David Baldwin Donald Zidik
David Baldwin Donald Zidik

Taxing fantasy sports

How should the fantasy sports player report income and expenses?

April 10, 2014
by David Baldwin, CPA, and Donald J. Zidik Jr., CPA

As the internet has grown enormously in the past decade, so has participation in online fantasy sports leagues. Last year, approximately 33 million people in the United States participated in these leagues, which include fantasy football, baseball, hockey, and basketball. Participants create teams using real players, and the games are played using those players’ actual performance in games.

Fantasy sports leagues and college tournament bracket contests now operate under the Unlawful Internet Gambling Enforcement Act (UIGEA) of 2006, P.L. 109-347 (31 U.S.C. §§5361–5366). This act sets the criteria that must be met for an online game to not be illegal gambling or a game of chance, but instead to be considered a game of skill. These criteria are:

  1. All prizes and awards offered to winning participants are established and made known to the participants in advance of the game or contest. The value of prizes or awards is not determined by the number of participants or the amount of any fees those participants paid;
  2. All winning outcomes reflect the relative knowledge and skill of the participants and are determined predominantly by accumulated statistical results of the performance of individuals (athletes in the case of sports events) in multiple real-world sporting or other events; and
  3. No winning outcome may be based:
    • On the score, point spread, or any performance or performances of any single real-world team or any combination of such teams; or
    • Solely on any single performance of an individual athlete in any single real-world sporting or other event.

To be consistent with the games’ being defined as not gambling, the fantasy sports league operators based in the United States report participants’ prize money as income using Form 1099-MISC, Miscellaneous Income, typically in Box 3—Other Income. They do not report using Form W-2G, Certain Gambling Winnings.

The income can be reported to the players using one of two principal reporting methods: the net payments method or the net earnings method (see Letter Ruling 200532025). The obligation to report is triggered using the 1099-MISC threshold of $600 when net payments or net earnings reach that amount.

  • Net payments is defined as the amount of payouts to the player in excess of the deposits during the year. This method does not accurately represent winnings if the player carries over a balance from one year to the next, which is then distributed.
  • Net earnings is defined as the amount equal to earnings in the account (winnings plus bonuses plus referral income) less fees paid.

If the players use a third-party processor such as PayPal, they may receive an additional report from that processor on Form 1099-K, Payment Card and Third Party Network Transactions, if their activity is substantial enough to require mandatory reporting.

Tax practitioners with clients who are actively involved in fantasy sports leagues, to the extent that their activities rise to the level of a trade or business, will need to consider whether to report the activity as gambling on a Schedule C, Profit or Loss From Business (Sole Proprietorship). Otherwise, the income should be reported as “Other income” on line 21 of Form 1040, U.S. Individual Income Tax Return.

Other miscellaneous deductions

If the participant’s involvement in fantasy sports does not rise to the level of a trade or business, net winnings should be reported as “Other income.” The amount reported on the Form 1040 will most likely have to be reconciled with the information reported on the Form 1099-MISC if the fantasy sports leagues in which the taxpayer participated used the net payments method. Losses that the fantasy sports leagues reported to the player would be reported on Schedule A, Itemized Deductions, as miscellaneous deductions, subject to the 2%-of-adjusted-gross-income floor, and not deductible for alternative minimum tax purposes. The benefit of deducting gambling losses would not be applicable in this situation.

Schedule C: Trade or business

If the client can substantiate that his or her fantasy sports activity is not a hobby under Sec. 183, but is an activity engaged in for profit, the total winnings, losses, and other additional expenses would be reported on Schedule C as a sole proprietor. However, net income would be subject to self-employment tax, and net losses may not be deductible without substantiated material participation. Additional expenses the taxpayer incurred for the activity could be deducted under Sec. 162.

Reporting the activity as gambling

Reporting these activities as gambling is inconsistent with the leagues’ interpretation of these activities and with their reporting using Form 1099, which would result in matching problems for the client. Whether reporting the income as gambling implicates the client as being involved in an illegal gaming activity is best not answered by the preparer. Reporting using this method would also require the client to provide all winnings and losses based on the correct interpretation of what “session” the client has participated in for each league (i.e., is based on an individual game, playoff, season, or any other contest that the league sponsors).

How to report

Practitioners should advise clients to properly track their deposits, winnings, and fees so that income or loss is properly reflected on their tax returns. Taxpayers should make any corresponding adjustments to the amount reported on Form 1099-MISC and attach a statement to their return to disclose the method that was used.

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David Baldwin, CPA, is a partner with Baldwin & Baldwin PLLC in Phoenix. Donald J. Zidik Jr., CPA, is a senior manager with Marcum LLP in Needham, Mass., and an adjunct professor of taxation at Suffolk University in Boston.