Daily Fantasy and Taxes - 2012 Update

by Kevin Dahle (rotokevin) Last Updated 2013-01-29 16:54:26

RotoKevin’s Disclaimer: I am a Certified Public Accountant, licensed in the State of Minnesota. However, any tax advice that may be contained in this article is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.

The growth of the Daily Fantasy industry in 2012 was pretty phenomenal, with several sites running contests with 6-figure prize pools. With more and more well-funded providers coming to market, there is more money in play than ever before. With more money being won, more and more players will find themselves receiving tax forms this year. Consider this your comprehensive guide to understanding it all.

What is this?

That form to the right is the one that sites are going to send you over the coming weeks. It’s called a 1099-MISC and is used for a bevy of purposes ranging from fishing boat proceeds, to sweepstakes winnings to non-employee consulting activities. It casts a wide net, and given that there is no specific form for DFS proceeds (maybe someday?) and that DFS is explicitly not gambling, it is really the only form that works.

Why did I get one?

The short answer to this is that you had a good year. The long answer is that is depends on which site you played on as, unfortunately, there is no universal standard. Well, there is one – $600 seems to be the agreed reporting threshold. How the appropriate figure is calculated, though, it breaks down to two common methods:

Net Payments – This is a very simple calculation: Total withdrawals – total deposits

Sites using this method: DraftStreet, DraftDay, BuzzDraft

The idea behind this method is that this is the net amount paid to the player. Basically, this method does not contemplate any earnings that remain in your account, but rather assumes that profits aren’t fully earned and subject to tax reporting until you withdraw them.

Potential pitfall to be aware of with this method: Since this calculation relies on the player withdrawing funds to trigger tax reporting, players that carry a significant balance over from one year to the could receive a 1099 for winnings in a year in which they actually have a net loss. For example, on December 31 the player had $2,500 in his account. In January, he loses $1,000 and withdraws the remaining $1,500 and plays no more DFS during the calendar year. This calculation would yield a 1099 of $1,500. The prudent course of action for players is to minimize the year-end carryover amount to avoid this pitfall.

Net Earnings – This is another simple calc: Gross winnings – total entry fees + referral earnings/deposit bonus

Sites using this method: FanDuel, DailyJoust

This is probably the purer presentation of the two. The result of this calculation reflects the net result of your site activity during the calendar year, whether withdrawn or left on the site for future play.

Notes on other sites: DraftKings, StarStreet, FantasySportsLive, Fantasy Feud

Fantasy Feud is Canadian, so they don’t issue 1099s. FSL uses a $600 per contest threshold for reporting. Since no contest on FSL pays over $600, they don’t issue any 1099s. StarStreet has adopted a similar approach, issuing 1099s for wins of $600 or more than reflect a greater than 300-1 prize-to-buyin ratio. The FAQ language at DraftKings is unclear regarding their tax policies.

Wait, what the heck is this?

Paypal users may also receive a 1099-K provided they received at least 200 incoming payments that aggregate to be in excess of $20,000. Yes, you have to hit both thresholds. Those numbers seem daunting, but it can happen without much difficulty, especially if you co-mingle your DFS play with personal or small business activity. The 1099-K will report the gross amount of payments received without regard for whether there is profit included or not. In some situations, you could receive a 1099-K from Paypal and a 1099-MISC from one or more DFS sites, resulting in income being reported twice to the IRS. Thankfully the appropriate forms contain a line to net the two, but you are probably best served avoiding the 1099-K if you can. The sites linked through RotoGrinders are the most reputable in the business. It’s a little silly to rapidly ferry money from site to Paypal and back.

A word on how taxes work – a.k.a – how much is the guv’ment going to take?

