By: Julian Fortuna, Esq.
Background
In 2021, the National Collegiate Athletic Association (“NCAA”) adopted an interim name, image, and likeness (“NIL”) policy (the “Interim Policy”), permitting student-athletes to be compensated for use of their NIL without impacting their NCAA eligibility. Under the Interim Policy, student-athletes may receive compensation for NIL activities subject to certain limitations. The Interim Policy prohibits NIL agreements without quid pro quo (e.g., as discussed below, compensation for work not performed) and agreements in which compensation is contingent on enrollment at a particular school or athletic participation or achievement. State laws and university-specific NIL policies may impose additional requirements or limitations on student-athlete NIL activities.
Since the Interim Policy was adopted, many organizations, generally referred to as “NIL collectives,” have been established by boosters and fans of one or more of a university’s athletic programs to develop and fund, or otherwise facilitate, NIL deals for student-athletes. NIL collectives generally operate independently of the affiliated university, and increasingly, multiple NIL collectives support a university’s student athletes. Some NIL collectives are formed as nonprofit entities under state law and have applied for and received recognition of tax exemption under section 501(c)(3) of the Internal Revenue Code. Other collectives have been established through a fiscal sponsorship agreement or as an activity or program of an existing section 501(c)(3) organization that supports the affiliated university or its athletic program. NIL collectives claiming to be tax-exempt typically use student-athletes as independent contractors to help further their charitable mission. For example, some provide in-kind contributions of a student-athlete’s services to other charities, including speaking, appearances, and other public relations services that help expand the charities’ reach and visibility in their communities. The student-athletes are typically paid by the tax-exempt collective to provide these services.
Internal Revenue Service Memorandum
On June 9, 2023, the Office of Chief Counsel of the Internal Revenue Service (“IRS”) published a memorandum dated May 23, 2023, which casts doubt upon whether NIL collectives may qualify for tax-exempt status under Section 501(c)(3). The twelve page IRS memorandum cites numerous regulations, rulings, and cases standing for the proposition that, in order to come within the statutory definition of a tax-exempt organization under Section 501(c)(3), an entity must be organized and operated exclusively for one or more exempt purposes (charitable, educational, religious, etc.), and that an organization will not meet that definition unless it 1) engages primarily in activities that further such purpose, and 2) serves public rather than private interests. When an organization serves both public and private interests, the private benefit must be clearly incidental, both qualitatively and quantitatively, to the overriding public interest. Whether an organization is operated exclusively for exempt purposes depends on the facts and circumstances in each case. However, an organization bears the burden of proof to establish that it is not operated for the benefit of private interests.
The IRS memorandum states that the primary benefit to student-athletes from a nonprofit NIL collective’s activities is typically compensation for services but that these benefits extend beyond compensation because NIL collectives relieve student-athletes of the transaction and compliance costs they would otherwise incur to participate in an NIL deal and that some collectives also provide additional personal benefits such as financial planning, tax assistance, legal advice, and assistance in personal brand development. Other factors listed in the IRS memorandum indicating that the primary purpose of a nonprofit NIL collective is to compensate student-athletes include:
Telling donors that most of their money goes directly to student-athletes;
Making public that all students on a particular team or position will earn a specified amount of money, or that this is the intended goal of the collective; or
Allowing donors to specify what athletic team will receive the donation without naming a charitable program that the donor wishes to support.
The IRS memorandum concludes that an organization that develops paid NIL opportunities for student-athletes will not, in many cases, qualify for tax-exempt status because the private benefits to student-athletes are not incidental to the exempt purpose of the organization. The IRS memorandum, which is not technically binding on taxpayers, describes the IRS’s opinion of what might be considered “incidental” for this purpose based on existing regulations and case law, separating the analysis into both qualitative and quantitative factors. The memorandum concludes that many NIL collectives operate for a substantial nonexempt purpose – “serving the private interests of student-athletes” – that is more than incidental to any exempt purpose furthered by the activity, and is therefore a tax-exempt status disqualifier. Although the IRS memorandum did not go so far as to say all NIL collectives inherently further a greater-than-incidental non-exempt purpose, it is expected that the IRS will take that position against the majority of collectives that have benefitted from tax-exempt treatment since 2021.
