NCAA: From Cream Cheese To Endorsements

You may have read that the NCAA voted to allow students to benefit financially from the use of their name, image or likeness.

In truth, their hand was forced when California Governor Newsom signed the Fair Pay to Play Act on Lebron’s television show “The Shop.” Other states, including Florida, were also lining up on the issue.

Newsom was striking at an organization that realized over a $1 billion in revenues last year from “student-athletes,” all the while banning players from receiving any compensation other than scholarships.

Mind you, this is the same organization that used to ban schools from serving bagels with cream cheese. The NCAA argued (with a straight face somehow) that a bagel was a snack but a bagel with cream cheese was a meal. Meals were a no-go.

The tax hook for this post came from North Carolina (U.S.) Senator Richard Burr, who indicated he would introduce a bill to tax scholarships if the student-athlete also earns money from endorsements.

Methinks that Senator Burr is not a fan of the new rule.

Alternatively, he may subscribe to the new-economics theory of taxing something until it stops doing whatever triggered its taxation in the first place.

Did you know that some scholarships are already taxable?

Yep, the plain-old variety.

Scholarships used to be tax-free until 1980. The Code was then changed to look at whether services were being performed as a requirement for receiving the scholarship. Teaching assistantships would now be taxable, for example.

There was further change in 1986, when the Code began taxing scholarships used for living expenses.  If one received a scholarship, it was now important to determine whether it was for tuition or for room-and-board. Tuition was tax-free but room-and-board was not.

COMMENT: This change seems erratic to me, considering that The College Board has reported that living expenses make-up over half the cost of undergraduate education.

Scholarships for non-degree students next became taxable.

I would have to think about what national existential peril we barely avoided with that change to the tax law.

Senator Burr would add another exception-to-the-exception if you could buy a jersey with someone’s name on it. Alabama’s Tua Tagovailoa comes to mind. Your being able to buy a jersey with his name and number would make his scholarship taxable. It probably means little in Tua’s case, as he is projected to be a first round NFL draft selection. Take someone in a less prominent sport and the result might not feel as comfortable.

Then again, someone less prominent would probably not get into a payment-for-name, image-or-likeness situation.

The Nick Saban Tax

Have you heard about the “Nick Saban” tax?

Let’s set it up.

There has been a longstanding tax provision limiting the deduction for public company executive compensation to $1 million. Mind you, this is not a restriction on how much you can pay an executive; the restriction only applies to how much you can deduct on a tax return. The restriction does not apply to all executives, either; it applies to the CEO, CFO and three other most-highly-paids.

But there was an exception large enough for the Fortune 500 to drive through. The exception was for “performance.” Magically and almost overnight, virtually all executive compensation packages became based on “performance.” Options were considered performance-based, and eventually options came to be passed around like candy. Realistically, one had to refuse to do any tax planning for this provision to actually apply.

This changed with the Tax Cuts and Jobs Act passed in December, 2017. Congress tightened up this code Section (162(m)) by taking away the performance exception. The $1 million cap now has a real bite.

But Congress was still looking for money.

Congress decided to put the same $1 million compensation limit on nonprofits.

This creates a quandary, as nonprofits (generally) do not pay tax. If I were a nonprofit executive and Congress threatened to disallow my deduction, I would not be feeling the tremulous fear of my for-profit peers.

Congress thought of that. They decided that the nonprofit would pay a 21% tax on my behalf.

Whoa. Now you have my attention. Granted, the tax is not on me, but we all know how this works in the real world. Only small children and Congress believes in free. The rest of us have to pay.

Congress passed a tax provision applying the $1 million cap to the five highest- paid employees of a 501(a), which includes a 501(c)(3). Think nonprofits, certain hospitals, colleges and universities and the like.

BTW medical professors were excluded from this, so it appears clear that Congress was trying to reach the athletics programs and their coaches.

But there is a problem.

Here is Code section 4960 imposing the tax:

       (c)  Definitions and special rules.

For purposes of this section-

(1)  Applicable tax-exempt organization.

