Important Clues from the IRS’s Letter on 501(c)(3) NIL Collectives

Last Updated on July 31, 2023

Disclaimer: This information is made available for educational purposes.  It provides general information and is not intended to provide specific legal advice. This information should not be used as a substitute for competent legal or tax advice from a licensed attorney and/or CPA in your jurisdiction.

NIL collectives have emerged as entities that help student athletes navigate endorsement deals and commercial opportunities arising from their NIL rights. Many collectives have chosen to organize as tax-exempt organizations under Section 501(c)(3) of the tax code, compensating student athletes for promoting and working with local, regional and even national charities such as Habitat for Humanity and Boys and Girls Club.

However, the tax-exempt status of these organizations has come under scrutiny after the Internal Revenue Service issued a memorandum in June expressing concerns regarding the tax-exempt status of the collectives.

This is admittedly not my area of law, hence the disclaimer above. However, I’ve spent the past month speaking to many attorneys and accountants who work with nonprofit entities, in addition to reading extensively on the subject, and I’m summarizing their feedback below.

Public vs. Private Interest

The main issue here is that 501(c)(3)s must serve a public interest, not a private interest. Organizations can do both, but only if the private benefit is clearly incidental to the public interest.

The crux of the 12-page memo is the assertion that 501(c)(3) collectives appear to be doing the opposite, focusing on private benefits with an incidental public benefit.

Key Factors Influencing the IRS’s Decision

The IRS’s memo challenging the tax-exempt status of these NIL collectives is based on several crucial facts. These facts shed light on the specific reasons behind the IRS’s stance and provide insight into their assessment of these organizations’ eligibility for tax exemption.

A tax news update from Ernst & Young did a good job breaking this down into a handful of key factors, which I’ve summarized below:

  1. Compensation as the Primary Purpose: The IRS emphasized that in many cases, the compensation provided to student athletes is not merely a byproduct of nonprofit NIL collectives’ activities but rather their fundamental purpose. This means that the organizations’ primary focus is on monetizing student athletes’ NIL rights and facilitating endorsement deals, rather than serving a broader charitable objective.
  2. Substantial Private Benefit: The private benefit received by student athletes from these nonprofit NIL collectives is deemed substantial compared to the overall public benefit derived from the organizations’ activities. The IRS assesses the balance between private benefit and public benefit and determines that the scale tips towards the individuals associated with the organization, raising concerns about the organizations’ tax-exempt status.
  3. Nonessential Private Benefit: The private benefit received by student athletes is seen as not being essential or necessary for the nonprofit NIL collectives to fulfill their exempt purpose. The IRS evaluates whether the private benefit is intrinsically linked to the organizations’ mission of promoting themselves or their partner charities. If the private benefit is found to be disconnected from this exempt purpose, it weakens the case for tax exemption.
  4. Additional Benefits Provided: Nonprofit NIL collectives often offer benefits to student athletes beyond mere compensation. These benefits may include working out deals with partner charities, providing services such as financial planning, tax assistance, legal advice, and personal brand development. While these additional services may be beneficial to the student athletes, they further complicate the assessment of whether the organizations primarily serve a charitable purpose deserving of tax exemption. (Although I wonder if you couldn’t successfully argue those services serve an educational purpose—see the quote below.)
  5. Non-Charitable Class: The student-athletes benefiting from nonprofit NIL collectives are not recognized as a charitable class. The IRS considers whether the individuals receiving the private benefit fall within a group traditionally recognized as charitable beneficiaries. If the beneficiaries do not fit within this framework, it raises questions about the organizations’ eligibility for tax exemption.

These facts play a significant role in the IRS’s decision to challenge the tax-exempt status of nonprofit organizations involved in NIL collectives. They underscore the IRS’s concerns regarding the nature of these organizations’ activities and the balance between private benefit and public benefit.

501(c)(3) collectives are going to need to carefully address these factors to demonstrate that they align with recognized charitable purposes and fulfill the criteria for tax exemption.

Private Benefit vs. Educational Purpose

In the memo, the IRS Office of the Chief Counsel said benefits provided to student athletes by 501(c)(3) NIL collectives is likely beyond the incidental private benefit allowed by tax law.

