Fifty shades of fantasy Gray area with your taxes

Daily Fantasy General Tax Reports

You may have had a great year in 2014 making a nice profit on FanDuel, DraftKings, or any of the other popular Daily Fantasy Sports sites. You may be licking your wounds with losses at some of the sites. But in late January or early February, you will receive a 1099-MISC form from one of those sites if you kicked some butt and received net earnings over $600 and it will show up in box 3. You may also be sent a W-9 form. requesting your SSN and address. I would advise compliance because the penalties are $50 plus an additional 28% withholding. As a CPA, I will advise you to report net earnings of $1, but anything over $600 is what will be reported to the IRS. Now, how do you calculate the “net profits” on most of those sites for 2014? Simply take your Withdrawals during the year, then add the Ending Balance as of 12/31/2014, then subtract Deposits during the year, and subtract the Beginning Balance as of 1/1/2014. This is a fair and accurate way to report your earnings to the IRS. Now the site doesn’t calculate that for you? They usually do and they should. But the amounts are not always correct and you, as a US participant and taxpayer, need to verify if it is incorrect.

So what does this mean for you? For most people, your net earnings will be reported on line 21 of your Tax Form 1040 as Other Income. But what if you have some losses as we mentioned above? For the “Casual” player where it is a hobby, losses and other expenses, up to the amount of Line 21, will be reported on Schedule A- Miscellaneous Deductions Subject to the 2% AGI Floor. How a theoretical example would work:

Salary Income: $60,000

FanDuel winnings: $5,000

DraftKings losses: ($3,000)

Deductible Other Expenses (Research, Internet Portion, DirecTV): ($1,000)

As a “casual” player this would mean your AGI is $65,000 and 2% of that is $1,300, so only $2,700 would be deducted ($4,000-$1,300) IF you itemize deductions instead of taking the deduction standard. For some of you starting your careers, still in college, don’t own a home, or even have a mortgage paid off later in life, it’s almost always wise to take the Standard Deduction. Then your losses and expenses would not benefit you at all. So what is the other alternative? File your daily fantasy sports (DFS) activities on Schedule C. Using the example, you would file your DFS activities as gross receipts of $5,000 and spend the $4,000 for a net profit of $1,000. This, along with his salary, would have an AGI of $61,000 instead of $65,000. Although your AGI will be lower, you will pay self-employment tax. Other factors to consider are overall AGI, other business activities, applicable AGI-sensitive credits, and the dreaded alternative minimum tax. There’s a lot to consider if you’re making them yourself!

Business vs Hobby Loss Rules

Now, you can just file a Schedule C if you want? Well, according to IRC 183, you have to run your daily fantasy activities like a business. The IRS uses the following 9 factors to determine if a DFS taxpayer is operating a for-profit business or hobby:

1. The way in which the taxpayer performs the activity. Do you complete accurate books? Do you have a separate business bank account? Were the records used to improve performance?

2. The expertise of the taxpayer or his advisers. Did the taxpayer study practical business activities? Did they consult with experts? For DFS, subscription to Rotogrinders Incentives or DirecTV would be evidence.

3. Does the time and effort invested in the activity indicate an intent to make a profit? For DFS, does this mean playing some random or “grind” lineups?

4. Have you made a profit from similar activities in the past?

5. The history of income or loss of 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 generate profit in some years (3 of the last 5, including the current year)?

7. The financial status of the taxpayer and does the taxpayer depend on DFS or have other sources of income? Many DFS participants are salaried, some quite high, but that doesn’t rule out Schedule C status.

8. Is there an expectation of appreciation of the assets involved in the commercial 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 are BOTH! This would be more applicable to the horse racing industry.

The above factors are not completely determinative of how you should file your return. Whether you introduce yourself as a casual “hobbyist” or a professional “grinder”, you are not set in stone. And Daily Fantasy is a new industry. One industry that I have worked in a lot in the past is horse racing. Typically, very few taxpayers are profitable, and the IRS often attempts to reclassify horse activities as a “hobby” rather than a “business,” sometimes eliminating large losses against other income. Daily Fantasy, as I’ve seen on some of the forums, the exact opposite can happen for profitable Grinders, especially when the IRS wants to classify the DFS entrant as a business rather than a prize winner. The IRS has the benefit of some hefty self-employment taxes if it’s classified as a business, if profitable, rather than a prize. Simply putting the 1099-MISC income on line 21 of your 1040 might not exactly work.

Do I know or do I not know, that is the question?

Box 3 of Form 1099-MISC, unlike Box 7 – Non-Employee Compensation, would suggest that DFS earnings are an Award. However, the IRS has challenged this not only for DFS, but also in the past in other activities. IRS income rule 58-112 characterizes a business as one that is “regular, frequent, or continuous.” In one case, under Revenue Resolution 77-356, it was determined that a Congressman was considered a business for making 10 speeches per year for $1,500 and exhibiting “a degree of recurrence, continuity, and availability.” To the contrary, Revenue Judgment 55-431 states that “as a general rule, an individual who accepts an occasional invitation to give a speech is not engaged in a trade or business.” So how does this translate to DFS? It depends on the frequency of your activities and only a tax professional can guide you if necessary. Not everything is bad if you have to declare as a company. If you’re grinding it, you’re surely using internet access, maybe a DirecTV package, paying for research like Rotogrinder Incentives, and other items to ensure your DFS grind is profitable. Now it’s much easier as a business to spend all or part of these items! That self-employment tax might not look so bad after all and could be eliminated with better expense deductibility. More like I said earlier, the lower AGI would surely help you in other areas like Credit, AMT, and Social Security taxation. You have a lot of options here, but as always, find a professional to make sure you do the right thing.

State and local tax issues

I have to be honest here, I’m more familiar with the mid-Atlantic region. But local issues and how you manage your earnings, regardless of where you live and your expenses, can have a HUGE impact on your tax liability. Did you know that in Pennsylvania and New Jersey DFS taxpayers may be better off filing as a business in the surrounding states of New York, Maryland, and Delaware due to DFS deductibility issues?

Philadelphia, New York City, and several municipalities in Pennsylvania and Ohio also have local considerations to address. As a Philadelphia resident, you may be subject to SIT (School Income Tax) or BIRT (Business Privilege) and NPT tax returns. Some exemptions apply. This could still hurt the 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 filing as a business must file an Unincorporated Business Tax (UBT) and possibly a MCTMT form if you live in New York City and surrounding areas in New York State.

Most common do-it-yourself tax software does not have the ability to file local returns that you may need to fully comply with taxes. Seeking a tax professional is highly recommended in these cases and what I have written so far only scratches the surface.

where to go from here

Simply putting the number received from your 1099-MISC into your H&R Block or TurboTax schedule for Daily Fantasy Tax purposes may not be the smartest 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 most 3 months from your Daily Fantasy site and giving it to your tax professional so they can determine the best course of action for your situation. If you’re not sure how to report your fantasy daily earnings, find a tax professional, either an enrolled agent or certified public accountant. As shown with this type of income, the IRS and other tax authorities can take many different ways to interpret your earnings.