The term "applicable tax-exempt organization" means any organization which for the taxable year-

(A)  is exempt from taxation under section 501(a) ,

(B)  is a farmers' cooperative organization described in section 521(b)(1) ,

(C)  has income excluded from taxation under section 115(1) , or

(D)  is a political organization described in section 527(e)(1) .

What is that Section 115(1)?

         § 115 Income of states, municipalities, etc.

Gross income does not include-

(1)  income derived from any public utility or the exercise of any essential governmental function and accruing to a State or any political subdivision thereof, or the District of Columbia; or …

What does this mean?

Congress thought that – by extending Section 4960 to reference Section 115(1) – it would reach those entities exempt via Section 115(1).

Entities such as Alabama.

Or the University of Alabama.

Why?

Because the University of Alabama is an instrumentality of the state of Alabama.

And here the tax law goes wonky.

The Courts have looked at the interaction of Sections 115(1) and 511(which is the unrelated business income tax which applies to a nonprofit). Can a state instrumentality (say a university) run a business – say a farm-to-table restaurant chain – and avoid the unrelated business income tax because of Section 115(1)? If that were the case, then Illinois could start a chain called Outfront Steakhouse, make a zillion dollars and never pay tax because of Section 115(1).

The Courts have clarified that is not the case. There is a limit to Section 115(1).

According to that reasoning, it seems to me that Congress should be able to tax those university salaries.

But there is another argument – the doctrine of implied statutory immunity. This arises from our federalist system of government: the federal government has to respect the state government. Under this theory, if the federal government wants to tax a state, it has to say so in an unambiguous manner – that is, it cannot be “implied.”

Continuing our example, if the federal government wanted to tax Illinois for opening a steakhouse chain and locating them adjacent to every Outback Steakhouse location throughout the land, it would have to say something like:

… the [] tax will apply to an entity relying upon Section 115(1) for nontaxability of their [] business activity should that activity be the same or substantially similar to a business activity conducted by a for-profit restaurant chain.”

That is explicit. That breaches implied statutory immunity. The tax would then stick.

Is that what Congress did with the new Section 4960(c) tax?

Nowhere close, it appears.

Under that reasoning the University of Alabama will not pay the Nick Saban tax, as the tax does not reach the University of Alabama.

There are universities clearly affected by this new law: Duke, for example, or Northwestern. They have to pay up. Think of it as the difference between a “public” university and a “tax-exempt” university.

But having the state name in the university’s name, however, does not mean that the university is exempt as “public.” It depends on how the university was organized and chartered. Texas A&M will be affected by the new tax provision, but the University of Texas - Austin will not. It is enough to give one a headache.

What happens next?

The easiest path is for Congress to revise Code section 4960 and clean up the language. Without Congressional action, you can be certain the “public” universities will litigate this matter. They have to.

But the likelihood of the present Congress accomplishing anything seems unlikely, at best.

Cincinnati Reds, Tax And Bobbleheads

Did you hear about the recent tax case concerning the Cincinnati Reds?

It has to do with sales and use tax. This area is considered dull, even by tax pros, who tend to have a fairly high tolerance for dull. But it involves the Reds, so let’s look at it.

The Reds bought promotional items - think bobbleheads - to give away. They claimed a sales tax exemption for resale, so the vendor did not charge them sales tax.

Ohio now wants the Reds to pay use tax on the promotional items.

COMMENT: Sales tax and use tax are (basically) the same thing, varying only by who is remitting the tax. If you go to an Allen Edmunds store and buy dress shoes, they will charge you sales tax and remit it to Ohio on your behalf. Let’s say that you buy the shoes online and are not charged sales tax. You are supposed to remit the sales tax you would have paid Allen Edmunds to Ohio, except that now it is called a use tax. 

The amount is not insignificant: about $88 grand to the Reds, although that covers 2008 through 2010.

What are the rules of the sales tax game?

The basic presumption is that every sale of tangible personal property and certain services within Ohio is taxable, although there are exemptions and exceptions. Those exemptions and exceptions had better be a tight fit, as they are to be strictly construed.

The Reds argued the following:

·      They budget their games for a forthcoming season in determining ticket prices.

