For over 50 years, Bloomberg BNA’s renowned flagship daily news service, Daily Tax Report® has helped leading practitioners and policymakers stay on the cutting edge of taxation and...
By Martha W. Kessler
Jan. 12 — The playing of daily fantasy sports (DFS) has spurred an abundance of controversy, with attorneys general in several states banning such games and regulators in others either requiring operators to get a license or attempting to establish regulations for them.
But regulators in another part of state governments—tax departments—are also grappling with how such games and the winnings they produce should be handled, by both DFS operators and players.
The initial response from many states has been to treat winnings as income, and taxpayers are required to report those winnings. The question of whether—and when—DFS operators are required to report the winnings, and when and how losses may be claimed against winnings, varies according to state.
Connecticut Revenue Commissioner Kevin Sullivan told Bloomberg BNA that the way gambling income is handled is “another good example of the growing gap between the world as it is and the world of traditional taxation.”
Daily fantasy sports—in which participants act as owners to assemble a team that competes against teams drafted by other fantasy players—has become a multibillion-dollar industry. The two lead companies in the industry are Massachusetts-based DraftKings Inc. and New York-based FanDuel Inc.
Legislators are likely to make frequent efforts to clarify the legal status of DFS during upcoming state legislative sessions. And efforts to define the issues surrounding fantasy sports may, in many cases, include language specifying how they should be categorized for tax purposes.
Alfred Yen, associate dean and professor at Boston College Law School, said he could also envision states levying special taxes on the industry because of a belief there might be an uptick in gambling addiction or other anti-social side effects to fantasy sports. “So you might levy a tax to deal with that,” Yen told Bloomberg BNA.
There might also be opportunism, Yen said—the levying of a “plain old sin tax.” Legislators might say, “ ‘the government needs money and we can impose a really high tax on you because otherwise you won't be allowed to operate.' ”
He noted that in some jurisdictions, an operator in the gambling industry is taxed far more unfavorably than an ordinary business, and that could happen in other jurisdictions. But action on the treatment of DFS may also come from areas outside tax and revenue agencies.
In some cases, such as in Hawaii, the tax department is waiting for guidance from the attorney general on how winnings and losses generated by the fantasy sports games should be handled.
And Thomas Shepherd, a partner with Jones Walker LLP in Jackson, Miss., said his office is aware the state gaming commission is awaiting guidance from the attorney general with respect to DFS.
In Maryland, Comptroller Peter Franchot (D) is convening state officials to discuss issues such as making sure the new gaming companies are operating legally, that taxes are being properly collected and that consumers are protected from any detrimental industry practices, spokesman Andrew Friedson told Bloomberg BNA.
In Massachusetts, the debate is proceeding on several fronts.
The Massachusetts Gaming Commission released a white paper Jan. 11 offering the Legislature information on issues surrounding fantasy sports.
It said the imposition of “extraordinary taxes” on any of the new gaming approaches is a matter that should be left to the Legislature.
But the panel noted that legal gambling “is typically subjected to extraordinary tax rates, both when there are very high profit margins (casinos) or when the gaming is barely profitable (parimutuel betting on horse racing).”
Those taxes are usually assessed on gross revenue rather than on profits, the commission said in the report, and such gross revenue taxes “can be an impediment to viability for new and innovative gaming companies.”
In earlier discussions, Gaming Commission Chairman Stephen Crosby addressed the issue from the company and individual side.
Referring to comments by Massachusetts Gov. Charlie Baker (R), who noted that DFS operating companies are required to pay taxes on profits and that players are required to pay taxes on their winnings, Crosby said the comments raise the question, “Should there be more?”
“I don't know. We want to be mindful,” Crosby said during an October hearing, “that if we come in heavy on this, you can crush an industry like this overnight.”
Draft regulations issued by Massachusetts Attorney General Maura Healey (D), the subject of a Jan. 12 public hearing, specify that DFS operations must comply with all applicable tax laws, including withholding rules and reporting of winnings, as well as consumer notification.
But guidance issued in late November by the Massachusetts Department of Revenue related to the taxation of gambling winnings and losses doesn't specify whether daily fantasy sports fall into the category of gambling.
In Nevada, the attorney general's office ruled in the fall that all fantasy sports operations must apply for a license to accept wagers from players in that state.
Monica Moazez, a spokeswoman for the attorney general's office, told Bloomberg BNA in late December that only one company, run by race and sportsbook pioneer Victor Salerno, has complied and been licensed. Salerno is chairman of American Wagering Inc., but also operates other companies.
All the gaming would be subject to the traditional gambling taxes, such as the gross revenue gaming tax and the federal sports wagering tax.
The discussion of how player winnings and losses are handled begins with the fact that all gambling winnings are taxable where income is taxed, explained Boston College Law School Professor Diane Ring. While withholding by players may be required only in certain games or at certain levels of winnings, the fact taxes aren't withheld doesn't mean winnings aren't taxable.
