NIL organization denied tax-exempt status

In Letter Ruling 202428008, the IRS denied tax-exempt status for an organization formed to facilitate arrangements by which student-athletes are compensated for their name, image, and likeness (NIL), because it was not exclusively operated for an exempt purpose and it provided a private, rather than public, benefit to the athletes. The ruling, released in July 2024, follows at least two similar letter rulings earlier this year and a 2023 Chief Counsel legal memorandum concluding that certain NIL-promoting organizations are unlikely to be deemed to serve an exempt purpose.

Facts: The applicant organization’s articles of incorporation state that it was organized exclusively for “charitable, religious, educational, and scientific purposes under [Sec.] 501(c)(3).” The articles also specify that upon dissolution, any assets will be distributed to another Sec. 501(c)(3) exempt organization or to the federal government or a state or local government for an exempt purpose.

The organization identified itself as a Type I supporting organization of another organization identified only as D, a Sec. 170(b)(1) (A) (vi) public charity. A Type I supporting organization must be operated, supervised, and/or controlled by its supported organization.

An agreement between the organization and D stated that it was in D’s best interest to “create a separate facility for accepting and administering charitable contributions intended to leverage the [NIL] of high school or college athletes” in support of various charitable endeavors while complying with federal and state law, along with rules of the National Collegiate Athletic Association (NCAA), the National Association of Intercollegiate Athletics (NAIA), the National Junior College Athletic Association (NJCAA), the conferences within these association, or any other similar association. The NCAA in 2021 ended its prohibition of NIL compensation to student-athletes after states passed legislation allowing it (see “Name, Image, Liability,” JofA, March 2023).

The specific activity and function of the organization is “to facilitate arrangements in which grantmaking through D to various public charities” may involve leveraging college or high school student-athletes’ NIL through “public appearances, social media, and the like.” These appearances may result in compensation to the athlete, in compliance with federal and state law, as well as rules promulgated by the athletic associations designated above. The compensation paid to these athletes would be paid directly by the public charity and not the organization itself.

The organization would receive and manage the contributions for these activities and assist in coordinating the relationship between the student-athlete and the public charity that will benefit from the NIL activities, while exercising due diligence to ascertain that: (1) the compensation is commensurate with services actually rendered, “not in excess of the value the athlete brings to the arrangement”; (2) the student-athlete’s opportunity to monetize their NIL does not violate federal or state laws or association rules; and (3) the organization receiving NIL services and/or grant money is qualified under Sec. 170(b)(1)(A)(vi) or 509(a)(2) and serves the exempt purposes consistent with D, which include “promoting the financial literacy of student athletes.”

Financially, the organization received or planned to receive a certain percentage of its support from gifts, grants, and contributions and the rest from gross investment income. Its expenses would include payments to student-athletes for use of their NIL and for administration.

Discussion: Sec. 501(c)(3) allows for exempt status if an organization is organized and operated exclusively for charitable, educational, scientific, and certain other designated purposes. No part of the organization’s net earnings may benefit a private shareholder or individual. The organization must also be organized and operated exclusively for one or more of the purposes specified in Sec. 501(c)(3) (Regs. Sec. 1.501(c)(3)- 1(a)(1)). If an organization fails to meet the organizational or operational test, it will not qualify as tax-exempt. Also, an organization will not be classified as tax-exempt if more than an insubstantial part of its activities does not further an exempt purpose (Regs. Sec. 1.501(c)(3)-1(c)(1)). 

The letter ruling determined that the organization was not operated exclusively for exempt purposes within the meaning of Sec. 501(c)(3). A substantial part of the organization’s activities was in “furtherance of facilitating arrangements” where grantmaking through D to public charities may involve the leveraging of the NIL of college and high school student-athletes. Even one substantial nonexempt activity can preclude exemption (Better Business Bureau of Washington, D. C., Inc., 326 U.S. 279 (1945)). Since providing funding for NIL opportunities was substantial and “not in furtherance of an exempt purpose,” the IRS ruled that the organization was not operated exclusively for exempt purposes in accordance with Regs. Sec. 1.501(c)(3)-1(c)(1).

To meet the operational test, an organization may not operate in a way that benefits individuals outside the charitable class if those individuals are served more than an insubstantial amount. The burden of proof rests with the organization to show that any private interest is not substantial (Regs. Sec. 1. 501(c)(3)-1(d)(1)(ii)).

According to the ruling, the student-athletes were not limited to a charitable class since they “do not fit into the categories contemplated in the regulations such as the poor or underprivileged” (Regs. Sec. 1. 501(c)(3)-1(d)(2)). The activities “appear to substantially inure to the private benefit of these student athletes.” The ruling further analogizes this situation to Rev. Rul. 76-152, where sales proceeds of art exhibited by an organization “formed by art patrons to promote community understanding of modern art trends” directly benefited the private interests of the artists, making the organization’s provision of benefits to private interests more than incidental to the other activities the organization performed.

