Many NIL collectives have been structured as nonprofit entities which have sought and obtained 501(c)(3) public charity status from the IRS.  These collectives usually partner with other charities to establish NIL opportunities for student-athletes.  Under these arrangements, the nonprofit collective typically pays the athlete in exchange for his or her promotion of the partner charity through personal appearances, speaking engagements and social media, or through participation in sports clinics for community youth and the like.

This past year, the IRS announced that many NIL collectives structured as nonprofit organizations fail to qualify as tax-exempt entities.  According to a generic legal advice memorandum (GLAM), many of these entities operate primarily for the private benefit of student-athletes, and thereby fail the “operational test” under Section 501(c)(3) of the Internal Revenue Code (the “Code” or “IRC”), which requires that tax-exempt organizations operate primarily for exempt purposes.  As a result of the perspective shared in this GLAM, the IRS has begun denying NIL collective applications for tax-exemption, as reflected in two recently released IRS Private Letter rulings (the “Rulings”) (Private Letter Ruling 202414007 and Private Letter Ruling 202416015).  

According to the IRS, the nonprofit NIL collectives described in these Rulings and in the GLAM further the following stated purposes: (i) providing opportunities for student-athletes to be paid for the use of their NIL, and (ii) contributing “to the greater good of the community” by raising awareness and support of their partner charities’ missions.  This article includes further discussion of the regulatory obstacles these nonprofit NIL collectives are facing, and the implications for collectives operating with similar missions.

IRS Rules Governing Tax-Exempt NIL Collectives

In order to obtain and maintain tax-exemption under IRC Section 501(c)(3), an entity must be organized and operated exclusively for one or more of the exempt purposes set forth in IRC Section 501(c)(3), which may be charitable, educational or scientific in nature (Treasury Regulation Section 1.501(c)(3)-1(a)(1)).

As discussed above, to be regarded as “operated exclusively” for exempt purposes, an organization must be engaged “primarily” in activities which accomplish exempt purposes (Treas. Reg. Section 1.501(c)(3)-1(c)(1)).  The presence of “a single nonexempt purpose, if substantial in nature, will preclude exemption regardless of the number or importance of truly exempt purposes” (GLAM, citing Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279 (1945)).

In addition, to be regarded as organized and operated exclusively for exempt purposes, an organization must serve a public rather than a private interest (Treas. Reg. Section 1.501(c)(3)-1(d)(1)(ii)).  To meet this requirement, an organization must establish that it is not organized or operated for the benefit of private interests, including for example, designated individuals, the founders of the organization or their family, or persons controlled, directly or indirectly, by such private interests.

That said, private benefit will not prevent an organization from obtaining exemption if the private benefit is incidental in both a “qualitative” and “quantitative” sense.   

The IRS has stated that 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” (GLAM).   A private benefit that is a “direct or intentional” benefit to designated or identifiable individuals would not be “qualitatively incidental” (GLAM).  

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

IRS’ Analysis and Conclusion Regarding Nonprofit NIL Collectives

According to the IRS, the nonprofit NIL collectives described in the Rulings and the GLAM operate primarily for the private benefit of student-athletes, in violation of the “operational test” under IRC Section 501(c)(3).  The following are key factors that went into its determination.  The IRS concluded that:

1. Providing paid opportunities for student-athletes is a primary purpose of the nonprofit NIL collectives’ activities — which means these collectives serve a private, rather than a public interest.

2. The private benefit to student-athletes is not “qualitatively incidental” to the collectives’ exempt purposes.  This benefit is not a “necessary concomitant” to accomplishing their exempt purpose of supporting partner charities.  According to the IRS, there “are alternative means by which you could promote local charities without conferring a substantial private benefit on these student athletes, such as by encouraging volunteerism” (Private Letter Ruling 202414007).

