Complicated Tax Issues Confront Student Athletes Earlier than Ever

CPAs across Pennsylvania likely will start seeing more student  athletes become clients this year, or the existing “kid” returns will now be more complicated than ever before. The reason for these new clients and added complexity is the now-allowable name, image, and likeness (NIL) income for student athletes.

Of course, with this access to new income there are new challenges for student athletes with respect to tax matters arising from NIL income. For one, NIL income compounds the tax treatment of scholarships as well as the relaxed rules regarding the payment of stipends to student athletes for their athletic engagement while completing their education. This feature recaps the developments in compensation to student athletes, the tax issues they face, personal financial planning considerations, and some university considerations to foment their student athletes’ long-term success.

New Developments

When it comes to the world of NIL income right now, the term “Wild West” may actually fall short.

The door swung wide open for student athlete compensation with the June 21, 2021, U.S. Supreme Court decision in National Collegiate Athletic Association (NCAA) v. Shawne Alston. The case was brought under the Sherman Act,¹ which prohibits arrangements made in restraint of trade. Alston asserted that the NCAA rules that limit compensation of student athletes create a monopsony, through which the NCAA and member schools earn billions of dollars at the expense of student athletes.

The Supreme Court concluded: “[University and alumni] traditions alone cannot justify the NCAA’s decision to build a massive money-raising enterprise on the backs of student athletes who are not fairly compensated. Nowhere else in America can businesses get away with agreeing not to pay their workers a fair market rate on the theory that their product is defined by not paying their workers a fair market rate. And under ordinary principles of antitrust law, it is not evident why college sports should be any different. The NCAA is not above the law.”²

After the 2021 decision, there was a collective “Now what?” The NCAA, its member schools, student athletes, and state legislatures have spent the past several years trying to construct some kind of structure for this highly fluid enterprise, in which it seems that anything goes regarding the compensation of student athletes. Some state legislatures, Pennsylvania included, were quick to pass legislation. Some states have not yet created law.

In the ensuing years since the decision, “collectives” have been established by alumni sports organizations. These organizations and marketing entities arrange for NIL income opportunities for student athletes. Universities, while also increasing scholarships, are trying to rein in control over compensation arrangements and protect their student athletes. It’s not easy. Some enterprising student athletes are going their own way, finding ways to earn compensation through social media influencing and affiliate marketing. Alumni organizations are also arranging for the housing of student athletes’ families on game weekends in donors’ homes, and cars are showing up everywhere for student athlete use.

Tax Issues for Student Athletes

All these varying potential sources of income raise enough tax issues to make a CPA’s head hurt, let alone the mind of a 20-year-old who has to study and attend classes, pursue their required athletic training and competition, engage socially, and now show up for NIL-income-related events. The following discussion is based on current law, and not the post-expiration potentialities of a number of Tax Cuts and Jobs Act provisions of the Internal Revenue Code (IRC).

Scholarships – IRC Section 61(a) says gross income includes all income from whatever source derived, with the fine print that says unless you can find an exclusionary statute. Lucky for students, IRC Section 117(a) excludes qualified scholarships from gross income. Looking at the definition in IRC Section 117(b), a qualified scholarship is excludible only to the amount of qualified educational expenses paid – or simply put, the tuition and fees required for enrollment or attendance of a student in a qualified educational institution of higher learning. So, a scholarship would be included in gross income to the extent the scholarship received exceeds qualified expenses. Count this as surprise number one to a number of students and families.

An important nuance appears in IRC Section 117(c). That provision establishes a limitation on the exclusion by stating that any amount that represents payment to the student for teaching, research, or other services that are required as a condition of the scholarship. Whether or not a payment is compensation for services or a scholarship is inherently a factual matter. The Tax Court precedent turns on whether a student is “paid to work” or “paid to study.”³

Nonscholarship Stipends – If a student athlete receives a nonscholarship stipend, the stipend will be independent contractor income, unless the facts of the service required fails the control tests in the independent contractor versus employee analysis. If the facts indicate there is an employee-employer relationship, the university will need to withhold and remit taxes on the stipend payments.

