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Friday, October 19, 2018

Weekly SSRN Tax Article Review And Roundup: Eyal-Cohen Reviews Schmalbeck & Zelenak's The NCAA And The IRS

This week, Mirit Eyal-Cohen (Alabama) reviews Richard Schmalbeck (Duke) & Lawrence Zelenak (Duke), The NCAA and the IRS: Life at the Intersection of College Sports and the Federal Income Tax, 91 S. Cal. L. Rev. ___ (2018).

Mirit-Cohen (2018)This Article is right down my alley. Athletics pretty much dominates my household of four boys (five, if you count my husband) that eat, sleep, and breathe all types of sports. Also, living in Tuscaloosa, AL, home of the Crimson Tide NCAA Champion leaves a mark. Bama’s beloved coach Nick Saban is often the subject of many discussions in my tax classes. So when I find something that interconnects both business (tax) and pleasure (sports), such as this Article, I grab the opportunity with both hands.

This Article offers a detailed account of the history and current status of the intersection between federal tax laws and college sports. The authors begin by stating that for many decades, college athletics enjoyed preferential tax treatment due to either the IRS’s lack of enforcement or direct tax benefits provided by Congress to college sports. This status quo was maintained until last year with the enactment of the Tax Cuts and Jobs Act of 2017 (“The 2017 Act”) that increased the tax burden on college athletics in several aspects. The authors seem optimistic about this change, yet recognize, that no similar signs of transformation have yet been observed from the IRS that has continued its lax enforcement policy regarding college sports.

The authors begin the Article by distinguishing in length between three subdivisions of athletic activity—Intramurals (affinity groups competing with each other at the same university), Nonrevenue Sports (intercollegiate athletics, “varsity” and “club” style), and Revenue Sports (NCAA “Division I” football and men’s basketball programs). Yet, not much of such distinction is being utilized in the Article as they go on and focus only on the latter category.

The Article discusses the operations of the IRC §511(a)(2)(B) that imposes regular for-profit corporate tax rates on unrelated business income (UBI) of tax-exempt organizations (such as universities) that regularly carry on activities unrelated to their exempt purpose (here, educational). Congress, the IRS, and the courts--have generally declared big-time sports to be sufficiently related to the educational enterprise to avoid the status of UBI activity. The authors question such favorable treatment. 

They claim that not applying UBIT on universities’ revenues from college sports activities is justifiable only if such activities relate to the broader educational purpose of the university. Yet, in their eyes “student-athletes” in such programs seem more like athletes than students in their selection, travel schedule, and graduation rates. Here I have to disagree with that statement, especially with the latter. University of Alabama takes pride in its student athletes’ GPA, having over 84 percent of them graduating college. Recent U.S. news reported Clemson has similar student athlete’s graduation rates, followed by Oklahoma and Georgia. Moreover, the point the authors are making about exclusive usage of facilities by student athletes for training, practice, and actual games, is also inaccurate in the case of University of Alabama who also uses Bryant-Denny Stadium and Colman Coliseum for community events and graduation ceremonies.  

Moreover, students nowadays participate, and a much larger number of students watch, big-time college sports events. And colleges also seek students involved in extracurricular activities as part of campus life such as musicians to staff the orchestra, actors to fill out their theatres, journalists to publish their newspaper and so on. These activities, if I may add, especially in a small university town such as Tuscaloosa, contribute to the community at large in distinctive ways and also help prepare students to life post-graduation. Athletics, therefore, is not necessary less so than any other extracurricular activity. Moreover, they are still a small portion of the university “primary” budget, which is dominated by the salaries of faculty and academic staff, construction and upkeep of the laboratories, classrooms and dormitories, management of the university’s endowment, and many other functions.  

Thereafter, the authors narrow their argument advocating to apply UBIT to revenues derived from broadcasting the games. The authors question the IRS’s justification for the exemption that “[T]he educational purposes served by exhibiting a game before an audience that is physically present and exhibiting the game on television or radio before a much larger audience are substantially similar.” They maintain that the experience of the television audience with small percentage of university connection, is much unrelated to the university educational enterprise, even if it helps recruit potential applicants for admissions. This argument applies even more so when special “networks” or cable and satellite providers receive subscription fees and pay substantial part of it to the conference that arranges the telecasts and passed it on to its member schools. While discrediting people who chose a university by the success of its athletic team, it seems that the authors are too quick to disregard the value of broadcasting (of any nonrevenue college, revenue college, or even high-school) sports provides and the enormous exposure to audiences such as  potential students, faculty, and donors that may not have heard of the institution otherwise. For example, in almost every broadcasting break of a game played by the Crimson Tide, the University of Alabama includes a long clip on the UA educational experience, scholarship strength, and engaged student life. If you calculate the cost of ten or more of these three-minutes-clips on prime time national TV you will find it is not negligible. And at least that imputed recruitment cost under the authors’ taxable broadcasting proposal should be allowed as a deduction. It is not merely “public recognition of the business by-product,” as the authors concede, but direct endorsement of its educational purpose and achievements.  

