analyze and synthesize information from the assigned readings while reflecting on your own lived experiences using personal examples, situations you observe in organizations and within your communities, and current events. two page, double-spaced
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TAXATION of COLLEGE SPORTS
On October 2, 2006, U.S. House Ways and Means Committee chairman Bill Thomas sent National Collegiate
Athletic Association (NCAA) president Myles Brand a long letter questioning why the NCAA and intercollegiate
athletics should be able to retain their plethora of tax privileges. Thomas pointedly inquired how the
hypercommercialized activities of Division I athletics supported the tax-exempt educational mission of U.S. colleges
and universities. This chapter seeks to understand this issue, both from the perspective of tax law and from that of
public policy.
Before one can meaningfully answer the question of why intercollegiate athletics should have tax privileges, it is
necessary to understand what those privileges are as well as the legal basis for them. There are three principle areas
of tax privileges for college sports:
1. The ability for donors to deduct 80% of “contributions” to athletic departments that are required for them to be
able to purchase season’s tickets to either football or men’s basketball games
2. The ability of college sports programs to issue facility bonds, which has tax-exempt interest to the holders
3. The ability to avoid taxation on activities that are unrelated to the purpose of the tax exemption held by U.S.
colleges and universities
These tax privileges are based on a broader tax exemption that is afforded U.S. colleges and universities. The
exemption, in turn, is based for public universities on the assumption that the state is providing a service that may
otherwise have to be produced by the federal government and for private universities on the assumption that
education is a public good whose development promotes the general welfare and functioning of our democratic
government. Public universities, as state enterprises, are automatically exempt, while private universities fall under
the 501(c)(3) category that provides exemption for charitable, nonprofit organizations. In 1976 the U.S. Congress
passed an amendment to 501(c)(3) that explicitly classified the promotion of amateur sports as a charitable activity.
Hence, the NCAA was able to obtain 501(c)(3) status and therefore is covered by the tax exemption, as are private
universities and colleges. According to Internal Revenue Service (IRS) code, however, both public and private
nonprofit universities are explicitly made subject to unrelated business income taxation (UBIT); and, as we shall see,
some key questions in connection to the UBIT arise about the relationship of intercollegiate athletics to the
educational mission of universities that form the basis for the frequently heard call for college sports to be taxed
DEDUCTIBILITY FOR DONATIONS
Let us now consider the three tax privileges that benefit intercollegiate athletics. Most of the 124 schools in the
Football Bowl Subdivision (FBS, formerly D I-A) in 2013 require their supporters and fans to make a sizable
donation to the athletic department in order to be able to purchase season’s tickets to the home games of the school’s
football or basketball team. One of the first schools to do this was the University of Texas in the early 1980s.
However, in 1984, Texas got some bad news from the IRS. The IRS ruled that since these “donations” to the
university were a payment for purchasing part of a ticket for their personal enjoyment, they would not be deductible
(as a gift to a charitable organization). Fortunately for the Texas athletic department, it had some powerful friends. In
particular, its alumnus U.S. representative Jake Pickle happened to be a member of the House Ways and Means
Committee. He wrote a bill, cosponsored by U.S. senator from Louisiana Russell Long, that stipulated 100% of the
preticket “contributions” was tax deductible for fans buying tickets to the University of Texas and Louisiana State
University football games (Dexheimer, 2007; Eichelberger & Babcock, 2012). Other schools quickly picked up on
the favoritism and lobbied for the provision to be made general. In 1988, the U.S. Congress obliged, passing a bill
that made 80% of all such ticket “donations” deductible for all universities (Gaul, 2012).
When Congress passed this deductibility provision, it was estimated that it would cost the U.S. Treasury $0.5
million annually. In 2012 Bloomberg News made open-record requests of FBS schools, but only 34 of the 120 FBS
schools at the time responded with data on the donations collected in order to purchase season’s tickets. Ohio State
University collected the most, with $38.7 million, followed by LSU with $38.0 million and Texas with $33.9 million,
and the 34 schools together collected $467.2 million. At 80% deductibility, this amounted to $373.8 million; and, at a
top tax rate of 39.6%, this amounted to individual tax savings (or cost to the federal government) of $148 million.
