The college athletics landscape is undergoing a significant transformation, particularly considering NIL compensation for student-athletes. Understanding and addressing the potential tax implications associated with this transformation is crucial for educational institutions to maintain tax compliance and mitigate potential risks.
Judicial and regulatory activity affecting NIL
Current NIL policy allows college student-athletes to receive compensation for their accomplishments and personal brand without violating National Collegiate Athletic Association (NCAA) limitations on player compensation. Under these rules, student-athletes are allowed to receive compensation from the use of their NIL, including endorsements, autographs, apparel, charitable appearances, training camps, and other business partnerships. However, a quid pro quo must exist for the compensation received.
In 2021, after the Supreme Court ruling in NCAA v. Alston, the NCAA first adopted its interim policy allowing college athletes to receive NIL compensation from NIL cooperatives, which are either tax-exempt organizations or for-profit entities that could be affiliated with, but operate independently from, a particular school. If the U.S. District Court approves the settlement in Grant House v. NCAA, educational institutions will be permitted to directly compensate student-athletes in certain circumstances, including revenue-sharing arrangements. This settlement also requires a clearinghouse database to report all NIL contracts over $600 and audit enforcement to determine if the NIL contracts are at fair market value. For this purpose, fair market value means that the transaction has “a valid business purpose related to the promotion or endorsement of goods or services provided to the general public for profit, with compensation at rates and terms commensurate with compensation paid to similarly situated individuals with comparable NIL value who are not current or prospective student-athletes.”1
Direct compensation by the educational institution raises challenges, including determining the most suitable payment method, how best to structure the payment, and determining whether the NIL contract is at fair market value. Additionally, educational institutions will have to consider whether to have the institution make the payments, to engage a third party (such as an NIL collective or other agency) to make the payments on behalf of the institution, or to establish a new entity to make the payment.
As college athletics increasingly resemble professional sports leagues, with potential salary caps and direct payments to athletes, questions arise regarding the tax-exempt status of the educational institutions. While the IRS previously has ruled that college athletics teams are integral to a university’s public and charitable purpose (see Revenue Ruling 67-291, Revenue Ruling 80-295, and Revenue Ruling 80-296), the evolving nature of college athletics might prompt the IRS to reevaluate these rulings. It remains to be seen how the IRS will interpret these changes.
Educational institutions also have to demonstrate that their NIL activities are secondary and incidental to their exempt purpose. Recently, the IRS issued a number of rulings, including Private Letter Ruling 202432020 and general legal advice memorandum 2023-004, providing that NIL payments to student-athletes serve a private interest rather than a charitable one and, therefore, the payments are taxable to the student-athletes.
To mitigate the risk to their tax-exempt status, institutions might use a third party to manage NIL activities. However, using a third party does not alleviate other challenges, such as valuing the payment arrangements or determining whether the total compensation paid to a student-athlete is reasonable under IRC Section 4958 or at fair market value for NCAA purposes.
Crowe observation
The IRS also has announced that it will be examining payments to student-athletes and NIL collectives. Educational institutions should anticipate ongoing questions regarding NIL payments made directly by the institution or through third parties.
Looking ahead
The introduction of NIL compensation in college athletics raises tax issues that educational institutions must navigate. Tax directors and athletic directors will need to proactively work together to address these issues. Establishing clear payment structures, determining the fair market value of cash and noncash components of a payment structure, and demonstrating the secondary and incidental nature of NIL activities to the educational institution’s charitable purpose are crucial steps to avoid noncompliance.
Educational institutions should consult experienced tax advisers to develop comprehensive strategies that align with their exempt purpose and allow the institution to comply with federal and state tax requirements.
