Taxes and Daily Fantasy Sports: The Duck Test

If it looks like a duck, walks like a duck and quacks like a duck, then it just may be a duck.

So said someone (this quote has been attributed to Walter Reuther among others), and it’s one of those cliches that have an impact in taxes. When something has the elements that make it look like something, generally the Tax Code will make it into that something.

Why am I bringing this up? Because of the popularity of daily fantasy sports sites. These sites allow contests based on the outcome of a day’s games in a sports league. For example, you can take various players in today’s NBA games and play against others who select their own players. Should your ‘team’ do better than your opponents’ teams, you win the contest.

The sites consider themselves to be skill games and contests and not gambling. They issue Form 1099-MISC’s to the winners, and put the income on line 3 (“Other Income”). They do not issue Form W-2G’s (“Gambling Winnings”) to their winners. For individuals who partake in these contests, how should they treat the income?

First, it’s income and must be included on the tax return. All income is taxable unless Congress exempts it; Congress hasn’t exempted daily fantasy sports income. So it must be included on your tax return no matter if you receive a Form 1099 or not.

Let’s say you play three contests, win $2,000 and never lose. You receive a 1099 noting $2,000 of “Other Income.” In this simple case, just include the income as “Other Income” on your tax return (line 21, Form 1040). No mater what the flavor of Other Income is you’ve included it.

Let’s say you make a living playing daily fantasy sports sites. You win $250,000 from various sites, and have $50,000 of losses. With that kind of income you are probably a professional fantasy sports player and should include the income and associated business expenses on a Schedule C. It sure looks like you’re in the profession of daily fantasy sports player–the first instance of the Duck Test.

Now let’s consider Jane. She plays daily fantasy sports occasionally. She receives a 1099-MISC noting her $30,000 of wins. She also has $20,000 of daily fantasy sports losses. For the sake of discussion, we’ll assume she has records proving those losses. Can she take those losses?

If you were to ask the daily fantasy sports sites, they would say no. They operate under the sweepstakes/skill game laws; there is no such thing as losses with skill games.

However, we’re concerned with Jane’s taxes, not a daily fantasy sports site’s taxes. A fundamental principal of US taxation is to look at the activity itself to determine what it is no matter what it calls itself. Ah yes, another instance of the Duck Test.

The tax laws on wagering (aka gambling) are different. You are allowed to take wagering (gambling) losses up to the amount of your winnings (ยง165(d) of the Tax Code). So we need to determine if daily fantasy sports are a wagering activity.

This is more difficult than you might think; wagering isn’t defined in the Tax Code. However, there are plenty of IRS and Tax Court rulings on this, and all say basically the same thing. For something to be gambling, three elements must be present:
1. A prize;
2. Chance; and
3. Consideration.

Clearly daily fantasy sports have elements 1 and 3. There’s a prize and there’s a cost to enter each event. Is there chance?

Gambling does not have to be 100% chance to be considered gambling. For example, poker is considered gambling under US tax law yet there’s plenty of skill involved with it. (Indeed, I’d argue that skill predominates over luck; however, there’s absolutely an element of luck in poker.) Let’s look at what’s involved with a daily fantasy sports contest. You generally select a team to play in a day’s events. Let’s say you selected Carlos Boozer and Shane Battier for today’s NBA daily fantasy sports contest. Those players scored 8 and 3 points, respectively. On the other hand, had you selected Taj Gibson and Chris Bosh you would have done far better; they scored 20 and 28 points. Yet before a single game who know what each player will score? If you had selected NBA star Lebron James you would normally do quite well; however, he didn’t play today.

There sure looks to me to be at least some elements of chance involved with who you select. While Carlos Boozer averages 14.8 points a game, he had only 8 today. On the other hand, Taj Gibson had 20 while he averages 12.9. Is that skill (that is, against the opponent they faced those players would play differently than their average) or is it luck? It’s probably some of each.

So daily fantasy sports have at least some element of luck. Then from a tax standpoint they sure look to be a form of wagering activity. There’s a prize, chance, and consideration. The Duck Test again: If it looks like a duck, walks like a duck and quacks like a duck, it might just be a duck.

So can players on daily fantasy sports sites treat their play like gambling? That’s something worth discussing with your tax professional if you partake in daily fantasy sports.

There’s a corollary to this: Do daily fantasy sports sites violate various gambling laws? (I am not an attorney and the following is just my speculation and not legal advice.) While the Unlawful Internet Gambling Enforcement Act (UIGEA) provides a carve-out for fantasy sports, there are numerous other gambling laws. Additionally, most states have laws on gambling. The daily fantasy sports sites all state they’re legal but I suspect that they probably violate various laws, mostly on the state level.

I looked at two sites. The first stated that the US government and most states consider fantasy sports to be a game of skill (this site doesn’t allow residents of AZ, IA, LA, MT, and WA to play). The second site used basically the same language and prohibits players from the same five states.

Unfortunately, many states look at just an element of chance to determine if something is gambling. And there’s no doubt that daily fantasy sports have such an element. The problem is that these sites are starting to bring in large dollars. That attracts attention, and some state attorney general is going to wonder the same thing that I am. He or she will conclude that the Duck Test applies and that these are gambling sites in violation of his or her state’s laws.


4 Responses to “Taxes and Daily Fantasy Sports: The Duck Test”

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  3. […] So far, I’ve been accurate on my predictions. Back in February 2014 I wrote, […]

  4. […] Of course, none of this should have been a surprise to anyone. As I said almost two years ago, […]