As a result of a court ruling, college football and basketball stars may soon share in the big money brought in through college athletics, but there hasn't been much discussion about the tax implications it could have on college athletes' tax-free education and the perks they receive.
THE COURT DECISION
In O'Bannon et al. v. NCAA, a judge for the Federal District Court for the Northern District of California ruled that NCAA regulations barring payments to college athletes were in violation of antitrust laws. The lead plaintiff in the class-action lawsuit was former U.C.L.A. basketball player Ed O'Bannon.
More than 10 years after graduation, O'Bannon discovered that his likeness was being used on a video game without his consent or compensation, and he accordingly filed suit. The court ruled in favor of O'Bannon, allowing colleges with football teams in the Top 10 conferences and colleges with Division I men's basketball teams to offer recruits a share of:
Revenues generated from the use of the recruits' names, images and likenesses while they are in school. The NCAA can cap this compensation while the student-athlete is enrolled in school, and the compensation can be in addition to a full "grant-in-aid" (a full scholarship).
Licensing revenue, to be deposited annually into trust funds for the student-athletes and paid to the recruits when they leave school or when their eligibility expires. The NCAA can cap the amount that can be contributed annually, and schools can offer lower amounts if they choose.
This ruling is set to go into effect in July of 2016 and applies only to Football Bowl Subdivision football recruits and Division I basketball recruits. The NCAA is appealing the ruling.
INFO ON SCHOLARSHIPS AND TAX
Qualified scholarships are excluded from gross income under Sec. 117, which means that the recipient does not pay tax on the scholarship funds. To get this treatment:
- The student must be a degree candidate at an eligible educational organization; and,
- The scholarship must be used for qualified expenses.
Qualified expenses are tuition and fees, as well as books, supplies and equipment required for coursework. Room and board, travel, and other costs are not qualified expenses.
SERVICES TO THE SCHOOL
Under the law, if the student is required to perform services for the school to receive the scholarship, the funds attributable to the services provided to the school are equivalent to taxable wages (with limited exceptions). Treas. Reg. Section 1.117-4 also emphasizes this point.
This type of restrictive language in the law and regulations raises questions about whether an athletic scholarship really qualifies as true educational assistance, or crosses the line as payment for services to the school.
ROOM AND BOARD
According to a 38-year-old IRS ruling (Rev. Rul. 77-263), an athletic scholarship is nontaxable only under the following conditions:
- The scholarship does not exceed expenses for tuition, fees, room, board, and necessary supplies.
- The school expects but does not require the student to participate in a particular sport.
- The school does not require any particular activity in lieu of participation and doesn't cancel the scholarship if the student cannot participate.
The first condition in this ruling does not mean that an athletic scholarship can be used to provide students with tax-free room and board. Rather, it means that the total scholarship awarded (both taxable and non-taxable portions) must not exceed the total cost of attending the school. If this and the other two conditions are met, then the portion of the athletic scholarship covering qualified expenses will be tax-free and not treated as payment for services.
IRS Pub. 970, Tax Benefits for Education, bears this out: Athletic scholarship recipients are referred to the same worksheet used by all scholarship recipients to determine the taxable and nontaxable parts of scholarship funds received.
WHAT COULD CHANGE
Few students who apply for athletic scholarships get one at all, much less get one of the limited number of full-ride athletic scholarships doled out each year. According to reports, the odds of a high school athlete getting any sports scholarship are only 2 percent, which only covers a fraction of their costs.
But what about the few star athletes who play basketball or football for one of the top college conferences and manage to get a high-dollar or full-ride scholarship? While we may know that they get much more than "regular" students -- and that their many perks are not just dorm rooms and cafeteria vouchers -- scholarships for these students are not called out for any special treatment in the Tax Code, limited IRS guidance, or even in the Internal Revenue Manual. Perhaps this could change.
THE TAX IMPLICATIONS
The O'Bannon decision refers to student-athletes' share of revenue from the use of their names and likenesses as "compensation." It is difficult to see how reporting this type of compensation as anything other than taxable income could ever be justified.
Students' share of licensing revenue would likewise have to be treated as taxable compensation. The fact that deposits might be made to trusts does not necessarily mean that the funds won't be immediately taxable. Although athletes may not have access to the trust funds while they are in school, the athletes would likely be taxed when the compensation is paid to the trust. And interest earned on the trust funds will certainly be taxable in the year earned. With all of this extra scrutiny, the other perks of being a star college athlete -- travel, guest passes, gear, health care -- might just show up on a Form 1098-T in the scholarship and grant box one day.
Finally, just as with medical residents, the very notion that the star player is really a student first and athlete second -- rather than a paid employee of the school -- will continue to be called into question.
It remains to be seen what will happen in 2016. The NCAA could win on appeal. And schools and conferences would have a lot to consider when deciding what to offer future recruits. Stay tuned.
Jackie Perlman and Alison Flores are principal tax research analysts at the Tax Institute at H&R Block, specializing in providing expert analysis on changes in the legislative, regulatory, and judicial tax world.
