IRS States That DFS Operators Are Liable For Excise Tax
By Kevin Vela
A recent IRS Internal Memorandum has ruled that DFS operators must pay federal excise taxes on entry fees, a viewpoint that, if enforced, could have widespread effects on the fantasy industry.
The memorandum concluded that DFS companies are
- liable for excise tax on wagers under IRC § 4401 (between .25% and 2%, depending on the originating state),
- liable for occupational excise tax on wagers under IRC § 4411 ($50 or $500 per operator per year), and
- likely required to register under IRC § 4412.
Obviously, the memorandum is in stark contrast to UIGEA, which has clearly exempted DFS and fantasy games as legal contests of skill, but it’s important to understand that UIGEA is not controlling over IRS audit procedures.
The memorandum clearly defines traditional IRS analysis of a “wager” to arrive at its conclusion. As part of this analysis, the memorandum states in part:
UIGEA was enacted in 2006, prior to the proliferation of DFS, and referred to traditional fantasy sports. Further, in its introductory section, UIGEA states: “No provision of this subchapter shall be construed as altering, limiting, or extending any Federal or State law or Tribal-State compact prohibiting, permitting, or regulating gambling within the United States.” 31 USC § 5361(b). Thus, UIGEA neither renders legal nor illegal any form of gambling within the United States; UIGEA simply provides ‘‘[n]ew mechanisms for enforcing gambling laws on the Internet [that] are necessary” because “traditional law enforcement mechanisms [were] often inadequate for enforcing gambling prohibitions or regulations on the Internet, especially where such gambling crosses State or national borders.” 31 USC § 5361(a)(4).
While we find the point about the UIGEA relating to traditional fantasy sports to be outdated, the analysis of DFS contests under the IRS definitions and precedence history of “wager” is substantial.
The guideline tax rates are .25% of all entry fees in DFS authorized states (IRC § 4401(a)(1)), and 2% of all entry fees in states where DFS is not authorized under law (IRC § 4401(a)(2)). Moreover, an operator who accepts fees only in DFS authorized states is subject to a $50 annual fee, and all other DFS operators are subject to a $500 annual fee (IRC § 4411).
It’s important to restate the rates are on entry fees and not profits, which we know is material in the DFS world.
The immediate ramifications are unknown. The major operators that have publicly commented share our view that the IRS definition and analysis are anachronistic and should be updated to reflect legal and cultural norms. For now, the memo has not been applied to any operator. That said, the IRS swings a big stick and all DFS operators would be wise to visit with their tax advisors immediately to plan for potential IRS tax payment.
 The rate of tax IRC § 4401(a) imposes on wagers accepted by a DFS operator depends on whether the wager is accepted in a state in which the wager is authorized. The rate of occupational tax IRC § 4411 imposes on a DFS operator depends on whether the DFS operator accepts only state authorized wagers under IRC § 4401(a)(1).