The Internal Revenue Service now has a new interest in sports and entertainment - and not just as a spectator.

At the start of October, Helio Castroneves, a two-time Indianapolis 500 winner and Dancing With the Stars champion, was indicted on six counts of tax evasion for allegedly failing to report about $5.5 million of endorsement income between 1999 and 2004. Each count carries a maximum prison sentence of five years.

Criminal tax evasion is not the only breach of law commanding attention. Recently, an IRS official publicly confirmed that the IRS is concentrating on general U.S. income reporting and tax compliance of foreign athletes and entertainers who work in the United States.

The bottom line is that the IRS now believes there is a problem, and they are watching.

Indeed, the IRS apparently has agents committed to monitoring certain high-profile sporting events. For example, IRS agents actually attend golf and tennis events to watch foreign athletes and their relationships with sponsors, and to document their business to learn if they are in compliance with IRS guidelines.

The agency's focus on global sports and entertainment was first announced in October 2007 with the launching of a task force to concentrate on reporting and compliance of high-income golf and tennis players, high-income musicians, and their representatives. According to a recent public announcement, however, the scope of the agency's focus has broadened, with ripple effects on other groups, including directors, producers, technicians, managers, coaches, promoters, etc.

STARRING ROLES

There are several issues that have become the center of IRS scrutiny, including the determination of an athlete's or entertainer's residency for tax purposes (which is broader in scope than residency for immigration purposes), characterization of income, business structures established by or for foreign athletes and entertainers, and potential improper use of treaties and income allocations. Castroneves' alleged tax evasion, in part, involves an abusive use of foreign shell companies to avoid U.S. taxes on his endorsement income from Penske.

Characterization of income is a crucially important issue. Under U.S. tax law, individuals who are neither citizens nor residents of the United States are subject to U.S. income tax on income they earn from performing services in the United States. (Prize money is not an issue, however, because tournaments generally withhold the appropriate amount of U.S. tax before transferring the prize money to the athlete.)

If, pursuant to a contract, an athlete or entertainer is required to perform services in the United States on behalf of a sponsor, payments received on the contract generally are considered to be personal-services income that is subject to tax by the U.S. For example, where a contract requires a foreign golfer to appear at the U.S. Women's Open wearing clothing bearing a sponsor's logo or using a sponsor's golf clubs, that athlete has performed a service on behalf of the sponsor in the U.S.

On this basis, the IRS believes that a portion of a foreign athlete's worldwide sponsorship income may be subject to U.S. income tax. The IRS also justifies taxation on the basis that the foreign athlete is able to attract and secure sponsorships, in part, because of their performance in U.S. tournaments. This position may sound harsh, but the U.S. is not the only country taking this position - consider the United Kingdom's tax authority's taxation of tennis star Andre Agassi's Nike endorsement income in 2006.

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