Guest Post: Here's why the IRS doesn't think most NIL collectives can be 501(c)3s
Here's what the law says, according to an expert
Good morning, and thanks for spending part of your day with Extra Points.
This should not be a shocking revelation to anybody who reads Extra Points. We expressed skepticism in this idea way back in 2022, as have many accountants and professors we’ve spoken to over the last year.
But why? To better explain how the current law works, and why the operational model that many NIL collectives are using is unlikely to be in compliance with that model…I reached out to an expert.
Samantha Bowie is a law student at the Sandra Day O’Connor College of Law at Arizona State University. She will graduate with her Juris Doctor and Master of Sport Law and Business degrees in 2024 and also holds a Master of Education from the University of Oklahoma and a Bachelor of Science in Sport Industry from The Ohio State University. She has experience working in all three athletic departments. She can be reached at [email protected].
I’ll turn the time over to Samantha.
This newsletter is not legal advice.
Name, image, and likeness (NIL) collectives can drastically change the lives of college athletes for the better. They can also serve as a positive force in the community. But the charity NIL collective is a misnomer. They may provide some charity, but like a business offering matching gifts or paid time off for charitable service, they themselves are not charities.
The IRS released a Friday memo stating that collectives are not 501(c)(3) tax-exempt charities. The memo is not an official position that requires charities and others to follow it, but it is persuasive, and collectives should at the very least pause donations for the time being and consult a tax lawyer, especially since there’s also a bipartisan Congressional bill floating around with the same opinion.
If you have never read an IRS memo but want to know what is happening, here is the hopefully less legalese version.
Internal Revenue Code (IRC) § 501(c)(3) requires organizations to meet a specific set of criteria. Other tax-exempt organizations unquestionably provide a public good (e.g., veterans’ organizations and cemetery companies), but only 501(c)(3)s allow a tax deduction for the donor.
A 501(c)(3) must meet 4 criteria. I think of these as a slalom race—you must clear all the gates to be a finisher. If you miss one, you are DQ’d from being a 501(c)(3).
They must be organized and operated exclusively for one of the exempt purposes stated in § 501(c)(3) (collectives fall in the general “charitable” category, not educational even if they provide some education modules).
No part of their net earnings may benefit a private shareholder or individual.
A substantial amount of their activities may not be related to lobbying.
They cannot participate in political campaigns.
We’re focused on the first two.
In the past decade, the IRS has placed less emphasis on applications for § 501(c)(3) tax-exempt status in order to address a backlog in applications and allow charities to fix deficiencies at a later date. In the application, an organization just needs to explain its proposed operations and show that its articles of incorporation is limited to and “organized for” one or more exempt purposes. If you poke around on a state’s nonprofit search, you’ll notice that most organizations literally copy and paste the statute.
What the IRS really cares about is if they are operated for the purpose (since it’s easier to see than in an application), but it also means that the 40 collectives who have received favorable letters of determination are legitimately tax-exempt (about 50 claim they operate as a nonprofit and are incorporated as such in their states).
A quick word on terminology. A tax-exempt organization is a federal designation. A 501(c)(3) is a specific form of a tax-exempt organization and is the only one where the donor also gets a tax benefit. There are 12 501(c) options, and a collective may fit into one of them, but that’s another newsletter. A nonprofit is a state designation. An organization can be a nonprofit without being tax-exempt, but not vice versa. I use 501(c)(3) to avoid confusion, but most people use nonprofit to include federal tax exemption.
The determination of a collective as a 501(c)(3) is not final and can be overturned by looking at actual operations using an audit (which can be triggered by a taxpayer complaint, random audit, or discrepancies in yearly Form 990 disclosures). Below is what an audit would uncover.
Anyone can say they are a charity, but operating like one can be a different story. Any activity a collective does that is not in furtherance of an exempt purpose and is more than insubstantial will end its 501(c)(3) status.
Most collectives lead with the fact they are primarily focused on college athletes receiving NIL deals, stating a purpose like “We benefit our school’s athletes through NIL opportunities and use their NIL platform to work with community charities.” Lurking underneath these ostensibly charitable purposes is the need to recruit and retain elite college athletes to stay competitive (and some flat-out say that). This is not an exempt purpose and is a significant part of these collectives’ organizations. That in and of itself makes them not charities.
