By: Todd Kesterson of Kaufman Rossin and Alyssa R. Wan of Fowler White
As Published In The Daily Business Review
As more donor groups have formed name, image and likeness (NIL) collectives as not for profit entities, the Internal Revenue Service (IRS) recently released guidance that effectively puts the brakes on the ability of these entities to collect tax-deductible donations from supporters. This guidance also raises compliance concerns for NIL collectives and possibly other charities.
History of NIL Collectives in College Sports
A college athlete is permitted to be compensated for the use of the athlete's name, image and likeness due to the NCAA's adoption of its NIL policy in 2021. Following this policy, special types of entities referred to as "NIL collectives" have been formed in order to facilitate payments to athletes as well as strengthen bonds of the alumni fan base to a particular university. An NIL collective is an entity that receives contributions from donors and then uses those contributions to pay an athlete in exchange for the use of the athlete's name, image and/or likeness in various types of activities.
Some NIL collectives have obtained tax-exempt status with the IRS and are recognized as charitable organizations, while others have been established as programs of existing charitable organizations that support a university. These IRS approvals are generally based upon the NIL collectives supporting the mission of existing charities. For example, an athlete may attend a partner charity's fundraising event to raise the profile of the event and the charity, or autograph memorabilia for the charity to sell, all at no cost to the charity. These activities benefit the charity, and the athlete is paid through tax-deductible donations raised by the charitable NIL collective. Other NIL collectives have not sought tax-exempt status with the IRS and are operating as for profit organizations.
Since these charitable NIL collectives have been formed, some observers have questioned whether or not they in fact qualify as tax-exempt organizations. The IRS has responded in a recent memorandum that states many NIL collectives “are not tax exempt” because they provide substantial private benefits (payments to athletes), which are not necessary to furthering the stated charitable mission of the collective. While this memorandum is directed toward NIL collectives, the legal principles explained in the memorandum may apply to any charitable organization that engages in activities that provide a private benefit.
Applicable Tax-Exempt Status Requirements
The key requirement for any charitable organization is that it is organized and operated exclusively for one or more tax-exempt purposes, meaning that it operates substantially for the public benefit rather than for the private benefit. The private benefit restriction is not limited to insiders; it also extends, for example, to a designated class of individuals who are not recognized as a charitable class or to for profit entities. Further, operating for the public benefit does not mean that all types of private benefits are prohibited.
All of these legal principles are interpreted by the tax law, permitting some charitable organizations to engage in certain non-charitable activities or to enter into service agreements benefitting private persons, while at the same time prohibiting others, all based upon the application of these principles by the IRS and the courts under a diverse range of circumstances. Because of the factual nature of these legal principles, in the event of an audit a charitable organization may be surprised by the IRS' view of the organization's operations and activities.
For example, in the case of a charitable NIL collective, the collective may, in fact, be furthering one or more tax-exempt purposes. As a result, those operating or benefitting from the collective may believe that it is properly operating in compliance with the tax law. However, furthering a tax-exempt purpose does not necessarily mean that the NIL collective is in compliance with the tax law because that is not sufficient to show that the collective is operating exclusively for tax-exempt purposes and for public benefit.
The IRS memorandum explains that the overarching principle is to consider "the purpose towards which an organization's activities are directed, and not the nature of the activities themselves." This translates to a two-part test in which the collective would need to demonstrate that any private benefit resulting from activities of the collective is "incidental," both (i) qualitatively (as a byproduct of the exempt activity and not direct or intentional) and (ii) quantitively (insubstantial in comparison to the public benefit).
Further, the IRS memorandum itself demonstrates the challenge in applying the "quantitatively and qualitatively incidental" test by citing to numerous IRS rulings and court opinions covering a wide range of factual circumstances involving charities operating art galleries, preserving the environment, training individuals for careers in political campaigns, publishing religious books, and others; none of the rulings or opinions dealt with an NIL collective. Ultimately, in the memorandum, the IRS concludes that “[a]n organization that develops paid NIL opportunities for student-athletes will, in many cases, be operating for a substantial nonexempt purpose—serving the private interests of student-athletes—which is more than incidental to any exempt purpose furthered by the activity.” Therefore, these NIL collectives will often not be tax-exempt.
Importantly, the IRS memorandum does leave open the possibility that some charitable NIL collectives may be operating in a manner that is compliant with the laws applicable to tax-exempt organizations. Although the memorandum is not legal precedent, it expresses the position of the IRS at this time with respect to NIL collectives and sets forth legal principles applicable to other charitable organizations with activities that result in a private benefit. Additionally, Bloomberg recently reported that certain senators have requested that the IRS publish formal guidance in this area and have introduced legislation prohibiting charitable deductions for payments made to athletes and recruits.
The Future of Charitable NIL Collectives
It seems likely that the IRS will be reviewing applications by NIL collectives for tax-exempt status with greater scrutiny than in the past as well as reconsidering, and possibly revoking, the exempt status previously granted to NIL collectives. Generally, the revocation of tax-exempt status is retroactive. However, the IRS memorandum specifically states that it may be appropriate in at least some cases for the IRS to exercise its discretion not to apply a revocation retroactively. Avoiding retroactivity would usually require the NIL collective to make a written request for relief to the IRS pursuant to prescribed procedures. The good news for donors is that, generally, the IRS will not disallow deductions for contributions made to an organization on or before the date the IRS publishes the notice of revocation, even if the contribution was made after the effective date of revocation.
Charitable NIL collectives or other charities operating with some private benefit may want to seek legal advice in reviewing organizational documents, the tax-exempt application filed with the IRS, corporate books and records, and operations and activities. Some of these organizations may even consider restructuring activities or altogether restructuring to a for profit organization.
The tax law in this area is complex and ever-evolving. If you have questions regarding forming and operating charitable organizations, dissolving or restructuring charitable organizations, or are considering making charitable gifts to an NIL collective or other organization, consider reaching out to professional advisors with expertise in tax law and accounting.
Disclaimer: This article is for educational and informational purposes only and does not constitute tax or other legal advice. The tax law imposes strict requirements that must be satisfied in order to permit an income tax charitable deduction when a charitable gift is made, and also limitations in certain cases, all of which are outside the scope of this article.
Todd Kesterson is a principal in the Miami office of Kaufman Rossin, one of the top CPA and advisory firms in the United States. He leads the firm’s Family Office Services practice and Private Client Industry Group, with a focus on providing sophisticated accounting, tax, and business consulting services to high-net-worth individuals, family offices, and their closely held businesses and not-for-profits. He can be reached at email@example.com and 561-620-1725.
Alyssa R. Wan is a shareholder in the Miami office of Fowler White Burnett, P.A. She practices in the Tax and Trust & Estates groups and serves as a Co-Vice Chair of the Florida Bar Charitable Planning and Exempt Organizations Committee (Real Property, Probate and Trust Law Section). Alyssa can be reached at firstname.lastname@example.org and 305-789-9272.