The paper I wanted to write, but found it has already been written
Spoiler: If you’re going to write an article claiming that paying athletes is going to result in colleges or the NCAA paying taxes on their sports earnings, you’re basically wrong. Even if college sports were totally taxable, there’s little chance of anyone actually owing any tax.
If you follow me on twitter, you may have seen me arguing one of my pet peeves, which is that I do not buy the argument that the tax-status of the NCAA or of major college football programs is an impediment to market-based compensation for college athletes. In essence that argument goes something like this:
1) Section 501(c)(3) of the tax code is explicitly reserved for promotion of “amateur” sports.
2) Absent amateurism, the NCAA and its member schools’ sports programs (or more narrowly, their college football and/or men’s basketball programs) would become taxable.
3) Thus donations, ticket sales, broadcast revenue, etc., would all be taxed,
4) Bringing college sports to, at the least, a much lower level of profitability or, in the extreme, vaporizing college sports to a virtual nothing.
I’m exaggerating a bit (though not that much), but as one example of this argument [absent the Herpes joke!], consider this excerpt from a blog post by Kristi Dosh, in which she explains her version of this argument (which also appears in her book “Saturday Millionaires”):
The real cost, however, is in the athletic department losing its tax exemption under Internal Revenue Code Section 501(c)(3). Currently, athletic departments (which are generally a separate legal entity from the university), athletic foundations/booster clubs and bowl games enjoy tax exempt status because they “promote amateur athletics,” an exempt purpose under the Code. If college athletes were compensated and found to be employees, revocation of this tax-exempt status would surely follow.
This would also be the case if college athletes, instead of being compensated by the athletic department, were allowed to profit from endorsements. It would only take a finding by the Internal Revenue Service that these athletes were no longer amateurs (ad I’m sure they’d hate to add another revenue source). And if college athletes are no longer amateurs it’s not just athletic departments who lose their 501(c)(3) status, it’s bowl games as well.
In addition to the taxes each athletic department would have to pay on any income, they’d likely lose large amounts of revenue as a result of donors no longer being able to make tax-deductible contributions. How would that impact athletic departments, which rely heavily on donor contributions to survive? A CFO at one FBS school told me a “very conservative estimate” would be athletic departments losing 50% of their current donations. I polled ten athletic department executives in total and the range was 25-50 percent.
Kristi and I have argued over this issue before. In a moment of agitation, I’ve told her consider this to be “concern trolling” where the actual issue isn’t a big deal but in the guise of making sure people are aware of the (overstated) ramifications, the author makes it seem like change is impossible. Kristi basically told me that if I was so smart, I should go write a paper on it. [Though she said it much more nicely than that!]
And so I started to do just that. I have the real luxury of being the nephew of one of the foremost scholars of the U.S. tax law of non-profits, Professor Stephen Schwarz of UC-Hastings College of Law. He literally (co-) wrote the book on non-profit tax treatment. I asked him if he’d co-author a paper with me. As politely as he could, he told me that what I wanted to study had already been done, and done quite well, by Professor John D. Colombo, a chaired professor at the Unveristy of Illinois. If you’re the kind of person who really enjoys reading a tax law paper over lunch [/raises hand sheepishly], you should go read Professor Colombo’s paper here:
Colombo, John D., The NCAA, Tax Exemption and College Athletics (February 19, 2009). Illinois Public Law Research Paper No. 08-08. Available at SSRN: http://ssrn.com/abstract=1336727 or http://dx.doi.org/10.2139/ssrn.1336727
Professor Colombo starts out with an important warning for those who might dive in without actually understanding tax law:
Unfortunately, most of the folks who opined on the subject [of the NCAA’s tax exemption] revealed virtually no knowledge of the actual law surrounding tax exemption for the NCAA or, more broadly, exemption for universities engaged in Division I football and basketball
Despite that warning, I’ve decided to turn this blog post into a sort of annotated book report, to summarize Prof. Colombo’s analysis, and offer it up to any would-be analyst of the economics of college sports. I know almost as little as the next economist about the intricacies of the tax code with respect to non-profits and tax exemption, but (rather than stay at a Holiday Inn Express), I have read Professor Colombo’s paper and I am prepared to help the world gain its wisdom.
Here’s what Professor Colombo’s excellent paper explains (with my own gloss provided in italics):
- There is an important distinction between an organization as a whole losing its tax-exempt status under 501(c)(3) and that same organization remaining exempt on the whole, but having certain lines of business subject to the Unrelated Business Income Tax (known as UBIT).
- I mention this first because I think it gets confused in the public eye. In essence, there are two questions, first whether the organization as a whole remains an untaxed non-profit and then whether some of its activities can be taxed, even if the organization is a non-profit.
- This matters, I think, for the question of charitable contributions by alumni to the sports program of their favorite team. For example, if the school remains a non-profit, then donations will remain tax-deductible, EVEN IF the football program’s TV revenue were determined to be Unrelated Business Income subject to the UBIT.
- The NCAA as an organization is treated differently than its member schools. The NCAA itself is covered by the special amateurism clause of 501(c)(3) but colleges and universities do not need to avail themselves of that section of the law, because they qualify as charitable educational institutions. Indeed, the special NCAA clause was only added in 1976, whereas the exemption for educational institutions has been around much longer.
