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Allowances for tax deductions for free bets and other promotional play lost U.S. states more than $120m in potential tax revenue in 2021, and some states are pushing back against unlimited deductions.
As of the end of 2021, 12 states allowed operators to deduct an unlimited amount of promotional play from their tax returns through state law or regulations.
Five states allow a limited amount of promotional play deductions, with two more allowing a limited number of deductions that slowly phase out over a multi-year period.
Last week, Colorado became the first state to change the approach of allowing unlimited deductions, with both chambers of the state legislature passing a bill to limit deductions, with the allowance shrinking over a five-year period.
The bill, which includes additional responsible gambling provisions and funding, awaits Democratic Governor Jared Polis’ signature to become law.
Effective January 2023, the bill limits sportsbook operators to deducting a maximum of 2.5 percent of monthly betting handle, with that limit decreasing by 0.25 percentage points each year, while also preventing operators from carrying over losing months to set off the following month’s taxes.
By 2026, online betting operators will be able to deduct no more than the equivalent of 1.75 percent of handle from their taxable revenue.
“We’ve had sort of a long philosophical discussion about this, I think, where the percentage for tax deductible has landed for the free bets is fair,” said House Speaker Alec Garnett, who sponsored the bill, earlier this month.
“Of course, we could go up, but I think this is a way to generate more revenue, it slowly starts to ratchet down and that will over time allow the market to accommodate that and will allow for [it],” he said. “I think you’ll see a change where those free bets start to go down.”
In addition to promotional play deductibility, a 10 percent headline tax rate and a low barrier for entry with more than 30 market-access opportunities have helped Colorado become one of the most operator-friendly jurisdictions in the United States.
Garnett also pointed out that since launching in May 2020, four corporate headquarters for online sports-betting operators have opened in the state, creating almost 10,000 jobs.
The result is a competitive market with more than $138m in promotional play deductions reported in 2021, the state’s first full year of operation since the launch.
As a result of promotional play deductions and a provision allowing operators to carry over losses to the following month, the state missed out on almost $15m in potential tax revenue, easily surpassing the $10.3m in taxes it collected.
In Michigan, another state that allows full deductibility of bonuses from taxes for online sports betting, operators deducted more than $181m in promotional play from a reported $292m in gross sports-betting revenue, resulting in more than $17m in potential tax revenue being missed, more than double the $7.2m collected in 2021.
The most significant deductions have been in Pennsylvania where, in the 2021 calendar year, more than $165m in promotional play was deducted from the state’s $505m in sports wagering revenue.
The result was just under $60m in tax savings, although the state did collect more than $122m in tax revenue as a result of its higher-than-average 36 percent tax rate, which applies to net proceeds after deductions.
Unlimited promotional deductions brought Pennsylvania’s effective tax rate down to just over 24 percent of adjusted revenues.
Nine states allow no deductions for promotional play, the most notable being New York.
Through legislation enacted last year, the Empire State hit operators with a one-two punch of a targeted 50-plus percent tax rate, ultimately settling at 51 percent, as well as a prompt notification from the New York State Gaming Commission shortly after legislation passed that relief in the form of promotional play deductions would not be allowed.
Only one state, Iowa, passed legislation in 2021 that granted operators unlimited promotional play deductions, with two others, Arizona and Ohio, passing bills with limited deductions — to sunset over a five-year period — that give operators a chance to acquire customers in the state.
Even with the limited deductions, however, Arizona operators were still able to deduct more than $96m in just four months of operations in what became the most hotly contested new market in the U.S. as the 2021 NFL season kicked off, deductions that would translate to more than $9.6m in tax revenue.
On the other side of the coin, New Jersey Democratic Governor Phil Murphy vetoed legislation last November that would have permitted operators to deduct any annual promotional play for online sports betting above a $12m threshold.
The legislature agreed with his recommendation to limit deductions to no more than $8m in retail promotional play.