3. The private benefit to student-athletes is not “quantitively incidental” when compared to the overall public benefit conferred by the collectives’ activities.  In the GLAM, the IRS noted that many collectives pay 80 to 100 percent of all donations to student athletes.  The IRS said, “for payouts anywhere within this range, the benefit to private interests is substantial by any measure and cannot be dismissed as merely incidental to [their] other purposes and activities” (GLAM).

4. Student-athletes being paid by nonprofit NIL collectives are not themselves a recognized charitable class.  The IRS noted in the GLAM that “absent a finding that NIL collectives select student athletes for participation based on need, such that their activities could be considered” as being “conducted for the relief of the poor or distressed, …payments to the student-athletes are properly regarded as serving private rather than public interests.”

The Future of Nonprofit NIL Collectives

As discussed herein, the IRS has begun denying tax-exempt status to some nonprofit NIL collectives for the reasons discussed above.  For similar reasons, the IRS has indicated that it may reconsider the exempt status of nonprofit NIL collectives that have already been granted exemption (GLAM).¹  These actions also have implications for donors, who cannot take a charitable deduction for contributions to nonprofit collectives whose exemption has been denied or revoked.

With the above in mind, it is critical for nonprofit NIL collectives to review the Rulings and the GLAM with counsel and ensure that their purposes and activities do not confer impermissible private benefits to student-athletes.  Nonprofit NIL collectives should also consult with counsel on the pros and cons of converting to a more flexible legal form, including, for example, a for-profit limited liability company structure, which is not subject to limitations on the type of activities it facilitates.

1 However, the IRS has also noted that in reconsidering the exempt status of such collectives, it may be appropriate to grant relief under IRC 7805(b) to limit the retroactive effect of any such revocations.

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While “pay-for-play” is still prohibited by the NCAA,² these new rules have opened the door for college athletes to explore a new world of sponsorships, endorsements and compensation.  For example, college athletes can now earn money for commercials, appearances, speeches, social media posts, hosting sports camps, giving lessons, writing books and more — all without violating NCAA rules.

“NIL collectives” have emerged as the chief brokers of these opportunities.  This article discusses what NIL collectives are, their legal forms of organization, and the regulatory framework that governs them.

How are NIL Collectives Structured?
NIL collectives are entities that are structurally independent of a school, yet fund NIL opportunities for the school’s student-athletes. They are typically founded by well-known alumni and supporters of the school.  Collectives generate and pool revenue raised through contributions from a wide variety of sources, including boosters, businesses, fans and more.  They use these funds to create opportunities for student-athletes to leverage their NIL in exchange for compensation.

While a number of NIL collectives have been formed as for-profit entities,³ in a growing number of cases, they have been formed as nonprofits. Numerous nonprofit collectives have, in turn, sought and obtained 501(c)(3) public charity status from the IRS, which potentially allows donors to receive a tax-deduction for their contribution to the collective.⁴

Tax-exempt collectives typically use student-athletes as independent contractors to help further their charitable mission.  For example, some provide in-kind contributions of a student-athlete’s services to other charities, including speaking, appearances and other public relations services that help expand the charities’ reach and visibility in their communities.  The student-athlete is paid by the tax-exempt collective to provide the services, while the other charities receive these services on a pro bono basis.

Special Rules Governing Tax-Exempt NIL Collectives
Collectives that obtain tax-exemption should be mindful of special rules that apply to tax-exempt entities.  These rules are enforced not only by the IRS, but also by State Attorneys General, whose responsibility is to ensure that charitable funds are used for charitable purposes. These rules require that tax-exempt cooperatives operate differently from the typical NIL collective.

For example, NIL collectives commonly facilitate endorsement, merchandising and marketing deals that allow for-profit companies to promote their products and services using a student-athlete’s NIL, which helps these for-profit companies increase business and revenues.  Many NIL collectives have the flexibility to promote such commercial interests due to their structure as for-profit (and therefore, taxable) entities.

However, facilitating commercial deals does not constitute a permissible purpose for a charitable, tax-exempt organization.  Therefore, if a tax-exempt NIL collective engages in such activity, revenues from this activity could be taxed by the IRS as unrelated business income – i.e., income from a trade or business, regularly carried on, that is not substantially related to the collective’s charitable mission.

