In 2021, there are many opportunities to play games for real money online, even if your particular state does not offer full-scale online casino operations. Daily Fantasy Sports (or “DFS”) is one hugely popular entertainment option. Real-money pure-skill contests are another. Video game tournaments, leaderboards, and prize pools are also available, as well as countless other options. Entrepreneurs all over the world want to enter the red-hot United States gaming market, but need to understand the legal nuances in order to effectively distribute their product and avoid legal issues with regulators, banks, and app platforms like the Apple App Store.
With skill-based games, it is important whether your game is more like fantasy sports or whether it a pure-skill contest. This distinction is critical because it determines where your game is legal (and whether you need a license) – and also affects your tax obligations to the IRS.
The following chart illustrates the three categories of games and the applicable regulations:
|Description/type of game||Category||Regulations|
|Players determine the amount of the wager and may apply certain level of skill to increase odds of winning (like hit or stay in blackjack), but odds always against the player. Winner is determined primarily by chance or chance is the dominant factor in determining outcome. Game is similar to a casino game like slots, blackjack, keno, or bingo. Game is a poker-like game. Game features a random mechanism, like a shuffled deck of cards, roll of the dice, or a spinning wheel. Bet is on the result of a single athletic competition, event, or performance of a single player.||Gambling||Highly regulated, illegal and criminalized activity (without a license)in all 50 states. Federal law also applies, including the monetary transaction restrictions through the Unlawful Internet Gambling Enforcement Act (“UIGEA”).|
|Players pay an entry fee, and then use research, data analysis, or other skill to build a team or portfolio to compete against other player-chosen teams or portfolios. Points or scores assigned based on real-life performance. Player does not control the performance of the players, stocks, currencies, or other portfolio components. Real-world events determine outcome. Similar to fantasy sports or a fantasy league. Prize pool must be known and fixed ahead of time.||Fantasy||Fantasy sports are expressly excluded from the scope of the UIGEA. Fantasy sports and leagues are permitted in about 80% of the states, but license and revenue tax is required in some. IRS views fantasy wagers as gambling bets and no different than sportsbook betting for tax purposes. Potential exposure to excise tax for providers.|
|Players pay an entry fee into a sports tournament or skill contest for the chance to win a prize (whether cash or otherwise) based on their own participation. Players determine the outcome through pure skill, such as strength, speed, agility, mental knowledge, mental quickness, or other physical or mental factor. Chance has minimal or no role in the outcome. Head-to-head games of timed solitaire, chess, checkers, blockbuster, Tetris-like puzzle games. Trivia contests. Most video game tournaments. Golf or tennis tournaments, hole-in-one contests.||Pure Skill Contest||Unregulated and not considered gambling in about 80% of the states. Regulated pursuant to license or outright prohibited in the remaining states. Not regulated under federal law. The IRS does not consider entry fees or skill wagers to be gambling bets.|
As a gaming company providing a new product, you obviously want to steer clear of classification as a gambling game. Unless you are a licensed casino (or working in partnership with a licensed casino) in one of the few states that have legalized online gambling, real-money gambling games are illegal. Not only do you risk fines and prosecution from state and federal law enforcement, but you will not be able to pass Apple or Google’s app vetting process, advertise on Facebook, or use a mainstream payment processor like PayPal.
Skill-based real money games are those where the outcome is not determined by chance. These games fall either into the “fantasy sports” or “pure skill contest” categories. In either category, the argument is that where chance is not a dominant factor, the game is skill-based and falls outside the definition of regulated “gambling.” Many real-money skill-based gaming platforms have adopted this “if it is not prohibited, then it is legal” approach to offer their products in about 80% of the United States. But there is a difference between the so-called “fantasy sports” and “pure skill contest” categories. The first difference is regulatory – state law treats “fantasy sports” and “pure skill contests” differently.
To fully understand the difference, it is important to know that the “it’s not gambling” argument is not new. In the early 21st century, it was widely used by online poker providers and then daily fantasy sports operators. Recall that between the early 2000s and 2011, Texas Hold’em became huge in the U.S., helped by online pioneers like PokerStars and PartyPoker that allowed anyone to play online poker from anywhere. ESPN was airing the World Series of Poker as part of its routine sports coverage. The 2006 James Bond franchise reboot Casino Royale even focused on high-stakes no-limit hold’em (as opposed to Baccarat in Ian Fleming’s original book treatment).
