NIL 501(c)(3) Collectives Beware: The IRS is Watching
The world of name, image, and likeness (NIL) continues to change with forces beyond federal law, state law, or NCAA bylaws: enter the IRS. The Office of the Internal Revenue Service’s Chief Counsel has announced, citing numerous supporting revenue rulings and tax cases, in a non-precedent setting memo that non-profit NIL collectives are not tax exempt because they fail to satisfy IRS regulations, which require such benefits that any student-athlete receives from a non-profit collective to be indirect and incidental, both qualitatively and quantitatively, from any private interest or purpose. The memo calls into question the deductibility status of contributions made by donors to such collectives.
For historical reference, the NCAA adopted an interim NIL policy in July 2021 (the Interim Policy), allowing student-athletes to receive compensation for the commercial use of their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, including state laws and regulations. Since the adoption of the Interim Policy, many organizations, generally referred to as “collectives,” have been established by boosters and fans of specific university’s athletic programs to help generate funds for NIL deals for student-athletes.
NIL collectives generally operate independently of the affiliated university, and increasingly, many universities have multiple NIL collectives that seek to support a university’s student athletes. Operating separate and distinct from universities and their athletic departments, many of the NIL collectives have been formed as nonprofit entities under state law and have applied for and received preliminary recognition of tax exemption under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended (“Code”). Code Section 501(c)(3) provides tax exemption under section 501(a) for organizations organized and operated exclusively for one or more of the exempt purposes set forth in section 501(c)(3).
In Treas. Reg. § 1.501(c)(3)-1(c)(1), an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities that accomplish one or more of the exempt purposes specified in section 501(c)(3). An organization will not be so regarded as tax exempt if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.
In addition, Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii) provides that an organization is not organized and operated exclusively for exempt purposes unless it serves a public rather than a private interest. To meet this requirement, an organization must establish that it is not organized or operated for the benefit of private interests, such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.
To be described in Code Section 501(c)(3), an organization must be organized and operated exclusively for one or more exempt purposes (charitable, educational, religious, etc.). This operational test is designed to ensure that an organization’s focus, resources, and activities are devoted to furthering those exempt purposes. Whether an organization is operated exclusively for exempt purposes depends on the facts and circumstances, and the organization bears the burden of proof to establish that it is not operated for the benefit of private interests. The current IRS memo declared and concluded that “an organization that develops paid NIL opportunities for student-athletes will, in many cases, be operating for a substantial non-exempt purpose – serving the private interests of student-athletes – which is more than incidental to any exempt purpose furthered by the activity.”
The impact of this IRS announcement could be substantial. As reported by SI.com reporter Ross Dellinger, dozens of the more than 200 collectives that have been created among the 131 FBS schools were preliminarily granted exempt 501(c)(3) status based upon creation of the collective and their IRS filings. These collectives have received millions of dollars from donors who believe that these contributions are tax-deductible donations. While the non-profit status of these collectives has been used to stimulate contributions to the collective for use with NIL opportunities for student-athletes, the ultimate status of these contributions is yet to be determined. Will these tax-exempt collectives stop receiving contributions? Will the IRS deny the deductible status of the collective contributions already made? Will the IRS penalize these donors for this potentially inappropriate tax deduction? Will the IRS revoke their tax exempt status?
As several for-profit collective organizations have stated, associating or having a partnership with a 501(c)(3) is one option, but in light of this recent IRS position, holding yourself out as a recognized 501(c)(3) might be problematic. Under these developing circumstances, collectives, their donors, and affiliated universities need to carefully consider the possible impact that loss of tax exempt status will have upon them.
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