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April 3, 2015
When Play Becomes Work: Are College Athletes Employees?
by Justin Morehouse

Full Text Published by Tax Analysts®

This article first appeared in the September 22, 2014 edition of Tax Notes.

Morehouse examines the federal income tax implications of the National Labor Relations Board decision that grant-in-aid scholarship football players at Northwestern University are considered university employees for labor law purposes.

I. Introduction

The National Labor Relations Board recently agreed to review a regional director's decision that varsity football players receiving grant-in-aid scholarships at Northwestern University are employees under the National Labor Relations Act (NLRA).1 The initial decision entitles the players to form a union eligible for collective bargaining rights under federal labor laws. However, with employee status, the players may have unanticipated items to bargain for.

The players currently receive their athletic scholarships exempt from federal income tax. Both Northwestern and members of the NCAA claim that treating the players as employees will automatically recharacterize the athletic scholarships as taxable income.2 Northwestern argued before the NLRB and in its post-hearing filings that the tax treatment of scholarship dollars is a persuasive reason not to classify the student-athletes as employees.3 The NLRB regional director didn't address that claim. The only mention of taxes is the statement that taxation was not a dispositive factor in determining if the players were employees. In a recent New York Times op-ed, a member of the NCAA's board of directors also assumed the players will become subject to income tax, which he advanced as a powerful reason to deny them bargaining rights.4

Neither Northwestern nor the NCAA considers that the NLRB decision doesn't bind the IRS to treat the players as employees or to treat the scholarships as taxable income. However, the NLRB decision could prompt the IRS to reconsider the favorable tax treatment of athletic scholarships. Evidence presented to the board could alone trigger that reexamination.

Various code provisions could allow the players to receive the benefits of the scholarships tax free. Among them are income exclusions for highly valued fringe benefits given to employees by employers, including universities. The players will likely need to bargain for a complex benefits plan in order to continue receiving their grant-in-aid scholarships tax free. Yet, it will also be in Northwestern's interest to structure a tax-efficient package. Whatever portion of the scholarship is included in taxable income is also subject to employment taxes. Northwestern, an otherwise tax-exempt organization,5 is obliged to pay employment taxes on the wages of its employees. Thus, both sides have much to gain from cooperating to ensure the players continue to receive their benefits tax free.

II. What Is Taxable Income?

The current definition of taxable income may be adding to the confusion. Section 61(a) names compensation for services, including fringe benefits, as statutory income, subject to specific statutory exclusions. Congress has enacted many exclusions over the years to encourage taxpayers to behave in particular ways. Athletic scholarships fall under section 117, which excludes tuition and related expenses from gross income when the scholarship meets specified criteria. The favorable tax treatment presumably promotes postsecondary education because students aren't taxed on money they receive for attending college.

Case law reinforces the expansive definition of income. Most notably, the Supreme Court in Glenshaw Glass defined income as "instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion."6 That raises the question of whether the football players have actual or constructive dominion over the value received as grant-in-aid scholarships.7 It has been argued that scholarships are excluded for policy reasons because scholarship students don't have dominion over the university's facilities or services beyond the reduced price of their tuition.8 Because of the general exclusion for athletic scholarships, that concept hasn't yet been scrutinized.

The factors for identifying constructive income may also play a role in determining whether the players receive income through the athletic scholarships. A taxpayer constructively receives income once the value is "credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time."9 However, the players don't constructively receive income if their "control of its receipt is subject to substantial limitations or restrictions."10 Therefore, scholarship money exclusively restricted to the payment of tuition may preclude the constructive receipt of income. Under that analysis, the players don't receive income from the tuition portion of their scholarships, although other funds, such as money for room and board, would likely count as income because the players directly realize those benefits.

III. Current Exclusion for Athletic Scholarships

Section 117(a) excludes from gross income "any amount received as a qualified scholarship by an individual who is a candidate for a degree." The provision applies to a scholarship, whether awarded by a university or an independent entity, as long as it meets specified statutory criteria.

Under the code, a qualified scholarship is limited to any amount received by the student for the payment of qualified tuition and related expenses, which means tuition, fees, books, supplies, and equipment required for enrollment and attendance for courses.11 In 1986 Congress explicitly limited the scope of qualified expenses to deny the exclusion for amounts received as room, board, and other living expenses.12 This was to address the perceived unfairness of students receiving tax-free funds to pay expenses not directly related to an educational purpose.13 Now, when a scholarship pays the student for housing, food, or general living expenses, those amounts are taxable income.