Name, Image, and Likeness Income – When students receive payments from collectives or other alumni or student-athlete management companies, the income will be included in gross income under IRC Section 61(a)(2), gross income derived from a trade or business, or IRC Section 61(a)(6), income derived from royalties. Because the payment hinges on a student playing their sport and often providing some sort of service or appearance, most NIL income will be trade or business income to the student. Most students have little in the way of expenses incurred to generate this type of NIL income.

All other creative means of providing resources to student athletes are included in gross income as well – use of cars, housing for parents on game weekends, etc. The issue of royalty versus trade or business income will be an interesting issue to watch develop. Creative attorneys should be able to craft contracts that are factually a royalty. The big distinction between trade or business income compared with royalty income is the self-employment taxes.

Affiliate Marketing and Social Media Income – Some student athletes enjoy great success as social media influencers. That income will also be trade or business income because the student athlete is rendering a service for the payments received.

Self-Employment Income – As an independent contractor generating self-employment income, a student athlete recognizes gross income, reduced by allowed trade or business expenses. This is primarily authorized by IRC Section 162, but there are many other sections as well. That business profit is subject to federal income tax, federal self-employment tax, and state and local income tax in states with income taxes. The self-employment tax (Social Security and Medicare) is imposed on self-employment income under IRC Section 1401 (a) and (b) at the rates of 12.4% and 2.9% respectively, for a total of 15.3%. IRC Section 164(f) authorizes an adjustment to gross income for one-half of the self-employment taxes assessed, in determining adjusted gross income of the self-employed individual.

The total tax burden of federal, state, local, and self-employment taxes varies by the nature of the applicable graduated income tax systems. After considering the adjustment to income for one-half of the self-employment tax, the qualified business income deduction, and the standard deduction, student athletes will often face an effective combined income tax and self-employment tax rate in the 20% to 35% range.

Dependency – With this inflow of revenue, an important issue arises as to whether or not parents meet the test to claim a student as a dependent. In most cases, a student athlete will continue to be a dependent for the parents. The standard deduction for a dependent is the greater of $1,250 (2023) or earned income plus $400, up to the amount of the basic standard deduction for a single person ($13,850 in 2023). It is important to note the inclusion of taxable scholarships in determining the amount of earned income for that purpose. So, many student athletes with scholarship and NIL income will likely enjoy the full single person’s standard deduction. Parents may still be entitled to the other dependent credit.

The Tax Bill and Estimated Payments – As independent contractors that do not enjoy the benefit of withholding at the source, student athletes are generally required to make quarterly estimated tax payments. Student athletes are therefore cautioned to immediately segregate about 30% of their NIL, stipend, and social media marketing receipts into separate tax savings accounts upon receipt of the income. By so doing, student athletes can avoid unhappy surprises at the filing date for their returns.

Multistate Income Tax Issues – What happens when a student athlete from New Jersey or Georgia attends a university in Pennsylvania? State taxing authority is murky for out-of-state student athletes, particularly student athletes from states without an income tax. And where would social media/influencer income be earned if students are technically out-of-state residents? (University residence is “temporary” for a full-time college student, with their permanent residence generally defaulting to their domicile.)

Entity Choice – Some advisers may suggest the formation of a single-member LLC for a student’s independent contractor activities. Student athletes should consult legal counsel and insurance advisers regarding the best solutions to manage their trade or business risks. A single-member LLC will be a default sole proprietorship (disregarded entity) reporting its income on Schedule C of Form 1040.

Income Reporting – Enhanced income reporting is here, so organizations that compensate student athletes are likely going to be reporting all of the income paid to student athletes, in cash and property. Student athletes must ensure the amounts reported for the use of property – like cars and housing for parents on game weekends – are properly valued and reported. Those amounts are generally reported on Form 1099-MISC or Form 1099-NEC. Payment settlement entities will report payments processed on Form 1099-K for social media influencing activities and affiliate marketing revenues paid through alternate paying organizations. The student athlete is expected to retain all necessary business records to determine their income from a trade or business.

