Most NIL collectives do not further a Sec. 501(c)(3) exempt purpose

The IRS Office of Chief Counsel (OCC) advised that in many cases, name, image, and likeness (NIL) collectives, which provide opportunities for college athletes to be compensated for the use of their NIL, will be serving the private interest of student-athletes, a substantial nonexempt purpose, and not furthering an exempt purpose under Sec. 501(c)(3).

Name, image, and likeness collectives

In 2021, the National Collegiate Athletic Association (NCAA) adopted an NIL policy permitting student-athletes to be compensated for use of their NIL without its affecting their NCAA eligibility. Under the policy, student-athletes may receive compensation for NIL activities under an agreement if the agreement requires quid pro quo (i.e., work for the compensation) and the compensation paid under the agreement is not contingent on enrollment at a particular school or athletic participation or achievement.

Many NIL collectives have been established by boosters and fans of one or more of a university’s athletic programs to develop and fund or otherwise facilitate NIL deals for student-athletes. NIL collectives generally are independent of the affiliated university, and, increasingly, multiple NIL collectives support a university’s student-athletes.

Nonprofit NIL collectives

In IRS parlance, “nonprofit NIL collectives” are organizations claiming a tax exemption under Sec. 501(c)(3) that develop paid NIL opportunities for student-athletes, regardless of whether the organization engages in other purportedly exempt or nonexempt activities. These collectives pool contributions and develop paid NIL opportunities for student-athletes of the universities they are affiliated with and pay compensation to the participating student-athletes in exchange for their NIL in a manner that is consistent with NCAA regulations.

Some of these collectives tell donors that they will pay anywhere from 80% to 100% of all contributions as compensation for NIL rights, while others state only that their purpose is to create an endowment to support the payments to student-athletes. A collective may provide opportunities for all of a university’s student-athletes, but some collectives support only a limited number of identified athletes or athletes in the affiliated university’s high-revenue sports. Some nonprofit NIL collectives also assist student-athletes with NIL activity reporting required by state law or university policy. Other collectives go further and assist student-athletes with personal brand development, financial planning, and tax compliance and even offer legal advice.

Sec. 501(c)(3), the operational test, and private benefits

Sec. 501(c)(3) provides an exemption under Sec. 501(a) for organizations organized and operated exclusively for one or more of the exempt purposes. A test has been developed, called the operational test, which is designed to ensure that an organization’s resources and activities are devoted to furthering those exempt purposes. Under this test, an organization is not operated exclusively for exempt purposes unless it engages primarily in activities that further an exempt purpose and it serves public rather than private interests. Under the operational test, the purpose toward which an organization’s activities are directed, and not the nature of the activities themselves, determines whether an organization is described in Sec. 501(c)(3). An activity may be engaged in for more than one purpose (a dual-purpose activity). However, a single nonexempt purpose, if substantial in nature, will preclude exemption regardless of the number or importance of truly exempt purposes.

With respect to private benefits, an occasional benefit to private interests, incidental to an organization’s pursuing its exempt purpose, will not generally cause the organization to impermissibly serve private interests. However, the private benefit must be “clearly incidental to the overriding public interest” if an organization serves both public and private interests (Rev. Rul. 76-206). A private benefit to non-insiders that is incidental in both a qualitative and quantitative sense will be incidental to the overriding public interest and will not preclude an organization from exemption under Sec. 501(c)(3).

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. To be quantitatively incidental, the private benefit must be insubstantial in amount when compared to the overall public benefit conferred by the activity.

A private benefit resulting from an organization’s activities must be both qualitatively and quantitatively incidental to find that an organization is not serving private interests more than incidentally. In other words, 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 and vice versa.

The OCC’s advice

The OCC advised that many organizations that develop paid NIL opportunities for student-athletes are not tax exempt and will not qualify as a Sec. 501(c)(3) organization because the private benefits they provide to student-athletes are not incidental both qualitatively and quantitatively to any exempt purpose furthered by that activity.

Qualitatively incidental: Applying the operational test, the OCC first considered whether the private benefits of nonprofit NIL collectives’ activities were qualitatively incidental. As it had previously stated in the memo, student-athletes generally benefit from a nonprofit NIL collective through the compensation the collective pays them for use of their NIL.

This private benefit is, in the OCC’s view, not a byproduct but is rather a fundamental part of a nonprofit NIL collective’s activities, as a collective’s primary activity is developing NIL opportunities that satisfy the NCAA’s quid pro quo requirement and that permit payments to student-athletes. The OCC also found that another reason the private benefit to student-athletes is not qualitatively incidental is that it is not a necessary concomitant to the accomplishment of a nonprofit NIL collective’s exempt purpose of promoting the collective or its partner charities. A private benefit is a necessary concomitant when the exempt purpose could not be achieved without benefiting certain private interests.

The OCC advised that it would be difficult for a nonprofit NIL collective to establish that it is impossible to accomplish its exempt purpose without compensating student-athletes for their NIL. In addition, the OCC stated that the other benefits typically provided by NIL collectives (brokering all aspects of the NIL deals offered and, in some cases, providing services such as financial planning, tax assistance, legal advice, and assistance in personal brand development) are not necess to the promotion and marketing of charitable causes.

A third factor the OCC found weighed against a finding that the private benefit to student-athletes is qualitatively incidental is that the benefit is generally directed to a limited noncharitable class: student-athletes. As the OCC explained, the IRS has found in some rulings that organizations whose activities benefited student-athletes were charitable organizations, but this was based on the IRS’s determination that the activities advanced education. The OCC found that the compensation payments made by NIL collectives do not further an educational purpose under Sec. 501(c)(3). According to the OCC, only if 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 the payments made by the collective are reasonably calculated to meet that need, would the payments to the student-athletes not be serving private interests.

Finally, the OCC considered, in assessing the benefit to student-athletes from a collective’s activities, the statements of numerous athletic directors, boosters, and others, in which they emphasized the importance of NIL collectives, including nonprofit NIL collectives, to the retention and recruitment of student-athletes. Because collectives are usually organized by boosters and fans of a certain school, the OCC found it is reasonable to assume that these organizers, as supporters of a particular school, have an interest in limiting a collective’s NIL opportunities to the student-athletes at that school rather than making these opportunities available to any student-athlete willing to participate in the collective’s activities. Thus, these statements and certain other factors indicated to the OCC that the collectives’ primary purpose was to compensate student-athletes and that assisting them in monetizing their NIL is a substantial nonexempt purpose of many nonprofit NIL collectives.

Quantitatively incidental: The OCC also stated it believed that in many cases a nonprofit NIL collective will serve a private interest more than incidentally in a quantitative sense. Many collectives intend to pay to student-athletes all funds after payment of administrative and other expenses, with some claiming that 80% to 100% of all contributions go to student-athletes. The OCC stated, “For payouts anywhere within this range, the benefit to private interests is substantial by any measure and cannot be dismissed as merely incidental.”

Reflections

Clearly, as the IRS suggests, most existing NIL collectives as they are currently run would not be found to be furthering an exempt purpose and thus will not qualify as a Sec. 501(c)(3) organization. If they fail to qualify as a Sec. 501(c)(3) organization, donations to those collectives will not be tax-deductible to the donors. Although many donors to an NIL collective may want a winning team enough to be willing to make donations to the collective regardless of whether the donation is deductible, the lack of a tax deduction for donations could put a crimp on a collective’s fundraising abilities.

Chief Counsel Memorandum AM 2023-004

Contributor

James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser’s tax technical content manager. For more information about this column, contact thetaxadviser@aicpa.org.