- Right off the bat, it’s important to recognize that what this means is that the tax exempt status of every college and university sponsoring FBS football is utterly unrelated to whether it pays its athletes in the form of the current Grant-in-Aid, or moves to a more market-oriented form of compensation. Colleges and Universities draw their tax-exempt status from their role as fostering education, which applies to the entire University, and even the most football-revenue-focused school out there (LSU) only derived 14% of its revenue from football. That’s an astoundingly large number, but even still, 86% of its revenue is coming from other sources (and most of those are truly educational). So it might be the case (though it isn’t) that football revenue is taxable, but the tax-exempt status of the University as a whole is not seriously in doubt.
- Colombo also adds that even though he disagrees with the finding, the Tenth Circuit has already ruled that for the purpose of UBIT applying to March Madness advertising revenue, the NCAA tournament is UBIT-exempt because it is not “regularly carried on”:
Though I would argue that the opinion is just flat-out wrong in its analysis, the Tenth Circuit essentially held in 1990 that the NCAA men’s basketball tournament was not “regularly carried on” for purposes of taxing the advertising revenue that resulted from the sales of advertising in the NCAA tournament commemorative programs.102 The court seemed to compare the NCAA’s sale of advertising for its tournament to the sales of advertising by sports magazines such as Sports Illustrated, which of course occur year-round, rather than seasonally.103
- In other words, in the same way that baseball is not “commerce” (despite being a gignatic business) with respect to the antitrust laws (and thus immune from those laws, at least in some aspects), March Madness is not “regularly carried out” and thus not subject to the UBIT law. Sometimes the law is stranger than fiction!
- For the schools, the question of whether various sources of football and basketball revenue are unrelated business income hinge in part on whether the profits are used to further their educational mission. Colombo explains in excellent detail how it is clear that many IRS precedents, there is an argument that because college football and basketball is distinct from the pure college element of college, it ought to be taxed via the UBIT now, independent of whether athlete pay is set by collusive fiat or an open market.
- But then Colombo explains that the IRS has not treated college sports this way at all, and in fact these questions have been tested under the tax code repeatedly, and in every case, the answer has been that these are not subject to the UBIT tax. Moreover, because the question for a college or university is whether it supports education rather than whether it supports amateur sports, that answer did not hinge on the amateur status of the athletes.
- As Professor Colombo writes:
Perhaps the biggest impediment to applying the UBIT to Division I football and basketball revenues at this time, however, is the legal precedent involved. These precedents go back as far as the UBIT itself: the House Ways and Means Committee report on the UBIT legislation straightforwardly stated that a university “would not be taxable on income derived from a basketball tournament sponsored by it, even where the teams were composed of students of other schools”;118 later, the same report stated “income of an educational organization from charges for admissions to football games would not be deemed to be income from an unrelated business, since its athletic activities are substantially related to its educational program.” Probably in part because of this legislative history, the IRS has ruled several times in many different contexts that college athletics are an “integral part” of the educational program of a university (and therefore clearly “substantially related” to a university’s educational program). Although the IRS briefly considered attempting to tax the revenues from the sale of broadcast rights to college football bowl games in 1977, the Service quickly reversed itself, and ultimately issued two formal rulings that such revenues were not subject to the UBIT.
Since then, the IRS has basically given up on any attempts to tax revenues associated with college athletic programs, with the exception of revenues that the IRS considered nothing more than payments for advertising, such as “sponsorship” payments that are now regulated by statute. … In 1991, the IRS issued two Technical Advice Memoranda that held that “sponsorship fees” paid by a business to a college, university or independent bowl association were taxable because they represented essentially nothing more than payments for advertising. … Congress responded to this initiative by amending the UBIT rules to eliminate “corporate sponsorship payments” from UBIT.
- So, what matters from the IRS perspective is not whether the athletes’ compensation is capped at a GIA or allowed to be set via the market. Rather, the IRS focuses on whether the activity is substantially related to its education program. One could argue that all this means is that the athletes must remain students, or that the compensation must include a scholarship, but it seems hard to see how the question of whether the money NBC pays to Notre Dame for the right to broadcast their home football games is or is not an integral part of the educational program of the University of Notre Dame would change if those Notre Dame players each got $25,000 upon graduation for every year they were on the school roster, as just one example.
- Maybe this is obvious, but what this means is that these questions aren’t hypothetical. We actually know what the answer is because the cases have been litigated and in each case the answer was that as long as the college sports revenue is well-integrated into the educational mission of the school, it’s not subject to the UBIT. Those decisions were not about amateurism, and so a change in the definition of amateurism, or even a complete abandonment of amateurism would not seem to matter, as long as the “College” part of College football or basketball remained in place.