The primary argument for legality was that poker is a game of skill, not chance, and therefore not gambling. Advocates pointed to the fact that skilled poker players were consistently able to beat their opponents, even though the game did involve the element of chance with a random shuffle of a card deck. In response to growing concern about unregulated real-money poker, a number of courts concluded that chance played a significant role in the outcome and Texas Hold’em is indeed gambling. The federal government took further regulatory action by enacting the Unlawful Internet Gambling Enforcement Act (“UIGEA”). The UIGEA essentially killed off any off-shore poker and other grey-market online gambling operations by targeting U.S. banks and payment providers and prohibiting them from facilitating wagering transactions. Those providers that continued to offer U.S. players real money poker games were shut down through federal law enforcement action on so-called “Black Friday,” April 15, 2011, and their executives charged with a number of felonies, including money laundering and fraud.
Daily Fantasy Sports emerged as an entertainment alternative around 2007 and relied on the same “it’s not gambling” argument as poker. Players would stake real money for a chance to play in a fantasy sports contest, where they would set a daily lineup of their own fantasy team and compete against others for the highest score. The highest score or scores would be awarded cash prizes. DFS relied on the definition of “bet or wager” in the UIGEA that expressly excluded fantasy sports contests. But, just because DFS is not illegal under the federal UIGEA (and MasterCard or Discover can process the associated wagering transaction) does not mean it is automatically legal. Some states concluded outright that DFS is “gambling” and is illegal. Others enacted legislation that DFS is not gambling. And some have done nothing at all. Thus, DFS offerings vary state-by-state: as of the date of this article, DraftKings and FanDuel both offer DFS in 41 of the 50 states. But DFS law is far from settled and remains in a state of flux; for example, in New York, DFS was authorized by the state legislature, but a lawsuit challenging the constitutionality of the law is pending on appeal. Texas is another example – in 2016, the Texas attorney general issued an opinion that DFS is illegal gambling, but both FanDuel and DraftKings continue to offer DFS in Texas pending the final outcome of various lawsuits.
On the other hand, games that are head-to-head contests of pure skill are legal in most states because they fall outside the state’s definition of “gambling.” These games – whether online or in person – allow participants to pay an entry fee and compete for a prize (monetary or otherwise). Even if the game is played on a smartphone, it is no different than paying a fee to play in a money tennis or golf tournament. Or paying an entry fee to participate in an arm wrestling contest at the state fair. In fact, certain states expressly exclude so-called “bona fide contests of strength, skill, or speed” from the definition of gambling, provided that the only persons making the wagers are the participants themselves. But although the analysis seems straightforward, providers of pure-skill contests disagree about where exactly real money games are legal. Various platforms have different lists of “restricted jurisdictions,” demonstrating their different tolerance for risk, and that the law remains unsettled in this area.
The second difference between fantasy and pure skill is tax treatment. Under the Internal Revenue Code, gambling winnings are taxable income, but may be offset by gambling losses. In 2020, the IRS decided that wagers made on DFS constituted a “wagering transaction” (i.e. gambling) under Section 165(d) of the Internal Revenue Code and the Tax Court agreed. This ruling was consistent with another 2020 internal IRS memo that concluded DFS wagers were subject to an excise tax, which is normally applied to wagers made at sportsbooks. The IRS’s analysis and conclusion that DFS is essentially the same as sports gambling has significant legal implications. Not only does it potentially expose DFS providers to millions of dollars in unpaid excise tax liability, but it is also an indicator of how the nature of the game may determine the outcome of “is it gambling” analysis. A game could very well be “gambling” for tax purposes, but at the same time “not gambling” under a state’s definition of “gambling.”
The skill-based gaming market is an attractive, fast-growing industry in the United States. However, it is also plagued by an uncertain legal landscape and inconsistent treatment at the federal and state level. Tax implications are also something to consider when designing your game. Whether you are a start-up or a well-established company looking to introduce a new game product, Artaev at Law can provide you with consulting and legal analysis required to do it right.
Have more questions? Do you need help getting your app through the Apple, Google, or Facebook review process? Contact Dan Artaev today by emailing firstname.lastname@example.org or by phone or text at (269) 930-0254.
Disclaimer: This guide is not intended to be and does not constitute legal advice. It is for informative and promotional purposes only. Do not take any action or refrain from taking any action based on this guide, and always consult with a qualified professional about the circumstances of your particular case. Each set of facts is unique and different circumstances apply to each individual business.
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