The second focus of the Article is the taxation of athletic scholarships, which albeit §117, have not been enforced by the IRS that relies on an old revenue ruling issued at a time when the NCAA disallowed withdrawal of scholarships in case of nonparticipation by student athletes.  The authors described such nonparticipation practice as a “slippery slope” and expressed concerns regarding the “one-and-done” business plan by which athletic players attend universities for one semester only and then go on to play at professional leagues. They mention University of Kentucky and Duke who have many freshmen players that leave to play at professional leagues soon after their first semester. The authors propose that the IRS issue a new revenue ruling, with facts consistent with current NCAA athletic scholarship rules and practices, stating that scholarships that can be withdrawn based on voluntary nonparticipation are not excluded from gross income under §117 and are subject to the payroll taxes as well as to the income tax.

The authors’ third emphasis in the Article is the tax benefit of claiming charitable deductions for the cost of season tickets under § 170(l), which was recently terminated by the 2017 Act.  Enacted in 1988, this provision allowed a deduction of 80% of the amount of donations to universities, where the donation was conditioned on the grant of rights to purchase tickets to university athletic events. The authors provide a detailed history of this issue showing Congress’ demonstrated tendency to go back-and-forth and favor college sports, and suggesting this is an area that warrants sustained caution. Congress explained that allowing deductibility of those charitable donations was made for administrability reasons and unavoidable valuation controversies between the IRS and many individual taxpayers as to the proper value of such payments to college athletic scholarship programs. Dismissing this valuation argument (maybe too soon), the authors hold that the essence of charitable donation deduction is to reflect true donations, not exchanges of more or less equal value. If the latter were deductible, they ask, why wouldn’t deductions be allowed for the payment of hospital bills by patients, or the payment of tuition by students? These examples seem highly distinguishable from rights to purchase tickets that may fluctuate between seasons, location, and membership longevity.     

Lastly, the authors discuss Congress’s newly imposed 21 percent excise tax on universities paying salaries over $1 million through the operation of new § 4960 added by the 2017 Act. The authors estimate this section to target over 240 football and basketball coaches. Yet, aside from football and basketball coaches, while the Act specifically exempts medical professionals, several key university employees such as presidents and sometimes their vices also reach seven figures salaries and are targeted by this new excise tax. The authors discuss the legislative confusion whether § 4960 applies to public universities as was discussed in length by tax law professor Ellen Aprill blog post (claiming public universities are exempt under the statutory immunity doctrine), Douglas Kahn’s Tax Notes Article (arguing the new tax specifically applies to § 501(c)(3) tax exempt organizations), Professor Aprill’s reply (universities can voluntary renounce their §501(c)(3) status and rely solely on implied statutory immunity), and the contradicting government officials’ views to such arguments. The authors view § 4960 in the large grand schemes of Congress’s latest decision to enforce § 162(m) on compensation paid in public companies to their top executives and remove the exception for performance-based compensation. Since, in the case of universities, the organization paying the seven-figure salary was exempt from tax, the solution, the authors explained, was to impose the penalty by way of an excise tax on salaries over $1 million, rather than by way of disallowing deductions such as the for-profit public companies case. The authors advocate that we should view § 4960 as reflecting a policy of market-be-damned disapproval of seven-figure coaches’ salaries (assuming it applies to public universities as well as to privates).The trouble is that the economic incidence of the new excise tax will likely not fall completely (if at all) on coaches but on major donors to athletic departments, the departments themselves, and nonathletic educational functions of the universities. And on that I comment “you're damned if you do and you're damned if you don’t.”

Here’s the rest of this week’s SSRN Tax Roundup:

https://taxprof.typepad.com/taxprof_blog/2018/10/weekly-ssrn-tax-article-review-and-roundup-eyal-cohen-reviews-schmalbeck-zelenaks-the-ncaa-and-the-i.html

Scholarship, Tax, Weekly SSRN Roundup | Permalink

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