fantasy sports companies.

The IRS is “saying we don’t care if you’re doing something illegal, you better be paying the IRS their money,” Wood said.

The IRS, Justice Department, and FanDuel didn’t immediately return requests for comment.

Potential Target

DFS companies could run into problems with the Unlawful Internet Gambling Enforcement Act of 2006 if they implicate themselves by agreeing to pay taxes on unauthorized wagers, Dunbar said.

That law generally prohibits gambling businesses from knowingly accepting payments in connection with the participation of another person in unlawful Internet gambling. The law specifically carves out fantasy sports from the definition of a “bet or wager,” which the IRS notes in its memo.

But the agency also says the law was enacted in 2006, prior to the proliferation of DFS, and meant to apply to traditional fantasy sports—one of the reasons the agency concludes that DFS entry fees are subject to wagering taxes.

Companies that pay federal excise taxes on wagering do have some protections against having that information disclosed.

Tax code Section 4424 says Treasury employees can only disclose a taxpayer’s wagering tax information in connection with the administration, or civil or criminal enforcement, of the tax laws.

The IRS in its Internal Revenue Manual, however, also notes that the code section isn’t “intended to impede a special agent’s legitimate tax investigation by placing insurmountable administrative obstacles in the agent’s path.”

Some of those restricted IRS disclosure rules may have little benefit to DraftKings, which as a public company would probably be required to disclose if it ended up owing and paying taxes on unauthorized wagers, according to Dunbar.

“There could be some frightening implications for the DFS operators in connection with this IRS opinion,” Lowenhar-Fisher said.

Murky Legality

Twenty-two states have affirmed that fantasy sports contests are games of skill and thus not gambling, according to the Fantasy Sports & Gaming Association, which said the IRS memo could “impact membership negatively.”

FanDuel and DraftKings don’t operate in Hawaii, Washington, Idaho, Montana, Nevada, Arizona, and Louisiana, according to their websites.

But the legality of the services they provide in a few states is murky.

Both companies, for example, accept Texas residents for DFS contests even though the state’s attorney general, in a 2016 opinion, said the contests violate Texas’s laws against gambling. There’s also a pending lawsuit in the state on this issue.

But, Wood pointed out, the attorney general’s opinion isn’t legally binding in court.

“In these states where it’s not affirmatively authorized, the IRS would have a hard time arguing those are illegal bets and should be taxed at a higher amount because there’s been no political will to enforce these AG opinions,” he said. “It would be litigated like crazy.”

Similarly, in Florida, a former state attorney general issued a non-binding opinion in 1991 that said certain paid-for fantasy sports leagues would probably be illegal under the state’s law. Some have pointed to that in the debate around daily fantasy sports, though it was written decades before FanDuel and DraftKings began offering their products.

According to Dunbar, Florida has “unambiguous statutes on games of skill and bookmaking that directly hit the business model of the fantasy sports operators.”

It is unclear how the IRS will treat entry fees accepted in those states.

The memo is a “really big deal,” Lowenhar-Fisher said. “And not just in tax world.”

To contact the reporters on this story: Allyson Versprille in Washington at aversprille@bloombergtax.com; Sam McQuillan in Washington at smcquillan@bloomberglaw.com

To contact the editor responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com

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