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Fifty Shades of Fantasy Gray Area With Your Taxes

General daily fancy tax returns

You might have had a great year in 2014 making some nice profits on FanDuel, DraftKings or any of the other popular Daily Fantasy Sports sites. You may be healing your wounds with discharge at some sites. But in late January or early February you will receive a 1099-MISC form from one of these sites if you kicked ass and received net winnings over $600 and it will show up in Box 3. You may also receive a W -9 Form requesting your SSN and home address. I would advise compliance because the penalties are $50 plus a backup hold of 28%. As a CPA, I would advise reporting net income of $1, but anything over $600 is what will be reported to the IRS. Now, how are the “net earnings” on most of these sites calculated for 2014? Simply take your withdrawals throughout the year, then add the ending balance as of 12/31/2014, then subtract the deposits throughout the year and subtract the beginning balance as of 01/01/2014. This is a fair and accurate way to report your income to the IRS. Doesn’t the site calculate this for you? Usually they do and should. But the amounts are not always correct, and you, as a participant and US taxpayer, should check to see if they are incorrect.

So what does this mean for you? For most people, your net earnings will be reported on line 21 of your 1040 tax form as other income. But what if you have losses like we talked about 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 AGI floor of 2%. How a theoretical example would work:

Salary income: $60,000

FanDuel winnings: $5,000

DraftKings Losses: ($3,000)

Other deductible expenses (research, internet portion, DirecTV): ($1,000)

As a “casual” player, that would mean your AGI is $65,000 and 2% of that is $1,300, so only $2,700 ($4,000 – $1,300) would be deducted IF you itemize deductions instead of taking the standard deduction. For some of you who are just starting out in your career, still in college, don’t own a home, or even later in life who have a mortgage that’s been paid off, it’s almost always wise to take the standard deduction. . Thus, your losses and expenses would not benefit you at all. So what is the other alternative? File your Daily Fantasy Sports (DFS) activities on a Schedule C. Using the example, you would classify your DFS activities as gross income of $5,000 and spend the $4,000 for a net profit of $1,000. With your salary, your AGI would be $61,000 instead of $65,000. Even though your AGI will be lower, you will pay self-employment taxes. Other factors to consider are overall AGI, other business activities, applicable AGI-sensitive credits, and the dreaded alternative minimum tax. So many things to consider if you do it yourself!

Business or Hobby Loss Rules

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

1. The manner in which the taxpayer carries on the business. Do you complete specific books? Do you have a separate business bank account? Have the recordings been used to improve performance?

2. The expertise of the taxpayer or his advisers. Has the taxpayer studied the business practices of the activities? Did they consult experts? For DFS, subscription to Rotogrinders Incentives or DirecTV would be proof.

3. Does the time and effort spent on the activity indicate an intention to make a profit? For DFS, does that mean playing a few random queues or do you “Grind?”

4. Have you made profits in similar activities in the past?

5. History of income or loss of the activity. If there are losses, are they due to circumstances beyond your control or did they occur during the start-up phase of the business?

6. Does the activity generate profits in some years (3 of the last 5, including the current year)?

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

8. Is there an expectation of asset appreciation for assets involved in business activity? This does not apply to DFS at all.

9. Does the activity lack elements of personal enjoyment or recreation? If the activity has large personal elements, it indicates a hobby. Well, for DFS, there are BOTH! This would apply more to the horse racing industry.

The above factors are not entirely determinative of how you should deposit. Whether filing as an occasional “Hobby” or a professional “Grinder” is not set in stone. And Daily Fantasy is a new industry. One industry I’ve worked in a lot in the past is horse racing. Normally, very few taxpayers are profitable, and the IRS often attempts to reclassify equestrian activities as “Hobby” rather than “Business”, sometimes eliminating heavy losses against other income. Daily Fantasy, as I’ve seen in some forums, the exact opposite can happen for profitable grinders, especially with the IRS wanting to classify the DFS participant as a business rather than an award winner. The IRS has the advantage of some hefty taxes on self-employment if it’s classified as a business, if it’s profitable, rather than a price. Simply putting the 1099-MISC income on line 21 of your 1040 might not work exactly.

SE or not SE, that is the question?

Box 3 of Form 1099-MISC, as opposed to Box 7 – Non-Employee Compensation, suggests that DFS earnings are a prize. However, the IRS has challenged this not only for DFS, but in the past for other activities. IRS Revenue Ruling 58-112 characterizes a business as “regular, frequent, or continuous.” In one case, under Tax Ruling 77-356, a member of Congress was considered a business for giving 10 speeches a year for $1,500 and showing “a degree of recurrence, continuity, and availability” . On the contrary, Tax Ruling 55-431 states that “As a general rule, a person who accepts a casual 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 specialist can guide you if necessary. Not everything is bad if you have to file as a business. If you grind it, you’re surely using internet access, maybe a DirecTV package, paid for research like Rotogrinders incentives and other stuff to make sure your DFS grind is profitable. It is now much easier for a business to spend all or part of these items! This self-employment tax might not look so bad after all and could be eliminated with better expense deductibility. Also, as I said before, the lower AGI would surely help you in other areas such as credits, AMT, and Social Security taxation. You have many options here, but as always, get a professional to make sure you’re doing the right thing.

National and local tax issues

I have to be honest here, I know the mid-Atlantic region best. But local issues and how you manage your earnings, regardless of where you live and what you spend, can have a HUGE impact on your tax obligations. 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 tax issues. deductibility in DFS?

Philadelphia, New York, and various municipalities in Pennsylvania and Ohio also have to deal with local considerations. As a resident of Philadelphia, you may be subject to SIT (School Income Tax) or BIRT (Business Privilege) and NPT tax reporting. Some exemptions apply. This could still hurt highly profitable Grinders in the City of Brotherly Love. New York City has a local tax related to state income tax. However, DFS taxpayers filing as a business must file an Unincorporated Business Tax (UBT) and possibly an MCTMT form if you live in and around New York State.

Most do-it-yourself tax software does not have the ability to file local returns, so you may need to be fully tax compliant. Consulting a tax professional is especially 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 on your H&R Block or TurboTax program for Daily Fantasy Tax purposes may not be the wisest choice. These programs are very heavy 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 recommend that you download the .CSV file of your activities monthly or at most 3 months from your Daily Fantasy site and provide it to your tax professional so they can determine the best course of action for your situation. If you are unsure how to report your Daily Fantasy earnings, please consult a tax professional, whether a registered agent or CPA. As this type of income shows, the IRS and other tax authorities can use many different ways to interpret your earnings.

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