Student-Athlete/Athlete-Employee: Tax Consequences, For Sure

Last March the football team at Northwestern University gathered to cast votes regarding whether or not they wanted to form the first union for college athletes. It seems unlikely that anyone stood up at that meeting before the vote and asked, "Wait, dude, has anyone considered the tax consequences of all of this?"

We suspect not, and as discussed below, there are likely significant tax consequences to both the student-athletes and to the school that need to be considered. Instead of second and one it's third and long.

The National Labor Relations Board's ("NLRB") decision to allow the Northwestern students to form a union hinged primarily on whether or not those student-athletes’ participation on the football team constituted an employer-employee relationship with the school. As employees, the student-athletes would be able to use their new union to seek fair compensation, negotiate better contracts (including scholarship deals), and pursue long-term health insurance (to name a few). However, regardless of how important or justified those actions may seem, they could come with two potentially deal breaking taxation-related "penalties" – first for the students, and second for the school. And unfortunately, they are not "offsetting."

First, if the courts ultimately grant the team their wish to be treated as employees, the student-athletes of the Northwestern football team could one day find themselves in the unfortunate situation of having to declare the annual value of their scholarships as taxable income.

Section 117 of the Internal Revenue Code governs all scholarships — academic or athletic. Students do not typically need to declare scholarships as income provided that the school grants the scholarships with “no strings attached.” The school cannot expect quid pro quo from the students in return for the scholarship. Unfortunately for student-athletes everywhere, the tax code leaves no room for interpretation on this issue. 

Any form of compensation that the student-athletes may receive in return for playing would invalidate the tax-exempt nature of their scholarships. Because many Division I athletes receive scholarships for full tuition and housing, the additional income they would need to report to IRS as employees could be $50,000 or more each year. Even at the lowest 2014 taxes rates, the tax on that income would be over $10,000 annually, or $40,000 for a four-year degree. The financial burden of that tax could be more than many of the athletes could afford. 

In this scenario, schools could find themselves obliged to increase the size of the scholarships such that the recipients would have enough cash left over after tuition and housing to pay the tax bills. Given the annual volume of athletic scholarships around the country (over $1.4 billion according to US News and World Report), schools could have to spend hundreds of millions just to cover the new taxes. 

A second potential consequence of granting student-athletes the status of employee could have grave repercussions for the school’s athletic department. Athletic departments enjoy a tax-exempt status because of their close relationship to the central educational mission of the school. The decision to treat student-athletes as employees could fundamentally invalidate that relationship. If the NLRB and other courts ultimately grant student-athletes employee status, a key factor in that decision will likely involve the fact that those activities have more to do with the entertainment industry than with education. Therefore, it is also likely that IRS will cease to acknowledge the tax-exempt status of athletic departments. The subsequent tax hit from Unrelated Business Income Tax (“UBIT“) could be substantial—15-35% at the federal level alone. 

But paying UBIT is only the tip of the iceberg. The most severe consequence for athletic departments would stem from the elimination of tax-deductible contributions. Contributions are by the far the largest source of income for athletic departments. Without their tax-deductible status, those donations would not be tax-exempt by the donor. This may not deter most small donations, but it could make the larger donors think twice before making a substantial commitment. 

Furthermore, any gift over $14,000 would be subject to the gift tax. Not only would substantial donors no longer be able to deduct their donations, they would also have to pay IRS up to 45% of the value of any gift over the $14,000 threshold. It is not a stretch to think that this might effectively end large contributions to athletic departments. If this were the case, athletic departments would likely need to restructure the way they receive funding. The drain on schools’ resources in that situation could be enormous, perhaps too much to handle. 

Last, but not least, issuance of tax-exempt bonds may no longer be possible. Tax-exempt bonds in the past have helped to support the construction of major facilities, fields, and stadiums. Issuing bonds at commercial loan rates would serve to further drain the resources of the department. 

In short, granting student-athletes employee status could be bad for students but catastrophic for athletic departments.

The NLRB’s decision in favor of treating the Northwestern football team as employees is currently on appeal by the school, and the discussion will likely continue to higher courts if the NRLB rejects the appeal. But even if the football team ultimately wins, they will need to take into account the enormous implications of the change in tax status for themselves and the athletic department before they move forward with their plan to unionize. It is possible that the unintended tax consequences could one day act as the deciding factor in this issue. One never likes to have the tax tail wag the dog, but in this case it just might. Time to huddle up.