In Private Letter Ruling 202540024, the IRS ruled that an organization formed to facilitate name, image and likeness (NIL) sponsorship deals for certain athletes of a college did not qualify as tax-exempt under IRC Section 501(c)(3) because it primarily served the private interests of those collegiate athletes rather than a charitable public interest.

Facts

The organization in question was incorporated in State C and aimed to support the educational mission of College E by facilitating NIL sponsorship deals for selected athletes. Its activities included managing NIL rights and funding sponsorship payments to the student athletes to promote the university and related charitable organizations. The organization did not limit the compensation athletes could earn, although it anticipated what amounts would exceed a specified dollar figure annually. The organization projected that a small percentage of its income would come from gifts and grants, while the majority would be generated from investment income. The organization's expenses were primarily related to NIL sponsorship deals, along with fundraising and professional fees.

Law and analysis

Under IRC Section 501(c)(3), organizations must be organized and operated exclusively for charitable, educational, or other exempt purposes. The IRS applies a two-part test to determine eligibility: the organizational test and the operational test. The operational test, as outlined in Treas. Reg. Section 1.501(c)(3)-1(a)(1)(ii), requires an organization to be operated exclusively for exempt purposes. Treas. Reg. Section 1.501(c)(3)-1(c)(1) does not regard an organization as operated exclusively for exempt purposes if more than an insubstantial part of its activities generates private benefit, rather than substantially furthering exempt purposes.

The organization's activities centered around securing and managing NIL rights for athletes, which directly benefited those individuals financially. The IRS emphasized that an organization must engage primarily in activities that further its exempt purposes. In this case, the IRS determined that the organization's substantial focus on providing compensation to individual athletes provided more than insubstantial private benefit to the athletes, and that such private benefit was not necessary and incidental to achieving the organization's tax-exempt educational or charitable purposes.

The IRS referenced several revenue rulings and court cases to illustrate its reasoning. For instance, in Revenue Ruling 61-170, an association of professional nurses that operated a nurses' registry to improve employment opportunities for its members and facilitate nursing placement services for the community was found ineligible for exemption, as its activities primarily benefited private interests rather than serving a public purpose. Similarly, the IRS determined that the NIL organization's focus on individual athletes primarily benefited private individuals and was not merely incidental to achieving the organization's exempt purposes.

The IRS also noted that the organization's activities did not align with the precedent set in Revenue Ruling 70-186, where an organization's activities to preserve a lake as a public recreation area, while benefiting some private individuals who owned lakefront properties, were primarily aimed at serving the public interest. In contrast, the IRS found the NIL funding organization to directly confer substantial benefits to a specific group of student athletes, and that such benefit was not necessary and incidental to furthering its exempt purposes.

The organization's funding of NIL deals was characterized as a direct monetary benefit to the athletes involved. This direct benefit is significant, as noted in Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279 (1945), because the presence of a single nonexempt purpose, if substantial, can preclude exemption regardless of the exempt purposes pursued. The IRS concluded that the organization's primary activity of compensating athletes for their NIL rights was not merely incidental to its exempt charitable activities but rather constituted a substantial part of its operations.

The organization also failed to establish that the student athletes it benefited constituted a charitable class. While an organization may benefit individuals, the IRS pointed out that it must do so in a manner that serves a broader public interest. In this case, the organization's activities were primarily aimed at a specific group — certain student athletes at College E — without demonstrating how these benefits served the public at large. The organization further failed to demonstrate that its NIL sponsorship and funding activities were necessary to accomplish an exempt purpose. Instead, the IRS determined that the organization's primary focus was on increasing the financial compensation of a select group of athletes.

The organization argued that its NIL activities were essential for the competitive success of the college's athletic programs, and that providing financial support to athletes was necessary for their recruitment and retention. However, the IRS was not convinced that these NIL activities primarily furthered the educational or charitable purposes of the college in a manner that would qualify for tax exemption under IRC Section 501(c)(3). Rather, the IRS determined that the substantial private benefits conferred upon individual athletes for use of their NIL was neither insubstantial nor incidental compared to the organization's other activities.

Implications

This ruling reflects the IRS's stated position in a 2023 generic legal advice memorandum (GLAM) (AM 2023-004) addressing whether nonprofit organizations that facilitate NIL payments to and sponsorship deals for student-athletes (NIL collectives) qualify for tax exemption under IRC Section 501(c)(3). (See Tax Alert 2023-1093). In that GLAM, the IRS determined that the benefit to private interests of student-athletes is more than incidental, both qualitatively and quantitively, to the tax-exempt purposes of most NIL collectives, so those NIL collectives do not qualify for tax exemption under IRC Section 501(c)(3). In both the instant ruling and the GLAM, the IRS emphasized that the student-athletes who benefit from the nonprofit NIL collectives are not a recognized charitable class.

This ruling emphasizes the importance of adhering to the operational test for tax-exempt status, not just for NIL collectives but for all IRC Section 501(c)(3) organizations, highlighting that any substantial private benefit derived from an organization's activities can jeopardize its exemption.

This ruling does not address the possible unrelated business taxable income (UBTI) implications of NIL collectives, higher education organizations or booster clubs receiving contribution income for programs that promote NIL opportunities for student-athletes. Presumably, that contribution income would be UBTI if any exempt purpose furthered by the NIL activity were secondary and incidental to the nonexempt purpose of benefiting student-athletes, suggesting that the activity is not substantially related to exempt purposes. Nor does the ruling address whether an NIL arrangement involving payments to student athletes for NIL licensing and/or services could have employment tax and/or income tax implications, issues the IRS is likely to address in the future.