Also, section 117(c) further taxes any amount received as payment for services a student is required to perform as a condition of receiving the scholarship. Football players generally play football as a condition of their athletic scholarships. On its face, that relationship appears to violate the limitation and should result in the receipt of taxable income for the entire amount of any scholarship awarded exclusively based on the student's athletic services. However, in Rev. Rul. 77-263, 1977-2 C.B. 47, the IRS excluded athletic scholarships from this statutory limitation because the benefit to the university was incidental and the primary purpose of collegiate sports was educational. The IRS hasn't since challenged or reexamined the treatment of athletic scholarships.

In Rev. Rul. 77-263, the IRS determined that the athletic scholarship is excluded from income when specified conditions are met. It noted, under the scenario considered, the absence of a substantial quid pro quo relationship primarily benefiting the university. Under the rationale of Rev. Rul. 77-263, a Northwestern football player will receive an athletic scholarship tax free as long as the university expects but does not require the player to play football and requires no particular activity in lieu of playing football, and if the scholarship isn't canceled in a given semester because the player can't participate in the sport. The revenue ruling thus prohibits a quid pro quo relationship between the player's participation in the sport and the receipt of an athletic scholarship.

Grant-in-aid scholarships awarded to the Northwestern football players constitute what is called "100 percent full ride equivalency." That equivalency is passed along to the players as fully paid tuition, fees, room, board, and books. At Northwestern, this amounts to $63,193 for enrollment during the regular school year, and up to $75,000 if the player takes a class during the summer session. If the player lives off campus, he is eligible for a cash stipend of $14,000 in lieu of room and board.14

Under current law, the players should receive only a portion of those amounts tax free. Although it is unclear, the record suggests that the players are receiving the entire amount as a qualified scholarship and are subject to no taxation on any portion of it.15 The section 117(b) limitation on qualified expenses subjects to taxation all amounts the players receive that are not directly allocated to tuition, fees, and books. According to Northwestern, only $47,405 of the $63,193 received for attendance during the regular school year is for tuition, fees, and books.16 However, players report none of the scholarship amount as income, and they aren't pursued by the IRS.17

Commentators agree that athletic scholarships as currently awarded should technically be subject to taxation because of the quid pro quo relationship.18 Documents referenced in the NLRB hearing, post-hearing filings, and the Northwestern appeal reveal that the grant-in-aid scholarships don't follow the strict guidance of Rev. Rul. 77-263. That could compel the IRS to revisit its previous determination, and the entire amount of the 100 percent full-ride equivalency could be disqualified from the statutory exclusion.

As stipulated by both Northwestern and the players in a joint exhibit submitted to the NLRB, the athletic scholarship agreement doesn't comply with Rev. Rul. 77-263. The document states: "All athletically related financial aid may cease at the time of withdrawal" from the sport.19 Further, a Northwestern exhibit states that it's the university's policy that "an individual who is offered and accepts athletically related financial aid will continue to receive such support provided that he or she continues to be a team member."20 That condition clearly violates the IRS's requirement that qualified scholarships not be canceled during a semester or condition the scholarship on mandatory activities.

Given this revelation, at least two things should happen. First, universities should review their documents to ensure they are in compliance with the law. That compliance check should include confirming that athletic scholarships are being properly excluded, that proper amounts of unrelated expenses are being reported as wages, and that employment taxes are being properly withheld. Second, to raise revenues, the IRS may review university documents and practices to ensure that scholarships are not being canceled midterm.21 If Northwestern is in violation, each player will be subject to income tax, back taxes, and possibly even penalties associated with the substantial understatement of income. For an individual player, the federal income tax liability at the marginal rate would easily exceed $12,000 per year.22 Also, each player's income would become wages subject to FICA taxes to be withheld by Northwestern.

IV. The Employee Relationship

To be clear, the players are not seeking compensation for services as a stated goal of collective bargaining. Through their representative, the College Athletes Players Association (CAPA), the players' stated non-monetary goals are guaranteed coverage for medical expenses of current and former players, programmatic efforts to reduce the risk of concussions, improved graduation rates, and due process guarantees for the consistent application of rules across university campuses.23 Their monetary goals of increasing scholarship awards to realistically cover the cost of living expenses and allowing players to enter commercial sponsorship arrangements only indirectly affect income in the university-player relationship.24 If the current tax treatment of athletic scholarships stands, the only change would be the imposition of tax on outside income from sponsorship deals.