·      All costs are thrown into a barrel: player payroll, stadium lease, Marty Brennaman, advertising, promotional items, etc.

·      They sell tickets to the games. Consequently, the costs – including the promotional items – have been resold, as their cost was incorporated in the ticket price.

·      Since there is a subsequent sale via a game ticket, the promotional items were purchased for resale and qualify for an exemption.

Ohio took a different tack:

·      The sale of tangible personal property is not subject to sales tax only if the buyer’s purpose is to resell the item to another buyer. Think Kroger’s, for example. Their sole purpose is to resell to you.

·      The purpose of the exemption is meant to delay sales taxation until that final sale, not to exempt the transaction from sales tax forever. There has to be another buyer.

·      The bobbleheads and other promotions were not meant for resale, as evidenced by the following:

o   Ticket prices remain the same throughout the season, irrespective of whether there is or isn’t a promotional giveaway.

o   Fans are not guaranteed to receive a bobblehead, as there is normally a limited supply.

o   Fans may not even know that they are purchasing a bobblehead, as the announcement may occur after purchase of the ticket.

The Ohio Board of Appeals rejected the Reds argument.

The critical issue was “consideration.”

Let’s say that you went to a game but arrived too late to get a bobblehead. You paid the same price as someone who did get a bobblehead, so where is the consideration? Ohio argued and the Board agreed that the bobbleheads were not resold but were distributed for free. There was no consideration. Without consideration one could not have a resale.

Here is the Board:

The evidence in the record supports our conclusion that the cost of the subject promotional items is not included in the ticket price.”

The Reds join murky water on the issue of promotional items. The Kansas City Royals, for example, do not pay use tax on their promotional items, but the Milwaukee Brewers do. Sales tax varies state by state.

Then again perhaps the Reds will do as the Cavaliers did: charge higher ticket prices for promotional giveaway games.

This is (unsurprisingly) heading to the Ohio Supreme Court. We will hear of The Cincinnati Reds, LLC v Commissioner again.

Michael Jordan, The Grizzlies And The Jock Tax

I have been reading recently that the jock tax may be affecting where athletes decide to play. For example, Ndamukong Suh, an NFL defensive tackle formerly with the Detroit Lions, was wooed by the Oakland Raiders but opted instead to sign with the Miami Dolphins. I can understand a top-tier athlete not wanting to play for a team as dysfunctional as the Raiders, but one has to wonder whether that 13.3% top California tax rate was part of the decision. Florida of course has no income tax.

Let’s not feel sorry for Suh, however. His contract is worth approximately $114 million, with $60 million guaranteed.

So what is the jock tax?

Let’s say that you work in another state for a few days. You may ask whether that state will want to tax you for the days you work there. Some states tell you upfront that there is no tax unless you work there for a minimum number of days (say 10, for example). Other states say the same thing obliquely by not requiring withholding if you would not have a tax liability, requiring you (or your accountant) to reverse-engineer a tax return to figure out what that magic number is. And then there are … “those states,” the ones that will try to tax you just for landing at one of their airports.

Take the same concept, introduce a professional athlete, a stadium and a game and you have the jock tax.

It started in California. Travel back to 1991 when Michael Jordan led the Bulls to the NBA Finals. After the net was cut and the celebrations finished, Los Angeles contacted Jordan and informed him that he would have to pay taxes for the days that he spent there.

Illinois did not like the way California was treating their favorite son, so they in turn passed a law imposing income tax on athletes from other states if their state imposed a tax on an Illinois athlete. This law became known as “Michael Jordan’s Revenge.”

How do you allocate an athlete’s income to a given city or state? That is the essence of the jock tax and what makes it different from you or me working away from home for a week or so.

If we work a week in Illinois, our employer can carve-out 1/52 of our salary and tax it to Illinois. Granted, there may be issues with bonuses and so on, but the concept is workable.

But an athlete does not work that way. What are his/her work days: game days? Game and travel days? Game, travel, and practice days?

Let’s take football. There are the Sunday games, of course, but there are also team meetings, practice sessions, film study, promotional events, as well as minicamps and OTAs and so on. Let’s say that this works out to be 160 days. You are with Bengals and travel to Philadelphia for an away game. You spend two days there. Philadelphia would likely be eying 2/160 of your compensation.