And this sum refers to only 34 schools. There are 124 FBS schools and 340 Division I schools (Eichelberger &
Babcock, 2012).
It seems reasonable to view these upfront “contributions” as similar to permanent seat licenses (PSLs) that are
sold by professional sports teams. PSL are essentially the first part of a two-part tariff to purchase a season’s ticket:
the total market price of the ticket is the prorated PSL (or “contribution”) plus the nominal ticket price. For any given
total market ticket price, university athletic departments can increase their ticket revenue by increasing the first part
of the tariff and lowering the second part. By raising the first part, the net (after tax) ticket price to the fan is lower
and, hence, the university can sell more tickets or charge a higher final price. There is no conceivable economic or
efficiency justification for the federal government to sacrifice tax revenues in order to subsidize the purchase of
season tickets (almost entirely by higher-income individuals) for big-time college sporting events. To the extent that
there are ancillary benefits from such a policy, these could be obtained through a more direct approach.
ISSUANCE OF TAX-EXEMPT BONDS FOR FACILITY CONSTRUCTION
Athletic departments in either public or nonprofit, private universities are able, through their schools, to finance
facility construction or renovation through the issuance of bonds, the interest on which is tax-exempt to its holders.
Bond buyers are generally high-income individuals. Consider the following example. If a bond buyer, in the highest
39.6% tax bracket, buys a nonexempt corporate bond, with, say, a 7% interest rate, the net (after tax) interest rate is
4.23%. For a tax-exempt bond to be competitive with this corporate bond, the interest would have to be only 4.23%
(or lower, given that there may also be an exemption from state income tax.) In this example, a bond to finance the
construction or renovation of a college football stadium would save 2.72%, which on a $200 million bond, amounts
to a $5.44 million annual saving on the bond’s debt service, or a yearly federal subsidy to the stadium of $5.44
million.
Since 1995, U.S. universities have spent more than $30 billion on sports facilities. Many observers believe there
is an arms’ race among schools, wherein the forces of competition push these expenditures on modernized structures,
replete with luxury boxes, club seating, signage boards, restaurants, and more. The federal subsidy encourages this
lavish spending.
Given that a university’s tax-exempt status is meant to underwrite its central purpose of education, there is a
legitimate question of whether the hypercommercialized business of big-time intercollegiate athletics is sufficiently
related to this central purpose to justify extending the exemption to the construction of sports stadiums, arenas,
training facilities, and tutoring buildings for athletes.
In his 2006 letter to the U.S. Congress, NCAA president Myles Brand wrote: “Athletics facilities, state-of-the-art
or otherwise, are necessary for the support of the activity for which there is a tax exemption. These facilities, often
paid for through bonds or charitable contributions, also generate revenue that offsets the operational cost of athletics
that might not otherwise be provided through institutional funds.” If, however, these facilities generate sufficient
funds to justify the investment in them, then there is no reason for the federal government to subsidize them. In the
end, the modern stadiums and arenas raise the revenue level of big-time college sports. Since there are no
stockholders to profit from successful sports programs and athletes are not remunerated beyond the basic grant-inaid, a substantial part of the additional revenue flows to the coaches and administrators of the system. Thus, critics
ask: Why should the taxpayer be called upon to support fancy facilities for college sports?
AVOIDANCE OF UBIT LEVIES
When a public or nonprofit institution sets up its own commercial enterprise, the net income of this operation may be
subject to taxation. This principle was established by the UBIT legislation passed by the U.S. Congress in 1950.
Before 1950, and dating back to a Supreme Court decision in 1924, charitable entities were permitted to run a
commercial business and not have to pay taxes on its profits if the profits were used to support the entities’ charitable
activities. In 1950, however, out of concern that such businesses would have an unfair competitive advantage over
independent businesses producing the same product or service and that the policy reduced government tax revenues,
Congress enacted the UBIT. In 2004, the government collected more than $192 million in UBIT revenue from 501(3)
(c) entities. This collection was based on reported gross income of $5.5 billion, constituting a tax rate of only 3.5%.