- Colombo also addresses the NCAA’s specific situation, which is distinct from that of its member schools. From my reading of Colombo, he would acknowledge they may be more vulnerable to a change in the law, since they are not an educational institution, but rather they do get their tax-exempt status under the portion of 501(c)(3) focused on fostering “national or international amateur sports competition.” Colombo doesn’t specifically ask whether paying athletes would change this status, but I would suggest that the bulk of the NCAA’s activity, even if FBS football and D1 basketball were to adopt a free-market compensation system would remain the promotion of amateur sports. So they might stay tax exempt, but clearly a case could be made that absent a change in the law, the NCAA would have its TV broadcast profits subject to the UBIT.
This is the final point, one which I have been making for a while on my own, that Professor Colombo explains so well.
- Even if schools or the NCAA itself were found to owe UBIT on the college football or college basketball earnings, the odds of any tax actually being owed are slim to none. Here’s Professor Colombo’s view:
Moreover, even if the UBIT applies to big-time college athletics, it may well be a paper tiger: it is likely that when rigorous tax accounting methods are applied to the revenues and expenses involved, coupled with some perfectly-legal creative overhead allocations that data indicate almost certainly are used by charities to offset any income otherwise taxable under the UBIT, no profit will be left that would actually be subject to taxation.
- Colombo explains that this is true both for the NCAA and for schools themselves. He writes:
With respect to the NCAA, it is unclear whether application of the UBIT would actually result in any tax impact. As noted above, the IRS has the ability under the UBIT to “fragment” revenues for UBIT purposes. Thus the IRS might attempt to apply the UBIT to, say, only the NCAA Men’s Basketball Tournament revenues or football licensing revenues. But the NCAA does not keep these revenues; instead, it distributes them to member schools after deducting its expenses. Under standard tax doctrine, the distribution of these revenues to member schools likely would be a deductible business expense (the “fee” that the NCAA must pay to member schools in exchange for the right to market their athletic “product” during the year, akin to a publisher agreeing to pay an author current royalties124). The result is that there likely would be little or no “profit” subject to tax under the UBIT even if it applied. …
One could safely assume that the vast bulk of this revenue, therefore, is generated by Division I football and basketball, probably mostly from the CBS Television contract for the Division I men’s basketball tournament. If the UBIT applied to this revenue, however, the NCAA would get to deduct all its regular business expenses directly attributable to the income and an appropriate portion of its overhead in order to determine its taxable income. … Thus the likelihood that the NCAA would actually pay any tax under the UBIT is remote; minimal tax planning could easily insure that the NCAA has no net business revenues to tax.
- Colombo then focuses on the many account tricks that would be available to colleges and universities if somehow their revenues became subject to UBIT (again, despite the fact that these issues have been settled by the IRS already for reasons unrelated to the amateur status of the athletes):
With respect to individual universities operating big-time athletic programs, the picture is similar. Although some schools report net positive revenues from football or basketball programs, these revenues are rarely subject to the kind of rigorous cost accounting used in the business world. …
A recent story in the Chronicle of Philanthropy surveyed 91 large charities filing UBIT returns; the authors noted that 51% of the charities reported zero or negative taxable income and were able to reduce $419.1 million of gross income into a collective $3 million deficit after allocating deductions and overhead.133 The NCAA and universities conducting big-time college athletics hardly are less sophisticated, and have even greater opportunities for aggressive cost allocation given the large capital investments and overhead costs of running their athletic programs. Accordingly, it is highly likely that if the IRS applied the UBIT to individual football or basketball program revenues (either at the NCAA or university levels), it would find no net profit from these programs to tax after factoring in depreciation on athletic facilities and a reasonable apportionment of overhead. As a result, I doubt that the general counsel of, say, the University of Michigan would cower much in the face of a threat by the IRS to apply the UBIT to Michigan’s football program.
So, the bad news is that the paper I wanted to write has already been written. But the good news is that if you care very deeply about the NCAA or your favorite college or university maintaining its tax exempt status, to the point that all other potential injustice pales in comparison with your dear old alma mater paying taxes on earnings from sports, you can rest easier tonight.
Even if the antitrust laws are more vigorously enforced and schools and the NCAA are no longer able to collude on player compensation, good old Uncle Sam still has plenty of love for the colleges and universities that play major college sports, and the odds of schools, or even the NCAA, paying taxes are, and will remain, basically nil, even if schools forgo collusion and compete with respect to athlete compensation.
So, Hooray for Tax-free Football!
As an addendum, I should add Kristi Dosh is correct that in some cases, including Kristi’s alma mater of Florida,the athletic department has been constituted as a stand-alone non-profit. I disagree with her that that is the norm, but it does happen. To the extent that practice puts a school at a disadvantage, tax-wise, to other schools, I suspect we’d see that practice come to an end in a heartbeat.
See Colombo pp. 4-9, where he contrast the two sets of requirements and explains (on p.7) that “Even if an organization is tax-exempt under Code Section 501(c), it may be required to pay the corporate income tax on net revenues from “unrelated” businesses.”
 See Colombo, pp. 9-10: “Prior to 1976, the question whether the NCAA as an entity was engaged in a charitable purpose (as opposed to universities conducting athletic programs) might have carried some doubt.…But in 1976, Congress made clear that promoting amateur athletics is, in fact, a prima-facie charitable purpose by passing an amendment to 501(c)(3) that specifically declares fostering “national or international amateur sports competition” as a charitable purpose.”