It is widely recognized that any legalization of Internet gaming in the U.S. will come hand in hand with its taxation. This is in part founded upon the argument that the federal government and state governments are foregoing significant tax revenues that otherwise would be had if Internet gaming was legal. The most recent bills by Congress and various states proposing legalization have set forth a variety of taxation schemes, some of which are more palatable than others, which provide insight into the measure of how Internet gaming could be taxed.
Congressman Jim McDermott’s (D-Wash.) most recent bill to tax Internet gaming, Internet Gambling Regulation and Tax Enforcement Act of 2009,1 proposes a form of taxation that is both alluring and irksome. The bill proposes a monthly 2 percent tax on funds deposited with an Internet gaming licensee, and the licensee cannot use the deposits to make the tax payment. This scheme, on the one hand, should be relatively simple to administer by the federal government and the licensees, since there is no need to analyze federal or state tax law to determine taxable income. However, this scheme (1) taxes licensees before a single cent of revenue is collected or a single cent of taxable income is generated, and (2) establishes the federal government as a market maker in the Internet gaming industry, by erecting tax barriers to entering the Internet gaming market that will deny access to some potential licensees. The tax barrier divides the potential licensee market between those licensees that have and those that do not have sufficient financial resources to pay the deposit taxes without first generating revenue or taxable income on an existing Internet gaming operation sufficient to pay the deposit taxes. The result is an Internet gaming industry with a single, high barrier to entry and a narrowed, almost predefined market of potential licensees.
The state proposals for Internet gaming taxation provide a broader range of methods to generate tax. Perhaps the most aggressive state taxation scheme is Hawaii’s Senate Bill 755.2 Hawaii’s bill proposes legalizing “peer-to-peer entertainment,” including live and Internet poker. The bill would permit two licensees to operate in Hawaii. Each licensee must pay a 20 percent tax on total wagers, a one-time fee of $100 million and provide free advertising for Hawaii. The unique feature of Hawaii’s proposal is the substantial one-time fee that may deter otherwise potential licensees.
Florida’s Internet Poker Consumer Protection and Revenue Generation Act of 20103 proposes legalizing intrastate Internet poker, subject to a 20 percent tax on monthly gross receipts, a licensing fee of $500,000 for the first year of operations and a 10 percent licensing fee on monthly gross receipts for each following year. Additionally, affiliates of the licensee also are subject to a 4 percent tax on monthly gross receipts and minimal annual licensing fees. Florida’s proposed 20 percent tax and 10 percent annual licensing fee are both based on monthly gross receipts; therefore, unless there is an internal government reason for separating a tax from a fee, it should be preferable, and more easily administered, if the tax and fee were consolidated into a single 30 percent tax on monthly receipts. The affiliate tax raises the issue of double taxation, because the licensee first is taxed on its gross receipts and then the affiliates are taxed on the same revenue after receiving it from the licensee. Nevertheless, the Florida bill smartly takes a step in the right direction to tax industries directly related to the Internet gaming industry.
New Jersey’s Senate Bill 4904 proposes legalization of Internet gaming, which includes not only poker, but also a wide variety of common casino games. The gaming would be subject to a 20 percent tax on gross revenue, a licensing fee of $200,000 for the first year of operations, and a licensing fee of $100,000 for each following year. New Jersey’s bill also created a nexus legal fiction by deeming all Internet wagers to have originated in New Jersey regardless of the player’s location and any intermediate routing of electronic data. New Jersey’s governor vetoed the bill, referencing questions of constitutionality under state law.5
Nevada’s Assembly Bill 2586 proposes legalizing Internet poker subject to a graduated tax on gross revenue (licensees would be subject to the same licensing process and related fees as other Nevada gaming licensees). The highest bracket in the graduated tax is 6.75 percent on gross revenue exceeding $134,000.7 Nevada’s bill also addresses the question of how interstate or intercountry Internet poker would be taxed. It would require each Nevada licensee to pay an additional 4 percent tax on gross revenues earned from players outside Nevada. Additionally, it authorizes the gaming commission to enter into compacts with other jurisdictions where interactive gaming is not prohibited so that Nevada may, among other things, regulate and share in the tax revenues. Although these provisions only require two to three sentences of assembly bill real estate, they address a broad area of tax law, namely nexus.