The low rate is a product of the 501(c)(3) entities’ ability to shift revenues and costs to lower the taxable income of
their unrelated entities (Colombo, 2010).
Understanding how the UBIT applies to big-time intercollegiate athletics is not a simple matter and, like much of
the law, is subject to interpretation. The basic criterion is whether or not the commercial entity’s output is
functionally related to and in furtherance of the basic mission of the charity (in this case, either education or the
provision of amateur sports), and IRS interpretation of this criterion over the years has tended to be narrow. For
instance, in 1968 the IRS ruled a hospital’s charitable purpose was providing health care to the patients in the
hospital; accordingly, a pharmacy within the hospital that provided drugs to patients in the hospital was functionally
related to the charitable purpose, but the sale of drugs to the general public by such a pharmacy was not. In 1973 the
IRS ruled that the sale of science books in an art museum bookstore was subject to UBIT but the sale of
reproductions or postcards was not. In the context of the university, a Treasury Department regulation stipulates that
“the presentation of … drama and music events contributes importantly to the overall educational and cultural
function of the university” and, hence, is not subject to UBIT (Colombo, 2010). Following this logic, a case can be
made to the Treasury to apply the same reasoning to intercollegiate athletics.
CASE STUDY
NYU and C. F. Mueller
Co.
In 1946, the owner of the renowned C. F. Mueller Co. passed away. Through a variety of personal connections, the
entire company was made available for purchase to the NYU Law School at the heavily discounted price of $3.5
million, along with a low-interest loan. Under the Law School’s ownership, the company flourished and the loan was
paid off after some 20 years. By 1975, out of the Law School’s total budget of $9 million, almost one-third came
from the profits of its pasta company. The fact that Mueller’s profits went untaxed was not overlooked by other pasta
companies. They pressured Congress to level the playing field, which it did with the UBIT law of 1950.
Mueller’s success met with another obstacle. The rest of NYU was in dire financial straits, running an operating
deficit of $4.4 million during 1974–1975 and was projected to grow in the coming years. NYU began an austerity
plan that included selling off its undergraduate campus in the north Bronx. The law school believed that its own
health was tied to that of the university and, ultimately, was persuaded to sell its Mueller operation and, in exchange
for greater law school budgetary autonomy, to share the proceeds with the university on a 59/41 basis. The company
was sold in 1976 for $115 million, for a capital gain of over $110 million (Brooks, 1977).
The IRS briefly contemplated taxing television revenues in intercollegiate sports back in 1977, but reversed
itself, and in 1980 ruled that TV revenues were not subject to UBIT (Colombo, 2010). In 1991 the IRS ruled that
corporate advertising/sponsorship revenue in college sports was subject to UBIT, but in 1997 Congress voted to
exempt such income from UBIT provided that it was not comparative and promotional in nature.1 Thus, Coca-Cola
could have a sign at the Camp Randall Stadium in Madison, Wisconsin, that simply stated “Coke” or “Coca-Cola
Supports Badgers’ Football,” but it could not have a tax exempt sign that stated “Coke Is No. 1” or “Nothing Beats
Coke for Satisfying Refreshment.”2 Similarly, buying naming rights to a facility does not involve explicit promotion
and is exempt from UBIT Taxation.
Current law also excludes all passive income from UBIT, such as royalty or licensing income from the sale of
logos, images, or game highlights. In 2005 licensing and royalty revenue in college sports was estimated at $203
million (Weisbrod, Ballou, & Asch, 2008).
For an entity to retain its 501(c)(3) status and, hence, its eligibility to remain tax exempt, it must also meet certain
limitations. One such limitation is that there can be no “private inurement,” or siphoning of surplus to the benefit of
an employee of the entity. In order to meet this standard it is required that employees be paid a fair, market-based
compensation for their services. The question has been raised about the high salaries of head coaches of Division I
football and men’s basketball teams and whether these constitute private inurement.