The description of Wildcat NIL (Kansas State) focuses on the NIL benefit of the collective without mentioning the “charitable” aspect. The call to action hammers home why the collective is important, and it’s not because Manhattan charities need more support.
It’s not just collectives supporting schools in the CFP that are twisting the “charitable” aspect into a recruiting call to action. Here are some passages from a collective supporting athletes at Temple.
But what about collectives who can twist themselves into a statement of purpose that sounds legitimate like “We partner with selected charities that can benefit from student-athletes' promotion of their charitable work and events.”? This is still not enough, as once a collective has a presumably exempt purpose, it must operate in a way that accomplishes its exempt purpose.
The Hokie Way is an example of a collective that highlights the charity aspect, but it otherwise operates exactly like the collectives above in that it is a very efficient way to distribute NIL cash and give donors a tax write-off.
The IRS has said that an organization that hired individuals to work a concession stand and whose profits were donated to charities was not itself a charity but rather acted as a professional fundraiser. The workers were not volunteering to run the stand; they were being paid to do so. This is exactly what a college athlete is doing.
No matter how much they may align with the mission of the charity, they are not volunteering and will not receive a donation form at the end of their shift. Instead, they will receive a Form 1099 from the collective to pay their own taxes. I’ve only come across one or two collectives who direct their money to the charity earmarked for the athlete. In every other instance, no money is actually being given to the real charity, only exposure or time.
Collectives state the service they provide allows charities to have celebrity college athletes speak and mingle at events, which will increase donations and visibility in the community, an opportunity most charities could not afford.
But when the only purpose of a collective is to collect donations, select college athletes, and find a charity for them to promote, they are not themselves fulfilling a charitable purpose. Below-cost services to the charity are only a secondary perk of being able to pay college athletes.
In fact, they are paying well above fair market value, and the value is determined by the value of the athlete’s athletic talents, not their ability to benefit the charity, even if those may be related to each other. They are simply redistributing donor funds to college athletes for their personal use in exchange for attending charity events and posting on social media.
“Market value” for charities is not the capitalistic “market value” the NIL Industrial Complex has been using as an excuse for paying college athletes whatever they want. A business can pay whatever they want, call it “market value,” and move on without trying to prove it to the IRS. The IRS cares about reasonable compensation which leads to the next prong.
If determining whether a collective has an exempt purpose and whether they operate in furtherance of it is too confusing, inurement of benefits to a private individual may be easier to pinpoint. Think of it as the NCAA’s extra benefits rule, but you lose your tax status instead of losing eligibility.
The IRS looks at private benefits to determine whether the organization is serving a public or exempt purpose under § 501(c)(3). Benefits must be distributed to a charitable class. A charitable class is the group of people the charity serves, and this group must both be indefinite and in need of the organization’s charitable purpose. The charity must also further a legitimate charitable purpose with controls that the individuals who are receiving funds accomplish the stated purpose such that receiving the benefit would be a public good.
Collectives are, in effect, declaring that college athletes as a whole need charity solely because they are college athletes. Since college athletes are the group receiving charitable funds, they must possess charitable characteristics as a group. Some college athletes undoubtedly come from backgrounds contemplated by the statute, but collectives have not stated that their purpose is to give money to college athletes from disadvantaged backgrounds so that they can focus more time on academics and athletics.
The IRS memo concurs that college athletes as a group are not a charitable class. Athletic Department foundations receive their tax-exempt status from the advancing education portion of the statute or as state entities (which is why a foundation like the 12th Man Fund should be very careful about its season ticket sales).
Nor is that enough to operate for an exempt purpose. Collectives must also choose athletes in a nonselective manner, eliminating the safe harbor for most collectives since they determine compensation based on the value of the athlete’s NIL and value to the team.
Collectives that pay the same amount of money to an entire team could potentially meet this requirement because they provide money to everyone in the charitable class (think college food bank that allows all students without proof of income), but, again, think of slalom gates. These collectives may be nonselective, but is the whole team composed of a charitable class? And is giving cash actually helping solve the identified societal issue? Each layer adds new complexities that must be satisfied. The purpose of the selection determines whether there is a charitable class. A collective seeking to serve multiple teams, but only giving money to football and basketball and one volleyball player or giving to football, basketball, and baseball at different amounts is selecting participants based on athletics profitability and serving the purpose of winning teams.