Also, if the IRS finds that these commercial activities constitute a primary or substantial non-exempt purpose of the organization, the IRS could revoke its tax-exempt status.⁵ State Attorneys General could bring enforcement actions for similar reasons.  Therefore, if a tax-exempt collective facilitates marketing or similar NIL arrangements, it should generally avoid arrangements promoting goods and services of for-profit companies.  However, it could use the NIL of student-athletes to help promote and amplify the charitable missions of nonprofits serving communities.⁶

NIL collectives are also becoming well-known for offering lucrative compensation to student-athletes in connection with promotional deals.  For many collectives, their status as for-profit entities give them the flexibility to do so.

But, in the context of a tax-exempt collective, these payments must be reviewed carefully to ensure they do not constitute “excessive compensation” for federal tax law purposes.  NIL collectives should therefore carefully structure athletes’ compensation in accordance with IRS rules to ensure it does not exceed fair market value.  Failure to do so could put the collective at risk of losing its tax-exemption, and lead to potential enforcement actions by State Attorneys General.

However, it should be noted that even if such compensation is determined to be reasonable, a tax-exempt NIL collective could nevertheless lose its exemption if the IRS determines that its primary or substantial purpose is to pay or recruit student-athletes.  For this reason, it’s important that tax-exempt collectives work closely with legal counsel to ensure they have well-constructed charitable programs.

Given the risks outlined above, an NIL collective seeking tax-exempt status should carefully consider whether any of its time and resources will be spent on pursuing commercial (non-exempt) activities.  Collectives considering such activities should consult with counsel to reconsider its structural options, and discuss whether it would be advisable to create a for-profit subsidiary to house any commercial activity.

NCAA Interim Rules
Aside from understanding the regulatory framework discussed above, NIL collectives (no matter their legal form) should have an understanding of the NCAA rules which, as of the time of this writing, consist of interim rules adopted in July 2021.  These interim rules will remain in effect until federal legislation creates a national standard (which is what the NCAA is calling for), or until new NCAA rules are adopted.  While the purpose of the interim rules is to suspend NCAA restrictions on athletes’ profiting off their NIL, the rules maintain certain guardrails to prevent “pay-for-play” and similar arrangements.  Subject to state law, the following is prohibited under the interim rules:

• NIL opportunities cannot be used as a recruiting tool for prospective student athletes.  Such an action is considered an “improper recruiting inducement.”  Therefore, NIL collectives should refrain from making offers of NIL opportunities contingent upon a student-athlete’s enrollment at a particular school.
• As discussed above, NIL arrangements that constitute “pay-for-play” are also prohibited.   This rule prohibits any kind of arrangement that constitutes compensation in exchange for a student-athlete’s participation or performance in college athletics.
• NIL agreements should be specific about the NIL work being performed by the athlete in exchange for compensation, and such compensation should be paid only for work performed.  Such compensation must be determined through an independent analysis, based upon the facts of each specific case and the value each athlete offers to an NIL arrangement.
• The NCAA interim rules prohibit compensation from any school in exchange for the use of a student athlete’s name, image or likeness.  In addition, schools may not direct how student-athletes use NIL compensation.  (For example, schools may not require a student-athlete to use NIL compensation for financial aid.) Athletic department staff are not allowed to represent student-athletes in marketing their athletic ability or reputation.  They also may not communicate with a recruit on behalf of an NIL collective.  In addition, such staff may not facilitate a meeting between an NIL collective and a student-athlete, including, for example, by sharing a recruiting list or watch list.

State Laws and School Policies
As noted above, the NCAA’s interim rules are subject to state law, which varies depending on the state.⁷  Therefore, NIL collectives should take steps to ensure compliance under any applicable state law, including any state law that applies to the collective, the school where the student-athlete is enrolled, as well as the state where the NIL activity will take place.

The collective should also look at any specific NIL policies established by the college.

