501c3 Foundations in NIL Operations: What Did the IRS Say?

August 17, 2023

Written by: Ashley Alford

The advent of Name, Image, and Likeness (NIL) freedom for student-athletes has ushered in a new era of opportunity, with over 250 collectives and hundreds of thousands of student-athletes signing NIL contracts. These collectives, some of which are 501(c)(3) organizations, play a crucial role in supporting collegiate athletes through collaborations with local businesses and community members, offering exposure and networking opportunities to enhance athletes’ brand value. However, the classification of being a 501(c)(3) collective can be complex, and recent legislation has highlighted the importance of affiliating directly with universities to maintain tax-exempt status.

Several universities have made headlines with their NIL fundraising branches, setting a precedent for affiliating 501(c)(3)s with the actual universities. Such collaborations provide distinct advantages, including direct scholarships and backing from credible institutions. On the other hand, private organizations offer networking opportunities with other brands and potential larger budgets with fewer university regulations.

One aspect that garners significant attention is the disclosure of independent contractors, particularly student-athletes engaged in NIL services. These filings provide insights into the payments made to contractors and the number of contractors compensated over $100,000 by the collective. Additionally, financial condition disclosures in the form of balance sheets offer followers the ability to assess the collective’s assets, liabilities, and overall financial health.

However, the IRS has raised questions about whether NIL collectives formed as 501(c)(3) organizations should maintain their tax-exempt status. These collectives have been scrutinized by the IRS due to a perceived imbalance between their public benefits and the advantages they offer to individual student athletes. It emphasizes that to qualify, organizations must operate exclusively for exempt purposes such as charity or education, with their activities primarily furthering these objectives. The key consideration is whether the activities primarily serve public interests rather than private interests. The IRS memo (found here) highlights that organizations must prove they are not operating for the benefit of private interests.

The operational test, “designed to ensure that an organization’s resources and activities are devoted to furthering those exempt purposes” is central to determining an organization’s eligibility for tax-exempt status. It hinges on whether an organization’s activities primarily advance an exempt purpose, and whether these activities serve public interests. The memo clarifies that a single nonexempt purpose, if substantial, can negate exemption, regardless of the number of exempt purposes.

The IRS underscores that the nature of activities is secondary to the purpose they serve. It acknowledges that activities can serve dual purposes but emphasizes that if a substantial nonexempt purpose is evident, exemption can be denied.

The memo explains that assessing private benefit is crucial. While occasional benefits that are incidental to an exempt purpose may not disqualify an organization, private benefits must be clearly incidental to the overriding public interest. Specifically, “to be qualitatively incidental, the private benefit must be a byproduct of the exempt activity or a necessary concomitant to the accomplishment of the exempt purpose.” Qualitatively incidental private benefits arise from exempt activities, while direct benefits to specific individuals are not qualitatively incidental. 

Quantitatively incidental private benefits must be insubstantial compared to the overall public benefit conferred by an activity. The memo references a case where an organization retained 10% of proceeds from sales and concluded that the private benefit was not quantitatively incidental due to its substantial nature.

The IRS applies these principles to nonprofit NIL collectives. It argues that private benefits to student-athletes are not byproducts of exempt activities but integral to the organization’s goals. It asserts that these benefits are not qualitatively incidental, as they are directed to a limited noncharitable class and are substantial rather than incidental.

The memo highlights the role of nonprofit NIL collectives in student-athlete retention and recruitment. It contends that these collectives often serve the private interests of student-athletes more than incidentally, both qualitatively and quantitatively. The IRS concludes that many nonprofit NIL collectives don’t qualify for tax-exempt status because the private benefits provided to student-athletes are not incidental to any exempt purpose.

The memo furthered this point by saying, “in assessing the benefit to student-athletes from a collective’s activities, this Office also finds significant the numerous statements by athletic directors, boosters, and others on the importance of NIL collectives, including nonprofit NIL collectives, to the retention and recruitment of student-athletes.”

In essence, the IRS memorandum suggests that many nonprofit NIL collectives may not qualify for tax-exempt status under section 501(c)(3) due to the substantial private benefits they provide to student-athletes, which do not align with the criteria of being incidental to an exempt purpose.

Navigating the Path Forward: Recommendations and Considerations for Nonprofit Collectives

Kristi Dosh, founder and CEO of Business of College Sports, acknowledged that going forward Collectives will need to keep some things in mind. Her recommendations for Collectives included 

  • Grants and Financial Aid

Student-athletes often rely on grants and financial aid to pursue their education. Engaging in profitable NIL ventures could inadvertently impact their eligibility for need-based aid. As income increases, the potential for reduced aid or even ineligibility for grants arises. It’s crucial for athletes to assess the potential trade-offs between NIL earnings and financial aid they currently receive.

  • Title IX Considerations

Title IX, a federal law ensuring gender equity in education, applies primarily to universities and educational institutions. However, when athletes engage with outside groups for NIL ventures, the situation becomes more nuanced. NIL organizations need to be aware of how these collaborations align with the principles of Title IX. Ensuring fairness and compliance with gender equity provisions remains important, even in external partnerships.

  • Tax Dependency and Family Taxes

As student-athletes embrace NIL opportunities, the possibility of significant earnings emerges. If an athlete generates substantial income, they may no longer qualify as a dependent on their family’s tax return. This shift in tax status can affect both the athlete’s tax liability and the family’s financial dynamics. Athletes should consider these implications and work with tax professionals to navigate this new territory.

  • Maintaining Nonprofit Status

When athletes partner with 501(c)(3) organizations for NIL ventures, both parties must ensure that activities remain aligned with the nonprofit’s mission. The IRS closely scrutinizes nonprofits to ensure they are serving charitable purposes rather than primarily benefiting individuals. Athletes and organizations must collaborate transparently to demonstrate that these ventures uphold the nonprofit’s mission while providing benefits to both parties.
In conclusion, as the world of NIL in college sports continues to evolve, the role of 501(c)(3) organizations in managing finances and facilitating NIL operations becomes increasingly critical. Transparency, compliance, and proper financial management are paramount to ensure that student-athletes and their respective universities benefit from this newfound opportunity while maintaining tax-exempt status and adhering to regulatory requirements. More information about the subject from Dosh can be found here.