The question at hand is not one that is easily answered with a blanket statement. Taxes are assessed in brackets with rates that increase as one’s income increases. For 2012, here’s what they look like:

For an example, let’s assume you are an unmarried dude making $40,000 as an accountant. Your income would be taxed as follows:

First $8,700 taxed at 10%
$8,701-$35,350 taxed at 15%
$35,351-$40,000 taxed at 25%

This is a bit of an oversimplification since the dollars above are technically for something called “adjusted gross income,” but let’s simplify things and just work with the gross. Got it? Okay, now say you won $2,000 playing DFS this year. Every dollar of that $2,000 would be taxed at the rate attributable to the bracket your total income falls, in this case the 25% bracket. That is, the Feds are going to want $500 of that $2,000 in winnings. You state is probably going to want a taste, too. Since this article is aimed at the masses, I’m not going to go through 50 more examples for each state. Okay, I’ll give you one. Florida won’t ask for a penny. They don’t have a state income tax. That’s just one more reason why db730 is truly living the dream.

Filing Information

Okay, so you have your forms and at least a remedial understanding of how taxes work. How do you report your earnings on your form 1040? Before we dive too deeply into this, know that you should always report all income, whether or not you receive a 1099 for it. Just because you don’t receive a 1099 doesn’t mean that unreported income couldn’t be found during an audit with tax owed and penalties assessed later. It’s always better to take your medicine up front as opposed to cheating and hoping not to get caught. Okay, on to the reporting stuff.

The first, and preferred, option for most will be to rely on these documents:

Pub 529
Pub 535 (2012 edition not yet available)

Application of these rules allows for the deduction of expenses to reduce your net profit. For example, let’s say that your entire DFS play for the year was conducted on DraftStreet and FanDuel. You profited $1,000 on DraftStreet, but lost $300 on FanDuel. DraftStreet will send you a 1099-MISC which must be reported in your gross income. Pub 529 allows for deductibility of miscellaneous expenses if they are incurred “to produce or collect income that must be included in your gross income.” There’s a pretty decent argument for deducting the $300. You can only deduct losses to the extent of your reported winnings. That is, if you have a net loss, you can’t get a tax benefit from that. Also, you can only deduct losses to offset winnings if you itemize deductions on schedule A. Don’t itemize? You’re out of luck under this section of literature. However, there’s another option, though it’s more aggressive.

For-profit hobbies

Hobby-Loss Rule (IRC 183)

If you can’t itemize deductions, you might want to consider representing your daily fantasy play as a for-profit hobby. Here are some of the general criteria the IRS suggests to support such a claim:

• Does the time and effort put into the activity indicate an intention to make a profit?
• Do you depend on income from the activity?
• If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
• Have you changed methods of operation to improve profitability?
• Do you have the knowledge needed to carry on the activity as a successful business?
• Have you made a profit in similar activities in the past?
• Does the activity make a profit in some years?
• Do you expect to make a profit in the future from the appreciation of assets used in the activity?

Going this route could enable you to deduct losses if you can’t use the first option and may also allow deductions in excess of your winnings in any given year. This is an exceptionally risky stance to take if you want to report a net loss in your first year. It is pretty much a guaranteed audit flag. If, however, you have shown a year or two of net winnings, bullet 6 becomes your best friend. Generally, this literature guides your DFS play away from “Miscellaneous Income/Expense” toward “Profit/Loss from Business” (Schedule C). This exposes your profits to self-employment tax, so this probably isn’t the more efficient approach for most, but it might be a viable option for some. Additionally, if you tripped the 1099-K thresholds, this is the most appropriate way to address the double reporting of income on 1099-MISC and 1099-K.

Additionally, moving to the schedule C would also enable you to deduct other expenses related to your DFS play. The easiest and most obvious expense would be net losses from other sites as discussed above, but that’s not the end of it. Some other things I would consider appropriate would be:

• Content subscriptions, such as RG Incentives, ESPN Insider, Baseball Prospectus, etc.
• TV sports packages – NFL Sunday Ticket, NBA League Pass
• A portion of Internet access fees – you can’t play without the internet. However, you’d also likely have the internet without DFS, so full deductibility is a bit aggressive for my taste.

Generally speaking, any expense you incur to carry on your DFS play and enhance your skills qualifies for deduction. There are several gray areas that I’d rather not speak to directly, but hopefully this gives you some general guidance.

Consult your tax professional to determine the most tax-efficient approach to reporting your earnings.