By Patrick Guinan, CPA. Mr. Guinan is the owner of PHL Tax Services and Dailyfantasytaxes.com. He is a graduate of Temple University’s Fox School of Business and a CPA licensed by the State of Pennsylvania. He is accepting new clients with Daily Fantasy Winnings nationwide and can file your return in all US States and Localities.
You may have had a great year in 2014 grinding out a nice profit on FanDuel, DraftKings or any of the other popular Daily Fantasy Sports sites. You may also be licking your wounds with losses on some of the sites. But come late January or early February, Uncle Sam will come calling if you were a winner.
You will receive a Form 1099-MISC from one of those sites if you received Net Earnings greater than $600 and it will be shown on Box 3. You may also receive a W-9 Form asking for your social security number and home address. Do not ignore these forms. Compliance is key because the penalties are $50 plus backup withholding of 28 percent. You should report net earnings of $1 or more, but anything more than $600 is what will be reported to the IRS.
So say you have a profitable year and you receive tax forms from these sites, you just want to get back to the daily fantasy grind, but now you have taxes to deal with. What should you do? Aside from calling a tax professional specializing in fantasy sports, you need to know some basic information about your taxes.
To calculate your “net winnings” simply take your withdrawals through the year then add ending balance as of December 31, 2014. Next, subtract deposits through the year and subtract beginning balance as of January 1, 2014. This is a fair and accurate way to report your earnings to the IRS. Now doesn’t the site calculate that for you? Usually, they do and should. But the amounts aren’t always correct and you as the participant and American taxpayer need to verify that if it is incorrect.
For most players, net winnings will be reported on Line 21 of the 1040 Tax Form as Other Income. But what if you have some losses? For the “Casual” player where it’s a hobby, the losses and other expenses, up to the amount on Line 21, will be reported on Schedule A – Miscellaneous Deductions Subject to 2 percent AGI Floor. Here is how a theoretical example would work:
Income from Wages: $60,000
Winnings from FanDuel: $5,000
Losses from DraftKings: ($3,000)
Deductible Other Expenses (Research, Portion of Internet, DirecTV): ($1,000)
As a “Casual” player, this would mean your AGI is $65,000 and 2 percent of that is $1,300 so only $2,700 ($4,000-$1,300) would be deducted IF you Itemize Deductions as opposed to taking the Standard Deduction. For some of you starting out in your careers, still in college, not owning a home, or even later in life having a paid off mortgage it is almost always wise to take the Standard Deduction. So your losses and expenses would not benefit you at all.
But what is the other alternative? Filing your Daily Fantasy Sports (DFS) activities on a Schedule C. Using the example from above, you would file your DFS activities as $5,000 Gross Income and expense the $4,000 for a Net Profit of $1,000. This, along with your wages, would have your AGI as $61,000 as opposed to $65,000. Even though your AGI will be lower, you will be paying Self Employment taxes. Other factors to consider are overall AGI, other business activities, applicable AGI sensitive Credits, and the dreaded Alternative Minimum Tax.
Business vs. Hobby Loss Rules
Now can you just file on a Schedule C if you want? Well, per IRC 183 you have to run your Daily Fantasy Activities as a business. The IRS uses nine factors to determine if the DFS taxpayer is operating a for-profit business or a hobby:
1. The manner in which the taxpayer carries on the activity. Do you complete accurate books? Do you have a separate business bank account? Were records used to improve performance?
2. The expertise of the taxpayer or his advisers. Did the taxpayer study the activities business practices? Did they consult with experts? For DFS subscribing to Rotogrinders Incentives or DirecTV would be evidence.
3. Does the time and effort put into the activity indicate an intention to make a profit? For DFS does this mean playing a few random lineups or do you “Grind?”
4. Have you made a profit in similar activities in the past?
5. The history of income or losses 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?
6. Does the activity make a profit in some years (3 of past 5 including current year)?
7. The financial status of the taxpayer and does the taxpayer rely on DFS or does the taxpayer have other sources of income? Many DFS participants are wage earners, some fairly high, but that does not preclude Schedule C status.
