Legal Law

What To Make Of The IRS Memo To Add A Tax On Every day Fantasy Sports activities Firms

The Internal Revenue Service recently issued a memorandum declaring that companies offering daily fantasy sports services should be required to pay a federal excise tax of 0.25%. The opinion held that the tax should not be applied to season-long fantasy sports competitions that may be held by those same companies.

DraftKings and FanDuel would be burdened the most by the imposition of a new 0.25% excise tax on their operations. In 2017, the Federal Trade Commission authorized legal action to block a proposed merger between the two companies based on an understanding that a newly formed combined entity would control more than 90% of the U.S. market for paid daily fantasy sports contests. The companies never merged, but still maintain their dominance over the industry.

“Our expectation is that DraftKings and FanDuel will use the substantial amount of ambiguity present in the opinion and corresponding statute to argue for a delay in implementation,” said Chris Grove of Eilers & Krejcik Gaming, a research firm focused on the U.S. gambling industry. “We believe they will likely be successful in obtaining this delay. What follows from there is less certain, as the potential impacts range from a nominal settlement to a material impact on each company’s bottom line. Smaller fantasy operators may be even more vulnerable to that potential range of outcomes as they lack the balance sheet and customer values that will insulate DraftKings and FanDuel.”

The statute referred to by Grove and included in the IRS memo is 26 U.S.C. § 4401, which states that there shall be imposed on any legal wager an excise tax equal to 0.25% of the amount of such wager. The ambiguity is in the definition of “wager” as it is used in that federal statute.

A definition for “wager” is provided in 26 U.S.C. § 4421(1), but it is not very helpful. In fact, the statute basically says that a wager is a wager, which makes it an impossibility to appropriately determine whether a daily fantasy sports entry fee should be construed as a wager for the purposes of applying the stated excise tax. The statute says,

The term “wager” means— (A) any wager with respect to a sports event or a contest placed with a person engaged in the business of accepting such wagers, (B) any wager placed in a wagering pool with respect to a sports event or a contest, if such pool is conducted for profit, and (C) any wager placed in a lottery conducted for profit.

It is one of the worst crafted definitions that I have ever seen. While companies offering daily fantasy sports options are certainly providing a service based on a sports event, the definition does not in any way help determine whether those companies are in the business of accepting wagers or whether the entry fees are wagers.

The IRS also recognized the lack of clarity and pivoted to applying the term’s “plain, obvious, and rational meaning” by citing to the Random House College Dictionary, which defines a wager as something risked or staked on an uncertain event, or a bet. It thus conveniently concluded that a daily fantasy sports entry fee fits into the definition of wager.

However, as my colleague Daniel Wallach astutely pointed out, numerous courts have held that the risk of loss element must be present on both sides of a transaction for the transaction to be considered a wager. For instance, an individual who places a bet with a sportsbook for the Miami Heat to beat the Indiana Pacers is, in effect, placing a wager because both the individual and the sportsbook has the risk of losing based on the outcome of the game. With daily fantasy sports, the operator does not bear the same type of risk; the only risk to the operator is that it will guarantee a certain prize pool and lose money if not enough people pay entry fees to cover the pre-set guaranteed prizes.

The IRS apparently does not believe there is any ambiguity, Grove says there could be ambiguity that the likes of DraftKings and FanDuel may be able to take advantage of, and Wallach’s position is the same as that of the IRS — there is no ambiguity — but comes to the total opposite opinion as the governmental entity.

Yet, the most important part of the IRS memorandum may be that it is not binding. As such, DraftKings, FanDuel, and other daily fantasy sports companies may continue to spurn the opinion, as there is currently no true threat that an excise tax will be enforced against them in the near future.

Darren Heitner is the founder of Heitner Legal. He is the author of How to Play the Game: What Every Sports Attorney Needs to Know, published by the American Bar Association, and is an adjunct professor at the University of Florida Levin College of Law. You can reach him by email at [email protected] and follow him on Twitter at @DarrenHeitner.

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