“You should put it on your tax return. Sometimes I think people are not always clear on that,” she said.
A second basic point, Ring said, is that gambling losses can't exceed winnings.
Internal Revenue Code Section 165(d) “is very clear. Gambling losses can only be taken to the extent of gambling gains,” Ring said. She said this is true regardless of whether the taxpayer is a casual gambler or purports to be a professional.
Winnings are then listed as income on the front of the federal return, and losses are itemized as deductions on Schedule A. For people who hadn't planned on itemizing and who only had a small amount of losses, it might not be worth itemizing, she said.
Ring's statements matches guidance posted on the Internal Revenue Service website that states that “gambling winnings are fully taxable and you must report them on your tax return.” The guidance specifies that gambling income includes, but isn't limited to, winnings from lotteries, raffles, horse races and casinos, and that in addition to cash winnings, it also includes the fair market value of prizes such as cars and trips.
The IRS website doesn't currently define whether fantasy sports winnings are considered gambling income, and the Service didn't respond to repeated requests as to how fantasy sports winnings are defined or to be treated.
The federal government does require a payer to issue a Form W-2G, Certain Gambling Winnings, if a player receives certain gambling winnings or has any winnings subject to federal income tax withholding, and the IRS notes that players may also be required to pay an estimated tax on gambling winnings. The agency also stresses that it is important to keep an accurate diary or record of gambling winning and losses. To deduct losses, the IRS says, taxpayers must be able to provide receipts, tickets, statements and other records that show both winnings and losses.
The question of what makes someone a professional gambler, and thus allowed to claim expenses, separately from losses, is a multi-factor issue, Ring said. Tax authorities are looking at how people carry it out, their expertise, how much time and energy they spend, their success, history in the activity, the amount of the profit, their financial status and the elements of pleasure or recreation, so it's a “mushy” test, she said.
It also raises the question of “hobby rules” used in determining whether someone is participating in a profit-seeking activity or a trade or business versus a hobby. When it comes to determining how winnings and losses should be handled for income tax purposes, Ring said, states are all over the board.
In states that do have an income tax, 30 start with the federal adjusted gross income. An additional seven states start with federal taxable income. The question is, then, how many changes the states make to that figure, Ring said.
A number of state revenue departments contacted by Bloomberg BNA said they begin with the federal AGI and therefore assume that gambling winnings and losses have already been computed.
Missouri bases its definition of taxable income on what is taxable at the federal level, said Michelle Gleba, a spokeswoman for the Department of Revenue. To the extent that gambling winnings are included in a Missouri taxpayer's adjusted gross income on the federal return, those winnings would be taxed in Missouri. And as a result of the Missouri tie-in to federal definitions, the state hasn't developed its own definition of gambling winnings, or discussed doing the same for winnings generated by participating in fantasy sports, she said.
Mark Muchow, deputy cabinet secretary at the West Virginia Department of Revenue, told Bloomberg BNA the state also uses federal AGI as its starting point for calculating state income tax, and uses the federal definitions regarding gaming income. There are no additional adjustments specially relating to either gaming income or losses for West Virginia tax purposes, Muchow said. A professional gambler may claim losses only to the extent that such income and losses are reported on Schedule C for federal income tax purposes, he added.
In Maine, where the individual income tax is based on the federal AGI, David Heidrich, spokesman for the office of the commissioner, told Bloomberg BNA that Maine Revenue Services “is not aware that the IRS has taken a position regarding the character of income or loss from fantasy sports activity.”
In some states, very specific guidance is offered.
In Massachusetts, the Department of Revenue's November technical information release implements statutory changes adopted in 2015.
The TIR lays out the income calculation rules regarding winnings and losses from specified wagering activities and adopts new withholding and reporting thresholds for different types of wagering. For example, a taxpayer may claim a deduction for losses at a casino licensed under Massachusetts statute, but only up to the amount of the winnings at a casino licensed under Massachusetts statute. So a taxpayer who also won money at a Las Vegas casino in that same year must report those out-of-state winnings, but can't claim any deduction for those out-of-state losses.
While that Massachusetts TIR lays out the method for handling various forms of gambling winnings and losses, it doesn't mention fantasy sports or other forms of e-gaming.
Legislation in California that was the subject of a hearing Jan. 6 would require a person or entity to obtain a license to offer fantasy sports games and outline the requirements that such an operator must meet. The original version of the bill (A.B. 1437) would require a licensed operator to facilitate the collection by the Franchise Tax Board of personal income taxes from registered players, and would also require the operator to provide current documentation to all state agencies.
In other states, such as Kansas, gambling winnings are taxed as ordinary income, but the state doesn't allow gambling losses to be deducted from winnings to determine the taxable income, according to Kansas Department of Revenue spokeswoman Freda Warfield.
