Most NIL collectives likely ineligible for tax-exempt status, IRS advises

An IRS Office of Chief Counsel legal memorandum (AM 2023-004) dated May 23, 2023, asserted that many name, image, and likeness (NIL) collectives likely operate for a substantial nonexempt purpose. NIL collectives, organizations created to facilitate and fund NIL deals for college student-athletes, have operated largely unregulated since they began to crop up shortly after the National Collegiate Athletic Association (NCAA) adopted its interim NIL policy in 2021 allowing them.

Student-athletes may be compensated for their NIL under the policy without affecting their NCAA eligibility (see NCAA news release (June 30, 2021)). In the wake of this decision, boosters and fans of NCAA member institutions moved to establish NIL collectives to create, facilitate, and fund NIL deals for student-athletes. Some do so via a fiscal sponsorship agreement, or as an activity or program of a preexisting Sec. 501(c)(3) organization that supports an affiliated university’s athletics department. Roughly one-third of the 250-plus NIL collectives have been granted Sec. 501(c)(3) tax-exempt status, the Chief Counsel memo stated in a footnote (citing a memo for a hearing of the House Energy and Commerce Committee, Subcommittee on Innovation, Data, and Commerce (March 27, 2023)).

Collectives operate independently of a university, and, in some cases, multiple collectives support student-athletes at a single university, the Chief Counsel memo noted. They can be thought of as a clearinghouse between donors and student-athletes, primarily facilitating and developing paid NIL opportunities for member student-athletes.

In the memo, the Office of Chief Counsel analyzed whether NIL collectives operate to further the private interests of their member studentathletes by financial means and whether these private interests are fundamental, rather than incidental, to any public good that is conveyed through these vehicles. The memo also considered whether the operation of an NIL collective furthers a tax-exempt purpose under Sec. 501(c) (3). Sec. 501(c)(3) provides in relevant part an exemption from tax under Sec. 501(a) for:

Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual.

Under the “operational test” in Regs. Sec. 1.501(c)(3)-1(c)(1), an organization may be regarded as operated exclusively for exempt purposes only if it engages primarily in activities that accomplish one or more of the exempt purposes specified above. It will not maintain Sec. 501(c)(3) exempt status if more than an insubstantial part of its activities does not further an exempt purpose. Further, an organization is operating for exempt purposes only if it serves a public interest, as opposed to a private interest (Regs. Sec. 1.501(c) (3)-1(d)(1)(ii); American Campaign Academy, 92 T.C. 1053 (1989)).

The operational test scrutinizes the purpose toward which an organization’s activities are directed, as opposed to the nature of the activities themselves (B.S.W. Group, Inc., 70 T.C. 352 (1978)). An organization could be engaged in a dualpurpose activity in which it operates for both an exempt and nonexempt purpose. However, whether a private benefit is conferred through its activities and the extent to which that private benefit overshadows its exempt purpose must be evaluated (Better Business Bureau of Washington, D.C., Inc., 326 U.S. 279 (1945)).

The operational test also requires an assessment of any private benefit conferred by an organization’s activities. Under Rev. Rul. 76-206, the private benefit must be “clearly incidental to the overriding public interest,” and purely a byproduct of the exempt activity or necessary for the overarching goal of the exempt purpose. However, a private benefit to non-insiders will not preclude an organization from exemption under Sec. 501(c)(3) if the private benefit is incidental in both a qualitative and quantitative sense.

Rev. Rul. 70-186 gives an example of a qualitatively incidental benefit (i.e., one that is not direct and intentional). In that ruling, an organization was formed to preserve a lake as a public recreational facility. While private lakefront property owners benefited from the lake’s preservation, a nonexempt activity, this was clearly incidental to the purpose of preserving the lake to be used as a public recreation facility, and it would be impossible for the organization to accomplish this exempt purpose without providing some benefit to lakefront property owners. However, the Chief Counsel memo concluded, nonprofit NIL collectives do not operate in a manner that primarily benefits the public’s interest.

To be quantitatively incidental, the private benefit must be insubstantial in amount when compared to the overall public benefit conferred by the activity. For example, a private benefit that is 90% of the benefits provided by an exempt organization would not be quantitatively incidental (Rev. Rul. 76-152).

The private benefit must be both qualitatively and quantitatively incidental. An activity that benefits private interests in a manner that is qualitatively incidental does not further exempt purposes if the benefit to private interests is quantitatively substantial. Similarly, if an activity provides a direct or intentional benefit to private interests such that it is not qualitatively incidental, it does not matter that the benefit may be quantitatively insubstantial.

Applying the operational test and private-benefit doctrine to NIL collectives, it is apparent that facilitating student-athletes’ monetization of their NIL furthers a nonexempt purpose, the memo stated. This provision of a private benefit is not incidental to, but is a fundamental part of, the NIL collective’s activities. Thus, the main objective of typical NIL collectives is to serve the nonexempt purpose of advancing student-athletes’ interests by creating NIL opportunities.

“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 Sec. 501(c)(3),” the memo stated (citing Miss Georgia Scholarship Fund, Inc., 72 T.C. 267 (1979)). As a result, student-athletes benefit financially from the opportunity provided by a collective to use their NIL, and that benefit is private and does not serve a public interest.

Many NIL collectives’ express purpose is to compensate student-athletes for activities facilitated by the collective. Consequently, it will be challenging for them to establish that any exempt purpose they undertake is quantitatively incidental to the provision of compensation to student-athletes for their NIL, the memo stated.

In addition to direct financial compensation, NIL collectives relieve student-athletes of legal, tax, financial, and consulting costs critical to participating in an NIL deal, the memo stated. Again, the payment of these costs is clearly for the private benefit of the student-athletes and does not further an exempt activity, as student-athletes themselves are not recognized as a charitable class.

While Rev. Rul. 55-587 and Rev. Rul. 67-291 establish precedent for some organizations that benefit student-athletes to receive recognition as organizations furthering an educational goal, these examples were determined to primarily benefit a public interest, and no individual was determined to privately benefit. However, as noted above, the opportunities provided to student-athletes to sell their NILs by nonprofit NIL collectives are private benefits that do not serve Sec. 501(c)(3) educational purposes. According to the Chief Counsel’s Office, “[a]bsent 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.”

Notably, the Chief Counsel’s Office also considered public statements from athletic directors, sports boosters, and other parties with direct personal or financial interests when determining the purpose behind the creation of an NIL collective. In doing so, it concluded that it is reasonable to assume that NIL collective organizers are supporters of a specific NCAA member institution and have an interest in limiting their collective’s NIL opportunities to studentathletes at their school, as opposed to a broader population of students, student-athletes, or any other group of individuals. Several NIL collectives even publicly state that they pass between 80% and 100% of all donations along to their student-athletes, thus indicating that the benefit to student-athletes is foundational to the NIL collective and that any public benefit is incidental.

While serving a private interest does not expressly disqualify an organization from being an exempt organization, the private benefit must be both qualitatively and quantitatively incidental to the organization’s public benefit. The evidence indicates that nonprofit NIL collectives serve student-athletes’ private interests, which is fundamental to their structure, and that, in most cases, any public interest is incidental, the memo concluded.

■ AM 2023-004 (5/23/23)

— Austin Arnold is a lecturer in taxation and financial literacy in the Cornell Law School; Matthew Geiszler is a lecturer in accounting in the Brooks School of Public Policy; and John McKinley is a professor of the practice in accounting and taxation in the SC Johnson College of Business, all at Cornell University in Ithaca, N.Y. To comment on this column, contact Paul Bonner, the JofA’s tax editor.