States Are Betting on Tax Revenue From Online Sports Wagering

In 2018, the US Supreme Court struck down the Professional and Amateur Sports Protection Act, a federal law that effectively had frozen authorized sports wagering across the country. The only state with a notable sports betting industry at that time was Nevada, which had legalized and regulated full-fledged sports betting prior to PASPA’s enactment in 1992, and which enjoyed a relative sports betting monopoly in the US, legacied in by the statute.

With PASPA invalidated, each state could determine if, when, and how to legalize and regulate sports wagering. The appetite for such wagering became apparent in many jurisdictions, as well as the desire to add much-needed revenue to state coffers.

While the PASPA case was pending, the American Gaming Association said that at least $150 billion was being illegally wagered on sports betting in the US each year. This multibillion-dollar backdrop supported efforts to consider the opportunities available to derive tax revenue from a newly authorized industry.

The numbers appear to loom large. New Jersey, the state behind the PASPA case, has since authorized both retail (brick and mortar) and online/mobile sports betting, and is seeing average total wagers, or handle, of $1 billion per month. New York joined the online sports betting fray in January 2022, reporting $1.67 billion in sports wagers placed in its first month, which is notable because it was truncated by a Jan. 8 start date. Massachusetts, the latest state to enter the market, hopes to emulate the success of New York when it launches—likely in 2023.

Betting on a Low-Margin Business

Despite the huge numbers associated with sports betting handle, profit margins for operators are quite low. The reported billions of dollars in wagers appear to indicate the activity’s popularity but do not tell the complete story with regard to the operators’ ultimate profit.

Sports betting is an expensive venture. Much of the handle is returned back to the customers. The hold, or revenue actually kept by the sportsbooks, is but a fraction of the handle generated. Of that revenue, high costs of operation must be paid. Aside from typical operational costs, expenditures toward customer acquisition have curtailed profitability. To operate in this highly regulated industry comes at a significant regulatory price via licensure fees and taxes, as well as costs associated with compliance and responsible gambling requirements.

Operators in unregulated markets don’t absorb such high costs and can more easily offer consumers a more competitive product, which further drives down margins for licensed, authorized businesses. States should consider the fiscal impact of regulation on lawful operators to encourage operation within their borders to best maximize those desired tax dollars.

Differing Approaches to Taxing Sports Betting

Unsurprisingly, the potential of untapped tax revenue has impacted states legalizing sports betting. States have struggled to strike the right balance between incentivizing sports betting operators while collecting sufficient taxes to justify legalization.

To reach the high gross revenue reported by operators, states have pursued gross receipts taxes on sports betting. One would expect that a gross receipts tax on a high-revenue industry would yield significant tax revenue. The problem is that for this industry, gross gaming revenue, or the amount of money placed on bets less how much was paid out on winning bets, is far lower than the amounts wagered. Further, the gross gaming revenue may include promotional bets, which are reported as gross revenue but which yield no actual revenue for the operator. By taxing an operator based on gross gaming revenue, the gross receipts tax may be levied on transactions where the operator actually lost money. The taxes are disproportionate to the actual profit earned by operators, which can drive operators out of a state if the rate is too high to support the operating benefits.

That’s the case in New York, which legalized online sports betting in January with a 51% tax rate on gross gaming revenue. While the rate itself may seem excessive, the actual impact on operators is greater than it appears because New York includes promotional bets in gross gaming revenue, essentially taxing revenue that does not exist. For a new market such as New York, promotional bets can make up a significant percentage of its bets, increasing the effective rate considerably. Rates this high can affect the industry’s willingness to engage in the New York market. Already, operators have been forced to cut back on promotional bets in the face of excessive losses in this first year. Operators may have to consider other measures as well, which will impact the product offering to customers.

Geography plays a role in the conversation, as both operators and players can merely cross the Hudson River to neighboring New Jersey. New Jersey taxes online sports betting revenue at 14.25%.For operators with in-state casinos, promotional bets may be deducted in determining gross gaming revenue, creating an even greater disparity in the effective rate between New York and New Jersey.

For most businesses, the solution to excessive taxes is to increase customers’ fees, but that model is imperfect here. Customers in New York might be willing to cross the bridge for a better deal in New Jersey or gravitate toward illegitimate sites that boast legality but are unregulated, unlicensed, and untaxed.

New York lawmakers may be counting on the appeal of a state that represents a strong market of both local and transient participants. Tax rates vary among the states, with geography, regionality, and population density, among other factors, affecting those decisions. States that have authorized sports wagering tend to hover in the 10% to 15% range, with outliers such as Pennsylvania at a 36% tax rate contrasting with Nevada’s 6.75% tax rate. Some states deduct promotional betting from the calculation, while others require its inclusion inflating the revenue figure. This highlights the need of operators to stay current on the nuances among the tax frameworks to maintain a profitable business in each state and to avoid an unexpected tax hit.

Conclusion

In just over four years, most states have approved sports betting in some form. It remains to be seen how the operators and regulators will continue shaping the industry and whether the state-by-state patchwork of tax rates will continue to hold. Lawmakers and operators are endeavoring to strike the right balance to make it both a profitable business venture and a strong state tax revenue producer. In the near term, operators will have to compare and contrast different states’ approaches to taxation to determine the best bet for their futures.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Stefi George is a tax partner at Akerman LLP in New York. She advises clients in tax planning, compliance, controversy, and litigation.

Tamara Savin Malvin is a litigation partner at Akerman LLP in Fort Lauderdale, Fla. She represents businesses and individuals primarily in the US, gaming and hospitality sectors, as well international entities sued in the US.

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