A number of states, including Nebraska, have regulations that include provisions aimed at nonresidents who gamble in the state, specifying that their winnings are considered Nebraska-source income and must be reported to the state, according to that state's Department of Revenue.
Jonathan Griffin, an analyst with the National Conference of State Legislatures, said the issue is a hot topic for state lawmakers and action is expected in a number of jurisdictions during the 2016 and 2017 legislative sessions.
North Dakota, for example, has laws in place that require those winning games of chance in the state to pay its income tax. However, according to Sen. Dwight Cook (R), chairman of the Senate Finance and Taxation Committee, fantasy football websites are something the state hasn't really looked at when it comes to taxation. He is confident the 2017 Legislature will examine them to determine how they should be approached.
The state's Century Code doesn't specifically state that Internet gambling is illegal in North Dakota. Cook said he expects the state will have to clarify exactly how fantasy football sites should be treated.
Under current state law, gambling winnings are treated as income. Non-residents must also report their winnings to the office of the state tax commissioner by filing an income tax return. Whether they will have to pay state taxes on their winnings would be determined by the amount of their winnings and whether they have any allowable deductions.
Rep. Greg Davids (R), chairman of the Minnesota House Taxes Committee, told Bloomberg BNA Dec. 16 he is confident the issue of fantasy football websites will be the subject of legislation when lawmakers convene in March. Davids said while any Minnesotan winning prizes from the sites would be required to pay income tax on them, legislators would like some clarification of revenues generated, as well as some clarification of whether the games constitute an expansion of gambling.
Ohio is extremely specific on how gambling winnings are taxable by the state and the four cities where casinos are located. These winnings are taxed as “ordinary income” at the same rates applied to a taxpayer's other income, according to the Ohio Department of Taxation.
Under Ohio's code, winnings from lotteries, bingo, raffles, horse races and casinos are taxable, including cash winnings and tangible prizes such as cars or vacations. Gambling losses aren't deductible. In the case of state taxes, all casinos must withhold 4 percent of winnings over the threshold for reporting—anywhere from $600 to $5,000—and pay them to the state on a quarterly basis, which will be reported as deducted and withheld on Form W-2G.
In addition, gambling winnings are subject to local taxes in the casino cities: Columbus levies a 2.5 percent tax that applies to both residents and nonresidents; Cleveland has a 2 percent tax that applies only to residents; Cincinnati's 2.1 percent tax applies to both residents and nonresidents; and Toledo's 2.25 percent city tax applies to both residents and nonresidents, with a $2,500 exemption claimed by filing a Toledo city tax return.
In Kentucky, every person making a payment of gambling winnings that is subject to federal tax withholding must deduct and withhold state income tax from the payment. Wages include gambling winnings subject to withholding as provided in Section 3402(q) of the Internal Revenue Code.
The withholding tax rate for gambling winnings is 6 percent of the proceeds paid (the amount of winnings minus the amount of the bet), said the Kentucky Department of Revenue. Gambling winnings of more than $5,000 from any sweepstakes, wagering pool or lottery, or any other wager—if the proceeds are at least 300 times the amount of the bet—are subject to income tax withholding.
Winnings from bingo, keno and slot machines are generally not subject to income tax withholding.
When asked how it ensures the taxes are properly handled, FanDuel replied that in its “terms and conditions” it clearly states that by depositing money or entering a contest, players are representing and warranting that they are not subject to backup withholding tax because they are exempt from backup withholding, because they haven't been notified by the IRS that they are subject to backup withholding due to a failure to report all interest or dividends, or because the IRS has notified them that they are no longer subject to backup withholding.
The company said it is fully compliant with the tax codes. Users are prompted to enter their tax details when they profit by $100 or more via a PayPal withdrawal. If they request a check, the company said it will refuse any withdrawal of $250 or more until a person enters tax details.
In early January each year, all winners who have won $600 or more, net of all entry fees, over the previous year must provide updated address and Social Security details to FanDuel.com. These details will be used to file a Form 1099-MISC, Miscellaneous Income, with the IRS, the company said.
If the user doesn't have tax details in January, and if the company needs the information to issue a Form 1099, FanDuel sends several e-mail requests asking for details. If people didn't follow instructions, their accounts are put on hold with a warning they will be suspended, the company said.
With assistance from Nushin Huq in Houston; Christopher Brown in St. Louis; Bebe Raupe in Cincinnati; Adrianne Appel in Boston; Laura Mahoney in Sacramento, Calif.; Mark Wolski in St. Paul, Minn.; William H. Carlile in Phoenix; and Jeff Day in Washington.
To contact the reporter on this story: Martha W. Kessler in Boston at email@example.com
To contact the editor responsible for this story: Ryan Tuck at firstname.lastname@example.org
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to email@example.com.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to firstname.lastname@example.org.
Put me on standing order
Notify me when new releases are available (no standing order will be created)