July 1, 2021 | Bloomberg Tax
FanDuel, DraftKings Save Millions on Taxes Thanks to Free Play
FanDuel and DraftKings commonly use free bets—often referred to as free play—to lure in new bettors, but some states are paying the price in lost tax revenue.
Hundreds of millions of dollars have been left on the table—money that some states had been counting on and promised voters when sports betting was spreading as a popular new tax tool across the country. The shortfall has impacted program funding and forced some states to make up the difference elsewhere. Meanwhile, the industry is hoping the perk catches on with lawmakers in more states.
“Lawmakers aren’t paying attention to this yet, but it’s coming,” said Brandon Loeschner, chair of the gaming group at RubinBrown.
Pennsylvania, Colorado, Michigan, and Virginia all allow online gambling companies like Fanduel and DraftKings to carve out any earnings tied to free play from their taxable revenue. Regardless if the company loses money or not, revenue tied to betting offers like boosted odds for either football team to score at least one touchdown, or a $500 match with a player’s first deposit, goes completely untaxed.
The online sports betting industry pushes for the deductions as an essential tool for them to offer promotions, which can attract new customers in new markets. It sells them as temporary, and somewhat seasonal depending on league calendars and marquee sporting events.
Since 2019, betting companies have excluded more than $336 million tied to free-play bets from their taxes, nearly half of their total revenue in those states, according to VixioGambling Compliance. Those deductions even include bets players lose, while the industry makes an untaxed profit.
“It’s flying under the radar. It’s in the fine print,” said Michael Pollock, managing director at Spectrum Gaming Group. “It’s partly because its new, but it’s also because states have been rushing to move headfirst into sports betting based on projections that may not have been realistic on day one.”
Colorado Water Funding Dries Up
When Colorado’s legislators voted to legalize betting in the state, they projected it would bring in extra money to help deal with its water shortage crisis. But in its first full year, gambling taxes brought the state only $6.6 million, less than half of what a ballot initiative had forecast.
Sports betting companies in the state have deducted 62% of their revenue from what gets taxed, thanks to language in Colorado’s law that lets them adjust their taxable base for promotional play. That language was passed after Coloradans opted to legalize online gambling at the polls, which directed a bulk of funds for the Water Plan Implementation Cash Fund to safeguard against declining water levels in the Colorado River.
“Voters went to the polls and thought it was going to pay for their water problem, but that was a complete lie,” said Steve Brubaker, a gaming lobbyist.
With sports betting revenue falling short, Colorado has had to use additional taxpayer money to bail out the fund. On June 24, Gov. Jared Polis (D) signed a $15 million bailout bill (H.B. 1260), sending the largest sum of general fund revenue in state history to the program.
“It’s as important to be as clear about what you’re taxing as it is to be about how much you’re taxing. For states like Colorado that promised to spend the money on water project, it’s a question of planning and forecasting,” said Ulrik Boesen, a senior policy analyst at the Tax Foundation. “If you’re calculating with a 10% rate that’s on the books, but your actual rate is more like 4.5 after the deductions, it’s impossible to forecast.”
Sara Leonard, marketing and communications director for the Colorado Water Conservation Board said she had not counted on sports betting revenue to make a dent for the first few years but welcomes the extra $15 million.
“We have other sources of funding for the Water Plan, and sports betting revenue will hopefully begin providing much more—and more permanent—funding to meet water plan goals into the future,” she said.
The state audits the free-play deductions as it does traditional deductions companies take on their taxes, said Suzi Karrer, a spokeswoman with the Colorado Lottery and Department of Revenue. She said sports betting has exceeded some of the initial projections, which varied when betting started due to uncertainty about how the tax would be structured.
None of the bill’s original sponsors could be reached for comment.
Sports Betting Tax Policy
The sports betting market is indicated by “handle”—the total amount users wager—and “revenue” or “hold,”—the money oddsmakers are left with after paying out bets users win. The federal government taxes handle, while all 30 states that have legalized since the Supreme Court struck down a sports betting prohibition three years ago, apply their taxes to revenue.
Colorado, Pennsylvania, Michigan, and Virginia stand out as the few that allow sports betting companies to adjust their revenue by deducting unlimited free play and promotional bets from their taxable base. Taxes in all four states make up a much lower proportion of operator revenue compared to other states.
Allowing uncapped deductions effectively make these gambling excise taxes function more like gross receipts taxes or income taxes, said Boesen.
“If there’s no cap on the amount of promotional deductions you can take, then it’s not an excise tax any longer,” Boesen said. “Because then, technically, any operator could eliminate the tax liability completely by just offering endless amounts of promotions.”
In Pennsylvania, FanDuel can deduct any amount it gives a user in free credit, as well as any of the user’s own money attached to a promotional wager, regardless of whether the sportsbook wins or loses, according to Adam Robbins, head of U.S. tax at FanDuel.
“We’ve largely seen a desire to tie promotions wagered to the deductions, as opposed to a regime where you tie the deduction to payouts in some way,” Robbins said. “The amount included into wagers ends up being the deduction, so it’s essentially a one-to-one wash and with certain limitations.”
Rush to Join the Party?
Lawmakers may have overlooked such language in part because of the rush to join the sports betting party, but also because mobile and online betting is still relatively new and the rate at which companies like FanDuel and DraftKings issue promotions has rapidly sped up as betting is legalized in more states.
Before the U.S. Supreme Court overturned the Professional and Amateur Sports Protection Act in 2018, mobile betting was almost all offshore, and legal betting was almost all in person. Offshore books don’t pay state taxes and casinos generally don’t offer promotions—thus there was no reason to allow them to adjust for these things.
“It’s something that the traditional brick and mortar operators didn’t necessarily have to deal with, with their retail sportsbooks,” said Loeschner. “Online is bringing this to the forefront because a lot of those operators are using free play as a way to entice new players, who are coming to the market looking for these promos.”
Perk Expansion on Deck
Promotion deductibility is not only baked into the formula in select states, but spreading to other states where sports betting is legal.
Arizona, Maryland, Louisiana, and Wyoming recently legalized sports betting. All will allow companies to deduct revenue tied to free-play. New York, which recently expanded to online play, won’t allow free-play deductions.
The industry is angling to expand the perk to boost its tax savings in other states that already have legal sports betting, too. Lobbyists are currently pushing bills in New Jersey and Illinois to allow the deductions.
In Iowa, free-play deductibility passed as part of an expansive revenue bill earlier this month. The state had taxed the industry without allowing the deduction since 2019.
According to a fiscal note attached to the bill, Iowa will lose $25.8 million over the next five years due to the adjustment. None of the bill sponsors could be reached for comment.
Loeschner, who serves as treasurer for the Fantasy Sports and Gaming Association, is confident governments will start taking a look at the growing number of promotions and the deductions they account for.
“My industry definitely needs to become aware of this issue.” Loeschner said. “But overall, it is a good thing, because it’s a sign of how rapidly sports betting has grown in such little time.”
The American Gaming Association, which lobbies on behalf of the industry, declined to comment.