Taxes in Daily Fantasy Sports
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.
Every year when I sit down to update this lesson, I reflect on all that’s changed in DFS since I wrote the first version in 2011. In a word: Everything. Prize and player pools exploded in 2014. There were more 7-figure checks awarded to players in December 2014 than there were in the history of DFS prior to the 2014 NFL season. The size of daily GPPs makes the IRS 1099 threshold of $600 seem almost trivial. More so than ever, understanding the tax implications of DFS play is critical. With that goal in mind, let’s explore taxes in daily fantasy.
Unlike things like wages or gambling winnings, daily fantasy income doesn’t have its own form, so it lives on this one, the 1099-MISC. This form literally covers everything from rental income to fishing boat proceeds. Sites will mail these to winners of $600 or more by January 31.
Six Hundred Dollars?
Yup, $600. Here’s the general formula that sites use to calculate your earnings to assess whether or not you should receive a 1099-MISC:
Net Earnings = Gross winnings – Total Entry Fees + Other Earnings 1
1 – Other Earnings includes referral earnings, deposit bonuses and rakeback rewards.
If you run that math and the answer is at least $600, you’ll get a 1099 for those earnings. Given that this formula accounts for every game you play during the year, it may be a mountain of data for your to track. In that case, use this shortcut:
Total Withdrawals + End Acct Balance – Total Deposits – Beginning Acct Balance
Hopefully that one is easier for you to manage. Hopefully you have some manner of measuring your level of profitability throughout the year. You’ll want to periodically review where you stand during the year so that you can evaluate how much to put aside for tax payments.
But how much is guv’ment going to take?
Great question. To answer that, let’s talk a bit about how income taxes work. Federal taxes are assessed in brackets with rates that increase as one’s income increases. For 2014, here’s what they look like:
If you happen to be fortunate enough to earn above the top bracket’s earnings band, every one of those dollars will be taxed at 39.6%. Oh goody. To further illustrate how this all works, let’s run through an example:
Let’s say you’re single guy making $50k per year slinging beer at the stadium for the local sports team. This is how the tax brackets raid your wallet for their share.
$0 – $9,075 at 10%
$9,076 – $36,900 at 15%
$36,901 – $50,000 at 25%
This is a bit of an oversimplification since the dollars above are technically for something called “taxable income”, but let’s simplify things and just work with the gross. Got it? Okay, now say you won $5,000 playing DFS this year on top of your day job. Every dollar of that $5,000 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 $1,250 of that $5,000 in winnings. Your state (and maybe county or city) is going to want their share, too, but each state has its own laws. Consult your tax professional for specifics on your state’s requirements.
That pesky other form
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 using schedule C will allow you 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.
For those wanting to dig a little deeper, Paypal has a great FAQ set up regarding the 1099-K. It is geared toward merchant activity, but DFS activity through Paypal works in the same manner.
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. Got it? Let’s go on.
The first, and preferred, option for most will be to rely on these documents:
• #1) Publication 529
• #2) Publication 535
Application of these rules allows for the deduction of expenses to reduce your net profit. Specifically 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.” If you view your DFS play in total, you can use this literature to support the deduction of losses from one site to offset earnings from another. 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. Even if you do itemize, there’s a tricky little thing called the “2% of AGI floor” to deal with. Let’s recycle our example from earlier to illustrate:
Our hero makes $50k from his day job and grinder his was to a $5k 1099 from a site. His total income is $55k. Assuming he itemizes deductions because he pays mortgage interest or some other such items, he’ll be able to deduct losses from another DFS site to the extent that they exceed 2% of $55k or $1,100. So assuming he had losses of $2k on another site, $900 ($2k – $1,100 floor) would be his net deduction for those losses. What if he only lost $1k playing elsewhere? Then that entire amount would be excluded by the floor.
For-Profit Hobbies (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 enables 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 most efficient approach for most, but it might be a viable option for some. 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.
Once again, let’s use pictures to see how the forms play together, again assuming our hero had $2k in losses on other sites:
So yeah, that’s how that works.
But wait, can I deduct other expenses?
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 – RG Incentives, ESPN Insider, Baseball Prospectus, etc.
TV sports packages – NFL Sunday Ticket, NBA League Pass, MLB Extra Innings
Services needed to play games – Internet access, mobile data
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.
This lesson is intended to broadly cover the intersection of taxation and daily fantasy. No article, no matter how well researched, can directly address every scenario. To determine how best to handle the tax implications of your daily fantasy play, consult your tax professional.