We recently had a business owner client approach us about his daughter going to college. She is a volleyball athlete and was awarded a full tuition athletic scholarship to her preferred college, BUT it didn’t start until her sophomore year. This had us thinking… are there any special tax provisions related to athletes that would result in our client’s business paying for his daughter’s freshman year tuition as a business deduction?
As a result of our research, we came across name, image, and likeness (NIL) contracts. Parents of student-athletes may wonder whether they can enter into a NIL contract with their child and write off the payments, either as a deductible business expense or a charitable donation.
This tax strategy has been making the rounds on social media. But, like much tax advice you might hear on social media, take it with a grain of salt. This article explains the NIL tax implications and what to know before engaging in these types of contracts.
What are NIL contracts?
Prior to July 2021, the National Collegiate Athletics Association (NCAA) prohibited student-athletes from profiting from name, image, or likeness for commercial purposes.
In response to class action lawsuits, court decisions, and recent NIL legislation passed in several states, the NCAA now allows student-athletes to enter into NIL contracts for compensation without impacting their NCAA eligibility. The new policy only pertains to NIL; students are still barred from entering into “pay for play” deals where payments are contingent upon participating in athletics or accepting improper recruiting incentives.
However, college athletes can now engage in NIL activities, provided they’re consistent with the laws of the state where their school is located. These deals can include autograph signings, product endorsements, teaching at camps, social media posts, etc. These contracts allow them to generate income while still participating in college sports.
Deductibility of NIL Payments
There are several ways businesses and individuals might make NIL payments to student-athletes. Let’s look at how you might structure these payments and the NIL tax consequences of each.
Payments to NIL collectives
NIL collectives pool cash from boosters to provide opportunities for student-athletes. They’re often founded by prominent alumni and influential supporters, and they pool funds from several donors and businesses, help facilitate NIL deals for athletes, and/or assist in providing benefits to enrolled student-athletes or their family members.
Initially, many of these collectives were set up as 501(c)(3) nonprofit organizations, which allowed contributions to the collective to be tax-deductible charitable contributions. However, in June 2023, the IRS Office of Chief Counsel released a memorandum (AM 2023-004) that concluded that contributions to NIL collectives are not tax-deductible charitable gifts “because the private benefits they provide to student-athletes are not incidental both qualitatively and quantitatively to any tax-exempt purpose furthered by that activity.
This memo is a sign that the IRS will deny new applications for 501(c)(3) status from collectives and may revoke the status granted to other collectives through audits.
NIL contracts as deductible business expenses
From a business perspective, entering into an NIL contract with a student-athlete can offer several advantages. For example, a local health food store might pay a student-athlete to share sponsored posts on their social media platforms, appear on local billboards or ads, or make in-store appearances. These kinds of promotions enhance brand recognition, create positive brand associations, and help the business differentiate itself from the competition.
When a business enters into a NIL contract with a student-athlete, the deductibility of those payments depends on several factors, including the nature of the business, the purpose of the payments, and applicable tax laws.
The following questions can help determine whether NIL payments are deductible business expenses.
Are NIL payments ordinary and necessary?
Generally, business expenses must be ordinary and necessary to be deductible. An ordinary expense is common and accepted in the industry. A necessary expense is helpful and appropriate.
Influencer marketing—like the kind done by a student-athlete—might be considered ordinary and necessary for certain types of businesses, such as a health food store, a physical therapist’s office, or a mobile phone company. The IRS might not find it ordinary and necessary for other businesses, such as management consultants or industrial manufacturers.
Do you have proper substantiation and documentation?
Businesses must adequately document and substantiate their expenses to claim tax deductions. This includes maintaining records of contracts, agreements, invoices, and other supporting documents that demonstrate the payment’s business purpose and commercial nature.
Have you followed advertising and endorsement guidelines?
Companies must adhere to advertising and endorsement guidelines set by industry organizations and regulatory bodies, including the Federal Trade Commission (FTC).
For example, the FTC requires anyone endorsing a product through social media to disclose if they have any financial, employment, personal, or family relationship with the brand.
Failing to comply with these guidelines could impact the deductibility of NIL payments or result in other legal consequences.
Tax laws and regulations can vary from state to state and country to country, so it’s crucial to understand your jurisdiction’s specific rules and requirements.
Review the regulations of your state and the student-athlete’s educational institution, or consult with a tax professional who is knowledgeable about the rules in your jurisdiction.
Is the NIL payment an arms-length transaction?
The IRS tends to scrutinize payments between related parties. For example, if a parent sells a house to their adult child, is that really a sale? Or is it actually a reportable gift disguised as a sale? When a parent hires their child to work in their business, is the child being paid a reasonable wage for the services they’re providing? Or is this a way for the parent to write off non-deductible personal expenses?
If you have an NIL contract with a student-athlete who isn’t related to you, this isn’t a concern. However, if the payment is to a related party (a sibling, spouse, child, grandchild, cousin, niece or nephew, etc.), you must ensure the fee is reasonable and reflects fair market value. This can be very difficult to pass the sniff test with the IRS, especially if you only endorsing your own child, if your child is not a top athlete or has a significant following.
Deducting NIL Payments: An Example
Let’s consider my client’s scenario (name and business have been changed for privacy) as an example to see how you might apply the factors above to your situation.
Dr. John Smith owns Dr. Smith, MD, PC. – a dermatology practice. His daughter, Sophia, is a volleyball player in her first year of college and doesn’t have a scholarship.
John wants to use NIL payments as a deductible business expense as a way to pay for Sophia’s tuition. Would these payments pass IRS scrutiny in the event John’s business was the subject of an IRS audit?
Some questions an auditor might consider include:
- Are the payments ordinary and necessary? What kind of marketing and promotional work did Sophia perform for the business? Are these kinds of activities standard in the industry?
- Was this an arms-length transaction? What services did Sophia perform for the business? Was her pay reasonable for the services provided?
- Are the expenses appropriately documented? Is there a contract in place, and did the business keep records of the hours Sophia worked or services provided and the business purpose?
If Dr. Smith, MD, PC. has never done this type of marketing before and pays Sophia far more than market rates for her NIL contract, the IRS auditor might reasonably conclude that John is disguising Sophia’s tuition as deductible business expenses and disallow the deduction.
NIL payments have the potential to be deductible expenses, but they are still relatively new and untested, so it’s essential to consider the tax implications before deducting them. If you’re interested in taking the next step in understanding the tax consequences of different business decisions, check out our ROI page to see if you’re a good fit for a complimentary tax analysis with Cerebral Tax Advisors. We’d be happy to show you how we can help your business maximize its deductions and boost its bottom line.