This method is referred to as the “duty days” method.

Cleveland separated from the pack and wanted to tax players based on the number of games in the season. For example, the city tried to tax Chicago Bears linebacker Hunter Hillenmeyer based on the number of season games, which would be 20 (16 regular season and 4 preseason). Reducing the denominator makes Cleveland’s share larger (hence why Cleveland liked this method), but it ignores the fact that Hillenmeyer had duty days other than Sunday. What Cleveland wanted was a “games played” method, and it was shot down by the Ohio Supreme Court.

Cleveland also had an interesting twist on the “games played” method. It wanted to tax Indianapolis Colts center Jeff Saturday for a game in 2008.  However, Saturday was injured and did not play in that game, making Cleveland’s stance hard to understand. In fact, Saturday was injured enough that he stayed in Indianapolis and did not travel with the team, now making Cleveland’s position impossible to understand. Sometimes bad law surfaces when pushed to its logical absurdity, and the Ohio Supreme Court told Cleveland to stop its nonsense.

Tennessee wrote its jock tax a bit differently. Since the state does not have an income tax (more accurately, it has an income tax on dividends and interest only) it could not do what California, Illinois and Ohio had done before. Tennessee instead charged a visiting athlete a flat rate, irrespective of his/her income. For example, if you were a visiting NBA player, it would cost $2,500 to play against the Memphis Grizzlies.

Tennessee also taxed NHL players (think Nashville Predators) but not NFL players (think Tennessee Titans).

I guess the NFL bargains better than the NHL or NBA.

One can understand the need to fund stadiums, but this tax is arbitrary and capricious. What about a non-athlete traveling with the team? That $2,500 may be more than he/she earned for the game.

Tennessee has since abolished this tax for NHL players but has delayed abolishment until June 1, 2016 for NBA players.

In other news, NFL players remain untaxed.

We have talked about the denominator of the fraction to be multiplied against an athlete’s compensation. Are you curious what goes into that compensation bucket?

Let’s answer this with a question: why do so many athletes chose to live in Texas or Florida? The athlete may have an apartment in the city where he/she plays, but his/her main home (and family) is in Dallas, Nashville or Miami.

Let’s say the athlete receives a signing bonus. There is an extremely good argument that the bonus is not subject to the jock tax, as it is not contingent upon future performance by the athlete. The bonus is earned upon signing; hence its situs for state taxation should be tested at the moment of signing. Tax practitioners refer to this as “non-apportionable” income, and it generally defaults to taxation by the state of residence. Take residence in a state with no income tax (hello Florida), and the signing bonus escapes state tax.

Consider Suh and the Miami Dolphins. California’s cut of his $60 million signing bonus would have been almost $8 million. Florida’s cut is zero.

What would you do for $8 million?

The NFL Is Giving Up Its (c)(6) Tax Status

So the NFL is going to relinquish its 501(c)(6) status, meaning that it will start filing as a regular, tax-paying corporation.

And I doubt it means much, unless someone simply has simply lost the plot when it comes to the NFL.

Let’s talk about it.

The gold-plate among tax-exempts is a 501(c)(3), which would include the March of Dimes, Doctors Without Borders and organizations of that type. The (c)(3) offers two key benefits:

(1)  Donations made are deductible, which is especially important to individuals.

(2)  Donations received are not taxable.

Point (1) is important because individuals are allowed only a limited plate of deductions, unless the individual is conducting a business activity. Point (1) is probably less important to a business, as the business could consider the donation to also be advertising, marketing, promotion or some other category of allowable deduction. An individual unfortunately does not have that liberty.

Point (2) represents the promised land. We would all like our income to be nontaxable.

The NFL is a (c)(6), which means that it does not receive benefit (1). It does not need benefit (1), however, as no one is trying to claim a donation.

Here is how the tax Code describes a (c)(6):

Business leagues, chambers of commerce, real-estate boards, boards of trade, or professional football leagues (whether or not administering a pension fund for football players), not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual.

