There was an oddity in the sports world that lasted for generations. Professional athletes profited from their status through sponsorships for their name, image, and likeness (NIL), yet these NIL opportunities were closed to collegiate athletes. The National Collegiate Athletic Association (NCAA) opened opportunities to their athletes within some limitations beginning in 2021. As with all things in life, this generated ripples in the tax world. Organizations known as “NIL collectives” have arisen to facilitate NIL contracts for student-athletes. There are over 250 NIL collectives, and about a third of these have been established as nonprofit organizations and received § 501(c)(3) recognition from the IRS. Such a status requires operating for one or more charitable causes, often termed exempt purposes. An entities tax exemption is jeopardized when they operate for any substantial nonexempt purpose. A chief counsel memorandum recently released by the IRS concluded that NIL collectives operate for a substantial nonexempt purpose “in many cases.”
Citing eight cases and five revenue rulings in addition to the statutory and regulatory authority, the IRS detailed the basis of its reasoning and reviewed the requirements for tax exemption. A § 501(c)(3) entity must meet the operational test and satisfy the private benefit doctrine. The operational test softens the statutory mandate of operating “exclusively” for one or more exempt purposes to require only operating “primarily” for one or more exempt purposes. The private benefit doctrine requires the tax exempt entity to prove “that it is not operated for the benefit of private interests.” The IRS found that the avowed purpose of a nonprofit NIL was to benefit a private interest, specifically the interests of the student-athletes. It may seem obvious but still important to note for the purposes of this analysis that student-athletes are not “a recognized charitable class.” Nevertheless, the IRS hypothesized that the interests of student-athletes could be transformed from a private interest to a public interest through “a finding that NIL collectives select student-athletes for participation based on need, such that their activities could be considered conducted for the relief of the poor or distressed, and that payments are reasonably calculated to meet that need.”
According to Sports Illustrated, certain leaders within the NIL collective community have prophesized IRS retaliation against nonprofit NIL collectives since the beginning of the phenomenon. NIL collectives who resisted benefactor pressure to claim tax exemption may now watch as the others scramble in damage control. This is an internal memorandum that cannot be used as precedent as a case or a revenue ruling would be able to be used. However, it clearly discloses the position of the IRS and its interest in this matter, leading many to believe that further IRS action may be imminent.
If you have questions or concerns about how these news reports may affect you or your business, please contact The Burton Law Firm at: 916-822-8700 or email info@lawburton.com for a consultation.
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California has required employers to “indemnify” employees for “necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties, or of his or her obedience to the directions of the employer” in substantially the same terms since 1937 under Labor Code § 2802.