Therefore, to be “organized or operated exclusively for exempt purposes,” the activity must serve a public rather than private interest, based on the facts and circumstances and the purpose toward which the activities are directed and not the nature of the activities themselves (B.S.W. Group, Inc., 70 T.C. 352 (1978)).

A private benefit results from an organization’s activities if the benefit of the activities is conferred on an “individual, group of individuals, or a separate entity by receipt of goods, services, income, or assets from the organization’s activities,” the letter ruling stated. In other words, if beneficiaries are specifically identified, like the student-athletes in the current situation, a private interest is served. However, if the activity serves both a public and private interest, the primary benefit is to the public if the private benefit is “both incidental in the quantitative and qualitative sense” (American Campaign Academy, 92 T.C. 1053 (1989)).

To be qualitatively incidental, the private benefit must be a necessary byproduct of the activity benefiting “the public at large” and accomplishing the organization’s exempt purpose. For example, in Rev. Rul. 70-186, an organization’s preservation of a lake for public purposes was impossible to accomplish without benefiting the private interest of the property owners. However, here, the organization did not demonstrate how making grants to “partner charities for payment to student athletes is necessary to provide benefits to the public” or how the organization’s activities furthered D’s exempt purpose. The organization was not like the one in Rev. Rul. 70-186 because the private benefit (compensation) to the athletes was not a byproduct of the organization’s activities. Instead, the activities of providing services to other charities depended on the athletes’ participation in the organization’s program.

To be quantitatively incidental, the private benefit must not be “substantial relative to the public benefit,” and, based on the facts and circumstances, the public benefit “from the organization’s activities must outweigh any individual benefit.” In Rev. Rul. 76-152 (described above), the direct economic benefit provided to the artists was a substantial private benefit that outweighed the “public benefit of promoting the arts.” Here, the public benefit provided to the other charities is outweighed by the direct benefit the athletes receive “through compensation for the use of their NIL,” the IRS stated. Also, the funds donated to other charities substantially benefit a private interest since they are “earmarked for specific athletes.”

The organization sought to distinguish itself from NIL collectives that were the subject of Chief Counsel Memorandum AM 2023-004 (see “Tax Matters: Most NIL Collectives Likely Ineligible for Tax-Exempt Status, IRS Advises,” JofA, Sept. 1, 2023)), although it admitted that some of its partner charities probably would be collectives. Any compensation the student-athletes receive would be a “means to promoting the ends these charities are pursuing, not the end itself.” According to the organization, its activities’ primary purpose would be to leverage the student-athletes’ rights of publicity in service of raising public awareness of, and thereby increasing public engagement with, its partner charities. Making a payment to a student-athlete in this situation, the organization reasoned, is similar to a university professor or honors student receiving a stipend or honorarium for conducting a workshop or speaking at a fundraising dinner.

In addressing the qualitative private-benefit measure, the organization further contrasted itself from an NIL collective in that it would provide “a certain amount of specialization and expertise that is required to safely navigate the NIL space.” It further maintained that a proper exempt function could be served by an organization whose activities consisted of “properly handling gifts in compliance with applicable laws and NCAA rules and to facilitate compliant NIL payment.” This, the organization claimed, was the space it would operate in.

In addressing the quantitative private-benefit measure, the organization stated that Chief Counsel Memorandum AM 2023-004 does not flatly conclude that an expectation to commit a large share of gross revenue to compensating student-athletes for services actually rendered is per se a more than insubstantial nonexempt purpose.

Conclusion: The IRS ruled that the entity was formed for the purpose of compensating student-athletes for use of their NIL. The organization, in the IRS’s view, also did not further “a charitable purpose or serve a charitable class as described in [Sec.] 501(c) (3) ” and operated for “substantial non-exempt purposes,” while providing a private benefit for these athletes. Therefore, it was denied tax-exempt status, and, consequently, donations made to the organization are not deductible by the donors.

This is at least the third IRS letter ruling this year (see also Letter Rulings 202414007 and 202416015) involving organizations seeking tax-exempt status for activities involving student-athlete NIL deals. Even though the facts were different in each ruling, their common conclusion was that seeking tax-exempt status for compensating student-athletes for NIL fails to operate exclusively for an exempt purpose while providing substantial private benefits to the athletes.

■ IRS Letter Ruling 202428008

— John McKinley, CPA, CGMA, J.D., LL.M., is a professor of the practice in accounting and taxation within the SC Johnson College of Business; Austin Arnold, CPA, is a lecturer in taxation and financial literacy within the Cornell Law School; and Jordan Fishman is a student in the Nolan School of Hotel Administration, all at Cornell University in Ithaca, N.Y. To comment on this column, contact Paul Bonner, the JofA’s tax editor.