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Intrastate iGaming: Federal Wagering Tax

So far, we’ve discussed how federal withholding and reporting obligations and the Bank Secrecy Act may be implicated with intrastate internet gaming activity in the U.S. This time we examine the possible applicability of another type of tax imposed by the Internal Revenue Code (“IRC”), the excise tax on wagers made under section 4401.

The federal wagering excise tax may apply for bets accepted on U.S. internet gambling sites. For accepted wagers authorized under state law, the excise tax is 0.25 percent of the wager amount and is paid by the entity accepting the wager. For all other wagers (i.e. wagers not authorized by state law) the tax jumps to two percent.

To determine whether the tax may apply to intrastate iGaming, the first question we must ask: What is a taxable wager under the statute?

IRC section 4421 provides taxable wagers include those placed:

  1. on a sports event or contest with a person engaged in the business of accepting such wagers;
  2. in a wagering pool on a sports event or contest conducted for profit; or
  3. in a lottery conducted for profit.

As an aside, any wager placed in a sweepstakes, wagering pool, or lottery which is conducted by an agency of a State acting under authority of State law is exempt from the tax. So if a state or an agency of a state operated an iGaming site, then the federal wager tax wouldn’t apply to wagers accepted on the site.

In general, the federal wagering tax applies on wagers accepted by race and sportsbook establishments in the U.S.

Online horse wagering exists today, and operators are required to collect and remit the tax on wagers placed. (Note: Parimutuel horse race wagers pursuant to state law are exempt.) Online sportsbooks at this time are not authorized under any state law, so those accepting wagers would be required to pay the tax at the higher two percent rate.

Does the tax apply to offshore online sportsbooks accepting wagers from U.S. customers? Probably not, unless the party accepting the wager is a U.S. citizen or resident.

IRC section 4404 provides that the tax applies only to wagers:

(1) accepted in the United States, or

(2) placed by a person who is in the United States (A) with a person who is a citizen or resident of the United States, or (B) in a wagering pool or lottery conducted by a person who is a citizen or resident of the United States.

This provision extends the wager tax to cross-border wagers accepted by American bookies. If the bookie located offshore is not a U.S. citizen or resident, then the tax should not apply. If, however, the bookie is located in the U.S., then the wager placed is taxable regardless of where the person placing the wager is located.

What types of bets may fall under the third type of a wager subject to the tax, “a lottery conducted for profit?”

Treas. Reg. 44.4421-1(b)(1) states “lottery” includes the numbers game, policy, and similar types of wagering. A lottery conducted for profit

includes any scheme or method for the distribution of prizes among persons who have paid or promised a consideration for a chance to win such prizes, usually as determined by the numbers or symbols on tickets as drawn from a lottery wheel or other receptacle, or by the outcome of an event.

Poker may be considered a lottery conducted for profit.

The regulation at least implies that the game must be one of chance. In IRS Revenue Ruling 57-521, the Service considered whether a puzzle contest was a lottery conducted for profit. Because “the element of skill rather than that of chance determines the winners” in the puzzle game, the IRS stated, the puzzle contest was not considered a lottery. Applying the skill versus chance analysis to poker, there is at least an argument that poker is not a lottery conducted for profit, especially in light of the recent Dicristina decision.

Even if poker falls within the definition of a lottery conducted for profit, it may nevertheless be exempt from the wager tax.

IRC section 4421(2)(A) provides that the term lottery does not include any game of a type in which usually the wagers are placed, the winners are determined, and the distribution of prizes or other property is made in the presence of all persons placing wagers in such game. Treas. Reg. 44.4421-1(b)(2) applies the exemption to card games and concludes, “no tax would apply in the case of card games.”

It’s clear that in-person poker cash games and tournaments are exempt. It’s far from clear, however, that we can deduce the same conclusion with respect to online poker wagers.

One can argue that the standard for “in the presence of all persons” is not merely physical presence, but also extends to virtual presence on the same online poker table.

Some slightly bad news: In Rev. Rul. 79-146, the IRS applied a physical presence standard to certain types of keno games. We shouldn’t place too much emphasis on this particular revenue ruling, however, because it was written well before virtual poker tables were around.

Another possible argument is online poker wagers are placed in “coin-operated devices,” as the wagering tax does not apply on any wager placed in a coin-operated device. Treas. Reg. 44.4402-1(b)(2)(v) says the following is an example of a coin-operated device:

A coin-operated machine that displays a poker hand or delivers a ticket with a poker hand symbolized on it that entitles the player to a prize if the poker hand displayed by the machine or symbolized on the ticket constitutes a winning hand.

Of course, nobody is putting coins into their computers to play online poker. (Note: Bitcoin enthusiasts may disagree.) But there have been indications the definition of a “coin-operated device” is not strictly construed to require actual insertion of coins to play poker, giving rise to an argument for regulated online poker wagers in the U.S. to fall under the exemption.

As you can see, intrastate iGaming in the U.S. raises more questions than answers for purposes of the federal wagering tax. Next time we will shift the tax discussion from federal to state by examining some gaming taxation models that states may consider adopting.

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