8. Is there an expectation of asset appreciation for any assets involved in the business activity? This is not applicable to DFS at all.
9. Does the activity lack elements of personal pleasure or recreation? If the activity has large personal elements it is indicative of a hobby. Well, for DFS there’s BOTH! This would be more applicable to the horse racing industry.
The above factors are not fully determinative on how you should file. Whether to file as a Casual “Hobby” or Professional “Grinder” is not set in stone.
Daily Fantasy is a new industry. A similar industry that I have worked extensively in the past is horse racing. Normally, very few taxpayers are profitable and the IRS often attempts to reclassify horse activities as a “Hobby” rather than a “Business”, eliminating sometimes heavy losses against other income. In Daily Fantasy, the exact opposite can happen for profitable Grinders especially when the IRS wants to classify the DFS participant as a Business rather than as a Prize Winner. The IRS has the benefit of some juicy Self Employment Taxes if classified as a Business, if profitable, rather than a Prize. Just placing the 1099-MISC income on Line 21 of your 1040 might not work exactly.
To SE or Not to SE, That is the Question?
Box 3 of the Form 1099-MISC,as opposed to Box 7 – Nonemployee Compensation, would suggest that the DFS winnings are a Prize. However, the IRS has contested this not only for DFS, but in the past in other activities. IRS Revenue Ruling 58-112 characterizes a business as one that is “regular, frequent, or continuous.” In one case, under Revenue Ruling 77-356, a Congressman was found to be considered a business for making 10 speeches per year for $1,500 and showed “a degree of recurrence, continuity and availability.” On the contrary Revenue Ruling 55-431 states that “as a general rule, an individual who accepts an occasional invitation to make a speech is not engaged in a trade or business.” So how does this translate for DFS? t depends on the frequency of your activities and only a tax professional can guide you if needed.
Not all is bad of you have to file as a Business. If you’re grinding it out, surely you are using Internet access, maybe a DirecTV package, paying for research like Rotogrinders Incentives and other items to ensure your DFS grinding is profitable. Now it is a whole lot easier as a business to expense these items in full or in part! That Self Employment Tax might not look so bad after all and could be wiped out with better expense deductibility. Plus like I said before, the lower AGI would surely help you in other areas like Credits, AMT, and Social Security taxability. You have many options here, but as always, seek a professional to ensure you do the right thing.
State and Local Tax Issues
I have to be honest here, I’m most familiar with the mid-Atlantic region. But local issues and how you handle your winnings and expenses regardless of where you live can have a HUGE impact on your tax liabilities. Did you know in Pennsylvania and New Jersey DFS taxpayersmight be better off filing as a business over the surrounding states of New York, Maryland, and Delaware due to deductibility issues in DFS?
Philadelphia, New York City and various municipalities throughout Pennsylvania and Ohio have local considerations to deal with as well. As a Philadelphia resident you could be subject to the SIT (School Income Tax) or BIRT (Business Privilege) and NPT tax returns. Some exemptions apply, but this could still hurt very profitable Grinders in the City of Brotherly Love. New York City has a local tax tied to the State Income tax. However, DFS taxpayers who file as a business need to file an Unincorporated Business Tax (UBT) and possibly an MCTMT form if you live in NYC and surrounding areas in New York State.
Beware that most common do-it-yourself tax software does not have the capability to file local returns you may need to be fully tax compliant.
Where to go from here
Simply putting the number received from your 1099-MISC on your H & R Block or TurboTax program for Daily Fantasy Tax purposes may not be the wisest choice. These programs are very cumbersome with business income and local taxes as well. You need to know how often you participate, how much you earn and keep good records of your activities. I would recommend downloading the .CSV file of your activities every month or at the most 3 months from your Daily Fantasy site and provide that to your tax professional so they can determine the best course of action for your situation.
The information in this article is provided for general educational purposes only and may not reflect changes in federal, state, or local tax laws. Before taking any action based on this information, we strongly encourage you to consult with a tax professional about your specific situation.