By the way, are you curious how the words “professional football leagues” got in there?

The NFL had been a nonprofit going back into the 1940s. During the 1960s it faced a challenge from the Al Davis and American Football League. An easy way to defuse an enemy is to recruit the enemy, and the NFL was talking to the AFL about merging. There was an issue, however, and that issue was antitrust. There were two leagues playing professional football, and there was a proposal on the table to combine them.

This made the proposed merger political.

It also meant that one had to go through Senator Russell Long, an extremely powerful senator from Louisiana.

Pete Rozelle, the then NFL commissioner, had an idea. What if the NFL “expanded” the league to include a team in Louisiana? Senator Long was quite interested in that turn of events.

And that is how we got the New Orleans Saints.

And, around that time, Congress amended the Code to include the words “professional football leagues.”

Back to our story.

So the NFL does not care about benefit (1). The reason is that the NFL does not receive monies from individuals like you and me. It receives money from its business members, which are the 32 NFL teams. Each team is a corporation, and payments by them to the NFL may be deducted a hundred ways, but none of those ways can be called a “donation.”

Notice that the “NFL” that is giving up its tax exempt status is NOT the individual teams. The “NFL” under discussion is the league office, the same office that organizes the draft, reviews and revises game rules, hires referees, and negotiates labor agreements with the players union. Each individual team in turn is a separate corporation and pays tax on its separate profits.

So is the league office a money-making machine, committing banditry by being tax-exempt?

Here I believe is the real reason for the NFL’s decision to relinquish its (c)(6): the NFL is tired of explaining itself. The NFL is an easy target, and the issue brings bad press when the NFL is trying to create good press, especially after recent issues with domestic violence and player concussions.  

But to give up the promised land of taxation…?!

Why would they do that?

What if there was no profit left once the league paid everything? You have to have a profit before there can be a tax.

That is, by the way, (c)(6)’s are supposed to work. They are not a piggybank. They are intended to promote the interests of their members, whatever that means in context. Years ago, for example, I worked on the tax filings for the Cincinnati Board of Realtors, a classic (c)(6). You can readily presume that its interests are to promote the recognition, status and earning power of realtors in the Cincinnati real estate market.

The same way the NFL promotes its teams in a sports universe including Major League Baseball, the NHL, NBA, NCAA sports, MMA and so on.

How about the $44 million salary to Commissioner Roger Goodell? Is it outrageous for a tax-exempt to pay a salary of this amount?

Outrage is a tricky thing. Someone might be outraged that a tag-a-long politician has become rich by having her ex-President husband steer – and then drain – donations to a family foundation while she was serving as secretary of state.

Let’s replace “outrage” with something less explosive: is it reasonable for the NFL to pay Goodell $44 million?

Well, let’s consider an alternative: each team pays Goodell 1/32nd of his salary directly.

The financial and tax effect is the same, although this structure may be more acceptable to some people.

So the NFL league office is going to be taxable.

And I am looking at the NFL’s Form 990 for its tax year ended March 31, 2013. For that year, the excess of its revenues over expenses was almost $9 million.

How I wish that were me. I would be blogging as the Travelling-Around-The-World Tax Guy.

Nine million dollars would trigger some serious tax, right?

Wait.

I also see on the Form 990 that the year before there was a loss of more than $77 million.

Ouch. That, in the lingo of a tax-paying corporation, is a net operating loss (NOL). It can be carried forward and deducted against profits for the next 20 years.

Let’s assume that $9 million or so profit for the NFL is a reasonably repetitive number.

Have we eliminated any tax payable by the NFL for the next eight or more years?

No, it will not work that way. The NOL incurred while the NFL was tax-exempt will not be allowed as a deduction when it becomes tax-paying. However, if it happened once, it can happen again – especially if the tax planners REALLY want it to happen.

Even if it doesn’t happen, the federal tax would be around $3 million, which is inconsequential money to billionaire team owners who are trying to maximize their good press and minimize their bad.

And remember: tax returns filed by a tax-paying corporation are confidential. There will be no more public disclosure of Goodell’s salary.

Although if I made $44 million, I would post my W-2 on Facebook.