The nightmare for CPAs is any transactions in digital currency. Many students dabble in cryptocurrencies, and some student athletes receive income in the form of digital assets and pay expenses using digital assets. Under present law, all digital asset transactions are treated as property transactions, with recognition of gain or loss. That characterization necessitates good basis tracking. That responsibility is difficult for many adults to fulfill, let alone a 20-year-old busy student athlete. Early referral to a digital asset tracking software provider is paramount for these folks.

Financial Planning Considerations

All of the general financial planning issues affecting any self-employed person apply to the student-athlete entrepreneur as well. Students with significant cash flows from NIL will need investment planning and advice. And don’t forget the retirement planning! Students may want to consider retirement opportunities like an SEP-IRA.

In addition to technical guidance, there is a need for financial literacy training. Such training can, at the very least, help students with their cash flow and tax payment planning, preparing a budget, reconciling their bank statements (a very minor percentage of college students do so), creating savings goals and plans, and so on.

University Considerations

NIL income arrangements represent a significant opportunity to develop a competitive advantage in student-athlete recruitment. But there are some limits. The Pennsylvania statute that permits student athletes to earn NIL income prohibits compensation to be provided in exchange for a prospective student athlete to attend, participate, or perform at a particular institution of higher learning.⁴

The NCAA and member schools are still figuring out the new business model. With lots of television and endorsement revenue at stake, they will figure out a model that works for the NCAA, the universities, and, now, students compensated for their efforts. Wise universities will develop relationships with banking, investment, and insurance providers to make services available to student athletes.

A university may be an IRC Section 501(c)(3) tax-exempt organization or a university tax exemption may be the result of a Commonwealth of Pennsylvania affiliation under IRC Section 115. The characterization of donations to tax-exempt universities may become a challenge. A charitable contribution deduction is generally available for donations to qualified tax-exempt entities under IRC Section170.  The charitable contribution you pay to your university’s student scholarship fund that is required to be paid to obtain tickets is a nondeductible charitable contribution. Universities will need to exercise care in their construction of contribution opportunities to properly classify charitable contributions received versus unrelated business taxable income. Some contributions may go to collectives that are not tax-exempt organizations. Any charitable contribution deduction is generally reduced by the fair market value of anything received by the donor. Appropriate receipting of such contributions and the benefits received by donors is important in sustaining the deduction.

Division 1 schools with big athletics programs are the beneficiaries of the current environment for student athletes. Other colleges and universities may be in for more of a mixed bag. The concentration of economics in favor of large universities comes during a challenging time for smaller institutions as higher education realigns to the demographics of the next generations.

Tax issues have a lead time. Therefore, tax preparation today can keep a student athlete out of the news for tax problems and help to ensure the student is focused on studies and athletics (hopefully in that order) and not on Tax Court.

Help Is on the Way

For students with less than $65,000 in income, a local Volunteer Income Tax Assistance (VITA) program may be able to help. Some universities in Pennsylvania have both a VITA program and a Low-Income Tax Clinic (LITC) available to help student athletes. Collectives and athlete management organizations may also have tax assistance or preparation services availability. Some universities provide educational opportunities for students in personal financial literacy, which can help the student-athlete-entrepreneur make better financial choices. Pennsylvania CPAs are going to get calls on these student athlete financial issues from the athletes or their parents. Note that the evolution of NIL income has changed the new athlete client timeframe. Rather than getting an athlete as they are entering a league draft, the professional athlete client may now be just entering college. Be ready.

¹ 15 U.S.C. Section 1.
² National Collegiate Athletic Association v. Shawne Alston et al, 594 U.S. (2021) p. 5.
³ See Farmer v. Commissioner, T.C. Memo 1990-199.
⁴ Pa. Senate Bill 381. Printer’s No. 972, Article XX-k, Section 2003-K.

Edward R. Jenkins Jr., CPA, CGMA, is professor of practice in accounting for Pennsylvania State University in University Park, managing member of Jenkins & Co. LLC in Lemont, Pa., and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at erj2@psu.edu.

Alexandra Pepe is a Master of Accounting student at Pennsylvania State University, who after graduation will be working in New York City as a transaction advisory analyst for A&M. Pepe is an accounting teaching assistant while also working toward her CPA. She can be reached at alexandragpepe@gmail.com.