The Internal Revenue Service (IRS) recently released a memorandum addressing the development of paid name, image and likeness (NIL) opportunities for collegiate student-athletes. While the memo explicitly states that the document “may not be used or cited as precedent,” it concludes that many NIL collectives that develop paid NIL opportunities for student-athletes are not tax exempt (as described in section 501(c)(3) of the Internal Revenue Code of 1986 (the Code)). This is because “the private benefits they provide to student-athletes are not incidental both qualitatively or quantitatively to any exempt purpose furthered by that activity.”
What are NIL Collectives?
NIL collectives are organizations generally independent of a college or university whose purpose is to create or facilitate paid NIL opportunities for student-athletes. They are often founded by influential alumni of universities and their business model includes pooling together cash from a variety of sources, including boosters, businesses and fans.
Although some NIL collectives are for-profit, others are organized as nonprofit organizations under section 501(c)(3) of the Code. Nonprofit NIL collectives will often partner with local and regional charities to develop paid NIL opportunities for student-athletes (in which student-athletes are compensated by the nonprofit NIL collectives for attending sponsorship events, autographing memorabilia, and hosting sports camps for either the collectives or their partner charities). Based on this model, nonprofit NIL collectives often publicly state that they serve two purposes: (i) to raise awareness and support the mission of the nonprofit NIL collective and its charitable partners, and (ii) to compensate student-athletes for use of their NIL. Benefactors of nonprofit collectives donate their money with the expectation of receiving tax deductions for their contributions.
501(c)(3) Organizations
An organization that qualifies under section 501(c)(3) of the Code (a 501(c)(3) Organization) is generally exempt from U.S. federal income taxation. Many 501(c)(3) Organizations rely on charitable contributions to fund their operations and further their exempt purposes. As noted above, a donor to a 501(c)(3) Organization may claim a tax deduction for their contributions (while donors that donate to entities that are not 501(c)(3) Organizations generally may not).
An organization will only qualify as a 501(c)(3) Organization if it can demonstrate to the IRS that it is organized and operated exclusively to further one or more exempt purposes (e.g., religious, charitable, scientific, educational, etc.). The exclusivity requirement in this operational test signifies that a 501(c)(3) Organization must primarily engage in activities that further its stated exempt purposes. Any nonexempt activities of a 501(c)(3) Organization cannot be substantial when viewed against the organization’s exempt purpose activities and must instead only be incidental in nature.
Furthermore, an organization will only be found to be organized or operated to further its stated exempt purpose if it serves public rather than private interests. Any private benefits conferred by an organization must be both qualitatively and quantitatively incidental in order for the IRS to find that such organization is not serving private interests. This “private benefit doctrine” is central to the operational test under section 501 of the Code, and a determination by the IRS that an organization primarily serves private benefits will usually be fatal to that organization’s attempt to qualify as a 501(c)(3) Organization.
The Internal Revenue Service’s Position
In its analysis of the operations of nonprofit NIL collectives, the IRS found that many NIL collectives provide private benefits to student-athletes that are not qualitatively or quantitatively incidental to their exempt purposes and are therefore not tax-exempt entities under section 501(c)(3) of the Code. A NIL collective’s main purpose is to help create or facilitate paid NIL opportunities for student-athletes, and the IRS has now stated that the private benefit to student-athletes is “not a byproduct but […] rather a fundamental part of a nonprofit NIL collective’s activities.” In its memo, the IRS cited numerous factors that it examined in making this determination, including but not limited to:
- The “very justification” for many nonprofit NIL collectives’ existences is to compensate student-athletes for NIL activities arranged for or facilitated by such NIL collectives, and the IRS recognizes that nonprofit NIL collectives play an increasingly important role in recruiting and retaining student-athletes for a particular school’s athletic programs;
- Nonprofit NIL collectives provide many benefits to student-athletes beyond compensation (including financial planning, tax assistance, personal brand development, etc.), and such activities are not necessary to the promotion of the nonprofit NIL collective’s charitable causes; and
- Nonprofit NIL collectives may pay out 80 to 100 percent of the contributions it has received to student-athletes.
Tax Implications for Nonprofit NIL Collectives
What does this mean for nonprofit NIL collectives going forward? It is now clear that going forward the IRS will only grant tax-exempt status to new nonprofit NIL collectives that can demonstrate that their primary purpose is something other than compensating student-athletes. It also now appears likely that the IRS will begin to review and potentially revoke the tax-exempt status of dozens of nonprofit NIL collectives that had been recognized as 501(c)(3) Organizations over the last two years. What is unclear is whether the IRS intends to apply these revocations retroactively, such that donors to such nonprofit NIL collectives will have their charitable deductions retroactively disallowed.
Regardless of whether such revocations are applied retroactively, affected nonprofit NIL collectives will have to navigate the U.S. federal tax implications of becoming taxable entities. Collectives that wish to nonetheless seek recognition as 501(c)(3) Organizations will have to find ways to adjust their operations such that their main objectives are not to pay student-athletes. However, based on this IRS memo, it appears that the goals of NIL collectives and section 501(c)(3) status under the Code may be at fundamental odds with one another. Being at the forefront of NIL is increasingly critical for universities competing at the highest level – but in the fast-evolving NIL landscape, proactive measures and continual assessments to ensure legal compliance is equally critical, and US tax law is no exception.
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For further information, please contact:
Patrick Ashby, Partner, Linklaters
patrick.ashby@linklaters.com