Both state laws and school policies may include reporting requirements that NIL collectives should be aware of, and some state laws prohibit athletes from entering into a contract that conflicts with the student-athlete’s team contract.

Understanding the regulatory framework governing NIL collectives will help avoid missteps that can lead to punitive actions by the IRS, NCAA or State Attorneys General, or scrutiny from Congress, which has also taken an interest in these entities.  As the NIL’s regulatory environment continues to evolve, it is incumbent on both collectives and student-athletes to take affirmative steps, including consulting with legal counsel, to ensure compliance.

1 This dramatic shift by the NCAA also came on the heels of its loss before the U.S. Supreme Court in NCAA v. Alston 141 S. Ct. 2141 (2021). Though NIL compensation was not the subject of this case, Justice Kavanaugh wrote a concurring opinion which suggested that the NCAA’s NIL compensation rules could be in violation of antitrust laws, and stated that “the NCAA is not above the law.”  The NCAA’s change also follows action by numerous states that, since 2019, had led the way in creating NIL rights for student athletes.

2 As discussed later in this article, “pay-for-play” refers to any kind of arrangement that constitutes compensation in exchange for a student-athlete’s participation or performance in college athletics.

3 Other legal forms taken by NIL collectives have included formation as for-profit limited liability companies (“LLCs”), which provides more flexibility in a number of ways.  For example, unlike tax-exempt nonprofits, for-profit LLCs are not subject to a cap on what’s considered reasonable compensation.  They may therefore offer student-athletes NIL work at any compensation structure.  For-profit LLCs are also not subject to limitations on the type of activities they can facilitate.  Therefore, unlike tax-exempt entities, for-profit LLCs may facilitate NIL arrangements for student-athletes such as merchandising or endorsement deals which promote commercial activities.  NIL collectives should consult with counsel to discuss the various pros and cons of these options.

4 On September 29, 2022, Senators John Thune (R-S.D.) and Ben Cardin (D-Md.) introduced the Athlete Opportunity and Taxpayer Integrity Act which, if passed, would “prohibit individuals and organizations from using the charitable tax deduction for specific contributions that compensate college or incoming college athletes for the use of their (NIL).”   They argue that “(s)uch activity is inconsistent with the intended purpose of the charitable tax deduction, and it forces taxpayers to subsidize the potential recruitment of – or payment to – college athletes based on their NIL status.”  As of the time of this writing, this federal legislation is the latest of more than a handful of NIL proposals introduced, but not yet passed, in Congress.  Congress’ appetite for eventually passing NIL legislation is unclear, though these proposals do indicate that NIL collectives are facing increased scrutiny from Congress.

5 Regs. Sec. 1.501(c)(3)-1(e)(1) and Sec. 1.501(c) (3)-1(c)(1).

6 One example of this approach is discussed in the previous section – i.e.,  tax-exempt collectives that provide in-kind contributions of a student-athlete’s services to other charities to help them promote their charitable missions.

7 As discussed above, the NCAA is lobbying Congress for legislation that would create a national standard, and thereby pre-empt differing state laws.

The post Seeking Tax-Exemption for a Name, Image and Likeness Collective (NIL)? What to Know. appeared first on Perlman & Perlman.

Are you looking for answers to legal questions that arise in cause marketing and corporate partnerships?  If so, look no further!

Last year, Selfishgiving.com founder and blogger  Joe Waters and I distributed a five-question survey to businesses and nonprofits regularly engaged in cause marketing and corporate partnerships, asking them to share their top legal compliance questions and challenges.  After reviewing the survey responses, we decided to create a series of blog posts to address the most common corporate partnership legal compliance questions covering four issue categories: (1) Advertising Disclosures; (2) Registration and Reporting Requirements; (3) Contracts; and (4) Unrelated Business Income Tax (UBIT).   I hope you will find these FAQs useful in helping to navigate the legal and regulatory issues that arise as your company or charity engages in corporate partnerships.