Another limitation is that there can be no “private benefit.” Private benefit refers to an outsider to a 501(c)(3)
organization gaining excessively from its relationship with the charitable entity, whether or not the payment is at a
market rate. Consider how the NFL and the NBA gain excessively from the development and promotion of players in
college sports. In baseball, the average major league team spends roughly $25 million on player development within
its minor league systems, while the NBA’s development league expenses are diminutive, and the NFL has no minor
league or development system. In this way, college sports serve as a minor league and development system for the
NBA and NFL, with the added bonus that Division I teams get enough media coverage so that the players come to the
pros with substantial public resumes and notoriety.
Finally, it is appropriate to inquire whether applying UBIT to college sports would make a difference. If college
athletic departments can shift costs and benefits among various college departments (e.g., buildings and grounds,
dance, music, dining services, general administration) and thereby avoid showing any net income; or if there is truly
no net income in most programs anyway, would it matter if college sports were subject to an income tax? The short
answer is that UBIT law also contains a fragmentation principle that allows the IRS to view the separate parts of a
501(c)(3) entity independently. Thus, in theory at least, the IRS could consider net income from football, basketball,
or corporate sponsorships, even though the entire athletic department did not generate a surplus. We turn now to
consider the debate around this aforementioned question.
STAKEHOLDER PERSPECTIVE
Myles Brand, Former NCAA President
The NCAA organizes intercollegiate athletics. Its officers and employees benefit when college sports flourish
economically. The president of the NCAA is a stakeholder in the system. Between 2002 and 2009, Myles Brand was
the association’s president.
In November 2006, Myles Brand wrote a 25-page response to the questions of U.S. Representative Bill Thomas
of California about why the NCAA and intercollegiate athletics merit the tax privileges they enjoy. Among Brand’s
comments, he wrote: “The lessons learned on the football field or men’s basketball court are no less in value or
importance to those athletes than the ones learned on the hockey rink or softball diamond — nor, for that matter, than
those learned in theater, dance, music, journalism or other non-classroom environments.” At a general level, few
would disagree with this assertion. Critics, however, would ask whether the commercialization of college sports is
congruent with the educational goals to which Brand alludes.
Brand also wrote: “If the educational purpose of college basketball could be preserved only by denying the right
to telecast the events, students, university faculty and staff, alumni, the institutions of higher education themselves and
even the American taxpayer would ultimately lose. The scale of popularity and the media attention given to football
and men’s basketball do not forfeit for those two sports the education purpose for which they exist.” Here Brand
suggests that limiting commercialization would not promote educational goals, but it would reduce the consumer and
financial benefits of big-time college sports.
JOINING THE DEBATE
Both at a technical level regarding the details of tax policy and at a political or philosophical level, a fundamental
question is whether commercialized intercollegiate athletics is functionally related to the educational mission of U.S.
colleges and universities. On the one hand, it can be argued that engagement in college sports by students provides a
salutary balancing of an otherwise largely cerebral and sedentary lifestyle. Participation in intercollegiate athletics
also can help athletes develop constructive personality traits, including the development of leadership skills,
teamwork, tenacity, good time management, and positive self-esteem. These qualities of college sports appear to be
functionally related to the educational mission of colleges and universities and, indeed, to provide an important
complement to help create a well-rounded and healthy college experience.
On the other hand, it can be argued that these positive attributes apply to college sports in intramural form or in
the less commercialized form of intercollegiate athletics of Divisions II and III. But at the highly commercialized
level of Division I, and particularly FBS, the time demands on the athletes, the intrusive, television-driven
scheduling of games, the frequent and increasingly distant travel, the lowering of admissions and classroom
standards, the transformation of college culture, the incentives to transgress NCAA rules, and the outsized payments
to the football and men’s basketball head coaches all detract from the central charitable and educational purpose of
the university.
The U.S. Congressional Budget Office (CBO) conducted a study in May 2009 that considered this issue, finding
that 82.3% of the revenues for FBS college sports came from commercial sources. This share fell to 28.8% in FCS
and to 27.9% in Division I without football. For universities as a whole, this share was only 10.9%, excluding
hospitals and athletics (Congressional Budget Office, 2009). The implication of the CBO finding is that big-time
college sports operate in a distinct fashion from higher education generally and, thus, could logically be given a
different tax status.
The NCAA has …
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