Student-athletes are not themselves a recognized charitable class. While the Service has previously recognized as charitable certain organizations whose activities benefited student-athletes, the rulings were based on a determination that the activities advanced education. Nonprofit NIL collectives make compensatory payments to student-athletes in exchange for services and the use of a valuable property right (NIL), which does not further educational purposes under section 501(c)(3).
IRS Memo

Specific Activities Mentioned by the IRS

The IRS memo also highlights additional factors suggesting that the primary purpose of a nonprofit NIL collective is to compensate student athletes. These are definitely things nonprofit collectives should take note of.

These factors include:

  1. Donor Communication: Communicating to donors that a significant portion of their contributions directly benefits student-athletes reinforces the notion that the organization’s main objective is compensation rather than advancing charitable purposes. Whereas it’s generally considered good form in the 501(c)(3) world to have the majority of funds going towards your mission (versus salaries and other overhead), the issue here is advertising a majority of funds going to student athletes, who themselves are not a charitable mission (unless you’re specifically serving financially distressed athletes (see the quote from the memo below).
  2. Team-Specific Compensation: Publicly indicating that all students on a particular team or position will receive a predetermined amount of money, or making it known that the collective’s intended goal is to compensate athletes, reinforces the notion that the primary focus of the organization is on providing financial benefits rather than engaging in activities aligned with recognized charitable purposes.
  3. Donor-Designated Allocation: Allowing donors to specify that their donation is intended solely for a particular athletic team without mentioning a charitable program or cause they wish to support implies that the nonprofit NIL collective primarily functions as a vehicle for channeling funds directly to student-athletes rather than supporting broader charitable initiatives.

These factors outlined in the IRS memo contribute to the overall assessment of the nonprofit NIL collectives’ primary purpose. They suggest a predominant focus on compensating student athletes rather than serving charitable objectives, raising concerns regarding the organizations’ eligibility for tax-exempt status.

Addressing these factors and ensuring transparency in donor communication and fund allocation will be crucial for nonprofit organizations involved in NIL collectives seeking to maintain their tax-exempt status.

I do think there’s an interesting phrase that followed the quote I called out above, however, that could offer some strategic realignment for nonprofit collectives seeking to retain their tax-exempt status.

“Absent 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, payments to the student-athletes are properly regarded as serving private rather than public interests.
IRS Memo

What’s Next for 501(c)(3) Collectives

The IRS’s position on the tax-exempt status of nonprofit organizations involved in NIL collectives has introduced significant uncertainties and challenges. The concerns raised by the IRS regarding the eligibility of these organizations for tax exemption call for careful evaluation and potential adjustments in their operations.

Loeb & Loeb explains in their client alert that the memo is not formal guidance and has no precedential value (although there is long-standing precedent regarding excessive private benefit already). They expect that before issuing any formal guidance, the IRS will conduct reviews of current nonprofit collectives. These reviews could take the form of mailed questionnaires or more targeted examinations and might result in a formal report summarizing findings and actions taken or instead focus on individual examinations.

While some organizations are concerned about the potential impact on their fundraising efforts and financial operations, others are considering alternative strategies to navigate the changing landscape. Most experts in tax law and accounting I spoke with expected any funds raised prior to the memo to remain tax-exempt and without penalty, while funds raising going forward might be more problematic if operations continue without any regard to the guidance in the memo.

“I would expect that historic donations to collectives will not need to be refiled or changed,” said Ken Kurdziel, CPA, partner at James Moore & Co., in the Journal of Accountancy.

The article in the Journal of Accountancy goes on to point out that contributions can likely be safely deducted until the IRS publishes an organization on the IRS Auto-Revocation list. However, collectives might want to add language to their receipts that say something like, “Consult with your tax professional regarding the deductibility of this contribution.”

As 501(c)(3) collectives navigate this complex landscape, it is essential to proactively address the IRS’s concerns and demonstrate their alignment with recognized charitable purposes. The outcome of this ongoing debate will have far-reaching implications for collectives and the broader NIL marketplace.

For more information on tax issues both 501(c)(3) and for-profit collectives should be aware of, check out the News & Brews podcast below from James Moore & Co.

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