Consider a collective model, one in which the collective’s principal activity is showcasing the speaking talents of unknown but promising local athletes. All of the athletes’ speeches are available for a price set by the athlete. Under this arrangement, when an entity wants to work with an athlete, the collective retains a small percentage of the speaking fee to cover costs and gives the athlete the remaining percent.
This pared-down explanation was created using an example of an impermissible private benefit contained in the § 501(c)(3) Treasury regulation. The regulation goes on to explain that the principal activity described serves the private interests of the person providing the work. The direct benefits are substantial and more than incidental to the stated purpose. Collectives are running a talent agency, and no other agency acting in this way is a charity.
The payment of excessive salaries is also a private benefit to an individual. Think about any nonprofit scandal when you find out the CEO is getting $500,000 and a private jet while sick kids need help. The athletes in this situation are the employees, not the charitable recipients.
Excessive compensation is determined by the job function performed. It’s hard to pin down, but a collective should be concerned if an athlete were to make more than, say, a very good professional speaker that speaks at charitable events or a pro athlete who attends events. Also, as shown above, excessive salary is not the only way a private benefit is shown; it’s just a shortcut to the charity losing 501(c)(3) status.
For example, the new Hail! Impact Collective at the University of Michigan is paying football players $40,000 a year for 24 hours of community service. That’s $1,666 an hour. Or THE Foundation paying $550,000 to four football athletes in exchange for public appearances. Meanwhile, Matador Club (Texas Tech) is getting a steal at $25,000 per football athlete for undisclosed charitable promotion.
Some charity work is done, but the driving factor of these salaries is not the benefit to the charity but rather the cost of attracting college athletes to an institution. There is value to the NIL of a college athlete being used for a charity, but the excessive payment for that NIL is not charitable and will make a 501(c)(3) lose its tax-exempt status.
THE REAL COLLECTIVE CHARITIES
Like any good soon-to-be (hopefully) lawyer, I am required to tell you that “it depends.” A collective could be a legit 501(c)(3) charity, and I think a couple are. For a collective to stay a charity, it helps if they have a narrowly tailored application process to better show a desire by the college athlete to participate in charitable work and to help define the class of individuals being served through the program. Collectives also need to select athletes based on criteria like need, ability to serve the charity, and stated interest, among others, but not including athletic ability (bonus: that helps with NCAA violations). Another avenue is creating an athletics arm of an existing charity. Charities that serve the business community might be legitimately helped by having college athletes partner with them, but adding an athletics fund must further that charity’s exempt purpose.
A collective wanting to be a 501(c)(3) will incur significant overhead monitoring activities to make sure any non-exempt activity does not become more than insubstantial, and that athlete selection is consistent with the law. But collectives willing to limit their scope and pay market-rate salaries may be legitimate charities. However, miss any of the gates, and the entire charity, including parts not related to athletics would lose exempt status.
THE PR DISASTER(S)
A public charity is PUBLIC. The benefit of being a 501(c)(3) is the donor tax-benefit, but the allure of a collective is leveraging the power of secrecy and intrigue to gain an advantage for the school they support. Collectives are reluctant to give accurate numbers regarding actual payments conferred and how much money has been raised to try and out-recruit another collective.
Collectives choosing to operate as a charity do not have that option. Form 990, a yearly reporting requirement to maintain 501(c)(3) status, requires charities to disclose the compensation for the five highest-paid independent contractors receiving more than $100,000 (which could include many college athletes) along with how much money was raised and how much money is currently on hand. Collectives wanting to avoid public comment from paying college athletes too much or too little or not raising enough money should organize as an LLC. for-profit.
In short, there’s nothing more certain in life than death, taxes, and, if not downright cheating in athletics, getting as close to the line as possible. Collectives do many good things in the community, but there’s more to being a 501(c)(3) than performing community service. Collectives who are willing to forego secrecy and big payouts may well be able to operate as a 501(c)(3), but if the goal is to efficiently redistribute large sums of money to a team of promising college athletes, a for-profit is the way to go.