The IRS and state departments of taxation have increased enforcement efforts targeting unreported income earned by student athletes from their name, image, and likeness (“NIL”). As the tax laws applicable to these individuals and their families are often complex and not well understood by those operating within those areas, audits of those taxpayers often result in significant revenue generation, making it worthwhile for the federal and state governments to pursue. In this installment of Tax Talk, we take a closer look at student-athletes and the tax laws impacting their NIL arrangements.
The NIL Rule Change & Its Tax Impact
In July 2021, the NCAA changed its rules and began allowing student athletes to profit from their NIL. These student athletes are now permitted to enter endorsement deals, appear in advertisements, sell merchandise, and receive compensation for social media content. Student athletes are generally young adults between the ages of 18 and 22 who may not have any experience with filing their own taxes, as they are often claimed on their parents’ tax returns as dependents while they are in college. However, this change in their ability to profit from their NIL deals will have significant financial and tax implications that neither they nor their parents may fully understand or are prepared to handle.
What Counts as NIL Income?
For example, a student athlete does not always realize that NIL income is more than just cash. It includes non-cash compensation like merchandise, gift cards, cars, and other benefits, such as expense paid trips. The fair market value (“FMV”) of goods and services is considered taxable income. Student athletes must track all income, whether it comes in cash, goods, or services, and every dollar must be accounted for on their tax filings. When the IRS or state tax agency audits them, the IRS often finds out during their audit that the student athlete or the family have not reported the FMV of all of the goods and services the student athlete and/or their family received in connection with the student athlete’s business.
Common Deduction Mistakes & Risks
Additionally, a student athlete and their families may not fully understand what a student athlete may deduct on their returns. Some student athletes and their families have gotten themselves into predicaments with the IRS and state tax agencies because they have deducted exorbitant amounts in expenses without the required documentation to support the expenses. As a general rule, expenses must be ordinary and necessary expenses paid or incurred in the carrying on of a trade or business. Ordinary expenses are those that are common and accepted in your type of business, and necessary expenses are those that are helpful and appropriate for your business. However, reimbursable expenses for which the taxpayer has the ability to be reimbursed by a third party for those expenses are never deductible by the taxpayer.
Planning Ahead to Avoid Consequences
In conclusion, it is imperative that student athletes and their families, if applicable, consider the financial and tax implications of running their respective businesses and select the appropriate business structure to suit their needs. Mistake of law is never a defense in the course of a civil tax audit and if the IRS feels that a taxpayer has willfully failed to report income to the IRS or inflated its tax deductions, these taxpayers could find themselves facing criminal charges for tax fraud in addition to being slapped with civil liabilities.
For more information on this topic or to seek counsel from our Taxation group, please reach out to request a consultation or call us at 216-696-1422.