In general, nexus is the constitutionally based concept that a person or company must have a connection or contacts with a state before the state can exercise jurisdiction over the person or company (e.g., subjecting a person to a state’s courts). With regard to taxes, nexus is a question of whether the person or company has sufficient contact with the state so that the state can impose taxes. The question that arises for Internet transactions is: How much contact is sufficient to impose state tax?
A familiar example is a state’s right to impose sales tax on Internet transactions. It’s clear that a business physically located and selling goods within a state would be subject to the state’s jurisdiction for taxation purposes. However, it is not exceedingly clear as to whether interjurisdictional Internet transactions have sufficient nexus to be taxed. Amazon.com recently ended its affiliates program in Illinois after the governor signed a bill into law that required the in-state affiliates to collect and remit sales tax on purchases made by Illinois residents from online retailers, even if the retailer has no physical presence in Illinois. Presumably, Amazon.com has no contact with Illinois, such as having servers, employees or offices physically located within the state or being an entity formed under and subject to Illinois law. Therefore, Amazon.com’s only contact, arguably, would be the electronic signals sent by an Illinois residence to the Amazon.com website ordering goods to be shipped by a third party into Illinois.
Solely intrastate Internet gaming does not breach the interstate or intercountry nexus issue as it is clear that the transactions, like the sale of goods, occur within a state and thereby the state may exercise its power tax. The issue of interstate or intercountry Internet gaming is, like the Amazon.com example, more complicated. For instance, assuming interjurisdictional Internet gaming legislation is enacted in the U.S., where would Internet poker transactions be subjected to tax if two states legalize Internet poker, and the licensee is located in one state and the players are in both states? In order to address the question of whether interjurisdictional Internet poker transactions have sufficient nexus to be taxed, Nevada’s bill requires all Nevada licensees to pay a 4 percent tax on all gross revenue generated by from players outside Nevada. In contrast with New Jersey, Nevada’s proposal does not have the same questions regarding the legality of a fictional nexus since licensee requirements include paying the tax on operations outside Nevada.
Sales and use tax issues also may impact legalized Internet gaming. Currently enacted and proposed state laws tax electronic goods or services purchased or accessed via the Internet. As a result, Internet gaming could qualify as an electronic good or service under state law and be subject to sales and use tax. States legalizing Internet gaming will need to consider whether exemptions from sales and use tax are appropriate.
As states and the federal government continue to take steps toward determining the appropriate taxation and fee scheme, it is probable that, like land-based gaming, they will move toward a similar, comprehensive scheme. The scheme should generate sufficient revenue to cover the costs for the initial licensing, cover the ongoing operating costs of the state regulatory authority and generate revenues for the state. Drawing from the proposals discussed and existing gaming tax practices, such a taxation and fee scheme may include (1) charging fees for the licensing process and, possibly, charging reasonable annual license fees, (2) taxing gross gaming revenue, (3) taxing affiliates on gaming derived revenue, (4) addressing interjurisdictional Internet taxation issues, and (5) selecting which games to legalize.
Footnotes
1 Internet Gambling Regulation and Tax Enforcement Act of 2009, H.R. 2268, 111th Cong. (2009).
2 Relating to Economic Development, SB 755 SD2 HD1, 26th Leg., (Haw. 2011).
3 Internet Poker Consumer Protection and Revenue Generation Act of 2010, HB 1441, 112th Leg., (Fla. 2010).
4 SB 490, 214th Leg. (N.J. 2010).
5 Lisa Fleisher, “Internet Gambling Vetoed in New Jersey,” Wall Street Journal, March 4, 2011, http://online.wsj.com/article/SB10001424052748703300904576178721367590598.html.
6 AB 258, 76th Leg., (Nev. 2011).
7 Nevada Gaming Commission, Gaming License Fees and Tax Rate Schedule, April 18, 2011, http://gaming.nv.gov/taxfees.htm.
Quinton R. Singleton is an associate in Lewis and Roca Corporate and Securities, Taxation and Gaming practice groups. His gaming practice focuses on casinos, restricted and nonrestricted gaming locations, sports betting, Internet gaming, sweepstakes and contests. He can be reached at qsingleton[at]lrlaw.com.
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