A monumental change is taking place for college athletes this summer, with many states having passed legislation to allow athletes to obtain financial income from selling their name, image, and likeness (NIL) to companies. With many states having laws taking affect this past week, the NCAA has now announced temporary rule changes to allow all athletes to take advantage of NIL. There will remain a lot of uncertainty and inconsistency until we get a federal law (being worked on), but one thing for certain is the IRS will be taking notice. I have yet to see any articles on the tax implications for these athletes and their families, so let me be one of the first to sound the alarm bells and encourage all athletes benefiting from NIL income to ensure you do not get sideways with the tax authorities.
Don’t mess with the IRS
Make no mistake, the IRS will see these new laws as a new source of income for the government, and athletes earning money while in college will now have to file taxes and report this income. If you do not comply, you will likely be subject to onerous penalties and interest for failure to file returns and pay your taxes. And my guess is most 18-22 year old’s do not have much experience filing taxes, as most likely did not make enough part time income to be required to file.
The types of income that these athletes will be making is similar to endorsement income made by professional athletes and other celebrities. And there are numerous examples of these more experienced, mature adults running afoul of the IRS because they did not file, or they did not properly report their income. Here are a few examples:
- Ozzy and Sharon Osbourne – As of 2011 owed the IRS more than $2 million for unpaid taxes from 2007 – 2009. The IRS put a lien on their house.
- Dionne Warwick – Filed for bankruptcy in 2014, stating she owed $10.7 million in federal and state taxes.
- Pamela Anderson – Owed more than $370,000 to the IRS and state of California for unpaid taxes in 2011.
- Nicholas Cage – At one time owed the IRS more than $14 million.
- Jim Thorpe – The professional golfer spent time in jail, owing the IRS $2 million in unpaid taxes.
You might wonder how these amounts are so large? The penalties and interest that the IRS will add to taxes owed can be quite onerous, and they can pile up quickly.
How will NIL income be treated?
This is a critical question to ponder. Once again, we can look to professional athletes and celebrities to see how the IRS views this type of income. Basically, it can be treated in one of two ways: as royalty income or as professional services income. And there is a significant difference in how much in taxes you will pay depending on this treatment.
Professional services income is considered “earned income” that is subject to FICA (social security and medicare) taxes. Therefore, this is considered business income, and in addition to income tax paid on these earnings, the taxpayer will also be obligated to pay FICA taxes of 15.3% (a portion of which maxes out at higher income levels). On the other hand, royalty income is not subject to FICA taxes, so the more that is classified as royalty income the better.
So how do you determine whether your NIL income is royalty income, professional services income, or some combination of both? We can get some insight from previous tax court cases, and in particular U.S. vs. Goosen. This was a 2011 court case involving Retief Goosen, a professional golfer who had a dispute with the IRS in regards to the classification of his income. Although the focus on this case was primarily whether the income was U.S. based or foreign based, it still provides insight and sets some precedents in how this type of income is classified. And a lot of it depends on the language in the contract.
However, here are some basics. If the compensation depends on you being physically present at an event, it is professional services income. For example, the athlete is present at a car dealership on a Saturday afternoon to promote the business, this is professional services income. In contrast, if the athlete is being compensated just for the use of his or her name or likeness, with no other obligations on the part of the athlete, then this would be royalty income. For example, let’s say EA Sports comes out again with college sports games with player likenesses, and the athletes get a check from EA sports for this. That is clearly royalty income. Sounds simple, right.
However, it can get more complicated. What if the athlete is being compensated for his or her likeness, but the athlete is required to pay in x number of games during that season to earn the fee? Or the fee is adjusted based on how often they play? Then you are likely to have some mix of royalty income and professional services income. In this arrangement, you should consider finding a tax expert to advise you, so that you both avoid issues with the IRS, but you also minimize the amount of taxes you pay.
Tax planning issues
There are legal ways to minimize some of these taxes. For example, you are able to deduct certain expenses from your personal services income to determine your taxable income. Also, for athletes who will likely have higher amounts of personal services income (a minimum of $50,000 – $75,000 per year), it may make sense to set up a loan-out corporation, which can help to reduce the FICA taxes owed. A tax advisor can assist you in determining if this makes financial sense and guide you through the process.
State tax issues
It’s not only the IRS who will be looking at this for new revenue, but also states that have personal income taxes. Keep in mind that you may owe tax in every state where you make appearances for a fee (except for those states with no state income tax). Also, your state of residence will tax all of your income, although most will give you credit for taxes paid to another state. What if your parents live in a state without a state income tax, and you go to school is a state that does have an income tax. Which state is your state of residence? This could have a significant impact on the taxes you will pay.
It is exciting to see that college athletes will now be compensated for their efforts, and this will be a financial windfall for many athletes that will allow them to support their families. However, along with that comes a requirement to make sure this income is not wasted through paying penalties and interest for failing to file or pay taxes. The IRS is good at tracking this type of activity, so it is not likely you can avoid paying taxes on this income. Athletes should always set aside a certain percentage of earnings to pay these taxes, and make quarterly estimated payments to ensure no interest charges are incurred. Finding a tax advisor to help sort through these complex tax issues and stay on top of compliance is a must.
If you would like to set up a free initial consultation to discuss your situation, give me a call at (479) 876-9980, ext. 102, or email me at Brent@seaycpas.com.