Click on the FAQ headers below to read the answers to each question, which are posted on SelfishGiving.com, and sign up for Joe’s informative and entertaining weekly email newsletter, which has all the latest trends and strategic advice about cause marketing and corporate partnerships!

Part 1: Advertising Disclosures

1. Are cause marketing advertising disclosure “best practices”  required by law? Some of our corporate partners think they are just “suggestions.”
2. What if a company insists on structuring a campaign where the donation is based on a percentage of its profits, rather than a percentage of the purchase price?
3. Have any companies gotten into trouble with regulators for failing to include certain information in their cause marketing advertisements?
4. Advertising disclosure problems only present a real legal risk to the corporate partner, not the charity, right?
5. Can the company simply state on the hang-tag or store signage, “10% of the purchase price will be donated to ABC Charity, see www.company.com/ABCCharity for details,” and then include the website URL where the minimum guarantee and/or donation cap can be found?

Part 2: Registration and Reporting Requirements

Company FAQ

1. Our company is conducting its first ever cause marketing campaign. I heard that we may need to file state registrations. How do I know if I need to register, what does it entail, and how long will it take?  Note: The answer to this includes a chart on the state registration and reporting requirements applicable to companies acting as commercial co-venturers.
2. I operate a small e-commerce business in Massachusetts that sells clothing online, and would like to run a promotion in which the company will donate $5 to a local, nonprofit homeless shelter for every special edition T-shirt sold through our website. Does my company need to register nationally? What, if anything, does the nonprofit need to do?  Note: The answer explains how to determine the parties’ fundraising compliance obligations specifically in the context of an online cause marketing promotion.
3. Our company’s cause marketing campaign launched last week and we just found out we are supposed to register in certain states as a commercial co-venturer! Are we going to face fines or other penalties?

Charity FAQ

1. Our charity was asked to be the beneficiary of a company’s charitable sales promotion, but we’ve never engaged in a cause marketing campaign before. What do we need to be aware of before we proceed with this opportunity?
2. Our nonprofit is already registered nationally, and discloses all of its CCV partners as part of our annual charitable solicitation registration renewals, so we should be set with our CCV-related compliance, right?  Note: The answer includes a chart on the state reporting requirements applicable to charities that have entered into a CCV agreement.
3. Our charity was approached by a start-up company that wants to conduct a cause marketing campaign to benefit our organization. When we told them they may need to register with certain states and obtain bonds, they were concerned about the cost and burden of compliance. We don’t want to lose the opportunity to build a partnership with this company. What can we do?

Part 3: Contracts

1. We are entering into a cause marketing promotion in which our charity will receive a portion of the proceeds from the sale of each Sellco product. SellCo sent us a draft contract to sign. It seems to describe the promotion the way we discussed it. Should we go ahead and sign it?
2. What provisions should be included in our cause marketing agreement? Note: The answer includes a 15-point cause marketing contract checklist!
3. Is there a way to streamline the preparation of cause marketing agreements so they are compliant with all 50 states’ laws as well as for online sales?
4. Our corporate partner wants to enter into a multi-year relationship that includes a significant financial commitment, and will involve numerous customer activations.  Only the details for the first activation have been solidified. How do we draft an agreement to cover this type of arrangement?

Part 4: Unrelated Business Income Tax (UBIT)

1.  My organization, Charity Corp., has a corporate partner, Cool Products Co., that is conducting a charitable sales promotion in which it will advertise that it is donating a portion of the purchase price from sales of a particular product to Charity Corp.  Cool Products has asked to promote their sales campaign to our members and donors through email and social media. I heard that charities aren’t allowed to promote these types of campaigns because it might subject the charity to a tax called UBIT.  What is UBIT, and why and when is it a potential problem? How do we avoid creating taxable income?
2. How can our organization appropriately communicate about a corporate partnership to our donors/members/social followers without crossing  the line into marketing for the corporate partner?
3. The UBIT rules make our corporate partnerships team feel constrained in our partner cultivation strategy. What options does our organization have to provide value to our corporate partners?

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