Proposed Legislation
A bill introduced in the U.S. Senate on May 4, 2023 would eliminate the possibility for any NIL collective to operate as a tax-exempt entity. The proposed legislation would prohibit individuals, organizations, and collectives from using charitable tax deductions for designated contributions that compensate collegiate student athletes or incoming collegiate athletes for the use of their NIL. The bipartisan Senate bill – known as the Athlete Opportunity and Taxpayer Integrity Act – was introduced by Senator John Thune (R.-S.D.), the ranking member of the Subcommittee on Taxation and IRS Oversight, and Senator Ben Cardin (D.-Md.), a member of the same Subcommittee.
In explaining the purpose of his proposed legislation, Senator Thune noted, “College athletes have the ability to benefit from opportunities related to their own name, image, and likeness, but outside organizations and collectives should not be able to write contributions off their taxes that are used to compensate athletes.” He continued, “This common-sense legislation would prohibit these entities from inappropriately using NIL agreements to reduce their own tax obligations. These basic taxpayer guardrails would protect athletes, strengthen NIL, and uphold the responsible stewardship of taxpayer dollars.”
Senator Cardin added, “In this new NIL era, we want to ensure that the opportunities available for student athletes to benefit from their own name, image and likeness are protected. We also have an obligation to protect taxpayer funds, which means that charitable deductions should be reserved for charitable activities. Purposefully blurring the line between private expenses and charitable contributions dilutes both these efforts.”
Both senators asserted that the collective models that result in payment to college athletes, through entities claiming 501(c)(3) charitable status tax deductible, is inconsistent with the intended purpose of the charitable tax deduction.
Potential Tax Impact on Donors
Donors should be able to deduct as charitable contributions donations made to an NIL collective before June 9, 2023 (the date the IRS memorandum was released to the public), if that NIL collective had obtained a favorable determination letter from the IRS regarding its tax-exempt status, and possibly after that date unless and until the IRS revokes the organization’s tax exemption because 1) a footnote in the IRS memorandum indicates that the IRS is considering, where appropriate, revoking NIL collectives’ tax-exempt statuses only on a prospective basis and, 2) the IRS’s Automatic Exemption Revocation for Non-Filing online FAQs states that “contributions may be deducted by persons unaware of a change in an organization’s status until the IRS publishes an announcement that contributions to the organization are no longer deductible.” Regarding the proposed legislative change, while Congress does have the authority to enact retroactive tax legislation, the Senate bill by its terms would only apply to contributions made in taxable years beginning after the date of its enactment.
Potential Tax Impacts on NIL Collectives and Student Athletes
If the tax-exempt status of an NIL collective is revoked by the IRS, the entity would become liable to pay taxes on its income. Such income would include gains from the sale of stock contributed by donors with a tax basis at the time of the contribution less than the amount received by the NIL collective upon sale. While, as stated above, a footnote in the IRS memorandum indicated that an existing NIL collective that had already applied for and received a favorable determination letter whose exemption is later revoked should be able to have that revocation only apply prospectively, if an NIL collective did not fully disclose all of its activities in its application for exemption, the IRS may attempt to make the revocation retroactive. However, the tax status of the NIL collective shouldn’t impact student athletes’ taxes. Athletes will still owe the same amount of taxes on the money they receive because they are still getting paid taxable income for the use of their NIL.
Conclusions
This IRS memorandum provides important guidance for NIL collectives that are considering seeking tax-exempt status. NIL collectives should carefully consider the points made in the IRS memorandum and take steps to ensure that their activities are primarily focused on furthering an exempt purpose. Any NIL collective that has already been granted tax-exempt status should begin preparing for an inquiry from the IRS by carefully documenting its grant-making activity, educational programs, collaboration with other charities, and any other activities that advance education or further other charitable purposes. If an NIL collective that has been granted a tax exemption uses a significant portion of its funding to provide direct payments to athletes, such entity should consult with tax counsel to address the possibility of changing its operational structure or restructuring as a for-profit organization in order to avoid IRS penalties.