A. A Cause for Concern?

The concern expressed by Northwestern and the NCAA is that the NLRB's determination of the players' employee status for labor law purposes will automatically trigger the IRS to treat the grant-in-aid scholarships as taxable compensation for services.25 That concern presupposes that the IRS will follow the NLRB decision and that the players are receiving compensation for services. The IRS isn't bound to treat the players as employees, nor is it bound to treat the scholarships as compensation simply because another federal agency makes a decision under a separate federal law. The IRS could choose to follow the NLRB decision, use it in applying tests for employer-employee relationships and the payment of compensation, or create its own standard for assessing employee status and compensation in these unique circumstances.

The NLRB emphasized that the scholarships represent compensation for services. That fact should trouble both the players and the university. Although the compensation-for-services factor wasn't dispositive in the employee status test, the IRS may find it significant that the NLRB used the same phrase found in section 61's definition of income. Also, as noted, documents submitted to the NLRB show that the scholarships are received exclusively for services rendered.26 It's therefore necessary to examine the rest of the NLRB employee status test to identify any further similarities with tests potentially used by the IRS to determine whether scholarship recipients should be treated as employees receiving taxable compensation for services.

B. The NLRB Employee Status Test

The NLRB used a multifactor analysis to assess whether the grant-in-aid scholarship recipients were employees. Employment was indicated by two factors: control by the university and compensation for services.27 The decision interpreted the definition of employee under the NLRA, which says that the term "shall include any employee."28 As the NLRB noted, the Supreme Court has held that the term "employee" is subject to expansive definitions under the common law.29 The common law test for employee considers any person performing services under contract subject to the other's control in return for payment as an employee.30

The NLRB concluded that the players perform services for the benefit of Northwestern. When the players sign a "tender" at the outset of each scholarship period, they create a contractual relationship with Northwestern that acts as an employment contract, the board said.31 It was persuaded that the grant-in-aid scholarships are compensation for services because Northwestern can immediately cancel or reduce even its four-year scholarships under a variety of circumstances, such as when a player voluntarily withdraws from the football team.32 Also bearing on that determination was the scholarships' connection to the quality of the players' work and compliance with athletic policies not required of students receiving need-based financial aid.33 The NLRB found that the players are subject to "strict and exacting control by [Northwestern] throughout the entire year."34 Factors indicating the magnitude of Northwestern's control included the coaches' authority to restrict the players' living arrangements and outside employment, and to establish daily itineraries (including meal and bedtimes) and the amount of time spent at practices.35

Northwestern argued that a redeeming educational purpose to the athletic services outweighed the employee status, similar to Brown University, in which the NLRB determined that graduate teaching assistants are not employees. The NLRB found Brown University distinguishable and declined to follow it. In that case, the board concluded that the graduate assistants weren't employees because of their status as students, the role of assistantships in their education, the assistants' relationship with faculty, and the financial support for attendance.36 By contrast, the Northwestern players aren't students for the purpose of playing football because it isn't required for their education.37 Also, playing football doesn't constitute a core element of education because the players receive no college credit for participation.38 Further, there is no faculty interaction in football because the coaches don't teach, and life lessons are insufficient to establish an educational purpose in their interactions.39 And finally, as noted above, the players' financial support for attendance is tied to their athletic services, whereas the Brown graduate students received the same aid regardless of whether they had assistantships.40

By distinguishing the players from graduate students, the NLRB set out a new test under which the control and compensation factors greatly outweigh the importance of an educational purpose to the relationship between the players and Northwestern. That characterization contradicts the relationship the IRS described in Rev. Rul. 77-263. The Service didn't consider the issue of control but rather determined that universities received only incidental benefit from funding collegiate sports and that the scholarship was an incentive to promote a player's academic pursuits. Unsurprisingly, the NLRB decision more closely resembles the common law control test used under the Fair Labor Standards Act and ERISA to determine worker misclassifications of independent contractors.

C. Resemblance to Independent Contractor Test

The IRS may find the NLRB decision persuasive because of its similarity to the test used to distinguish employees from independent contractors for employment tax purposes. Although independent contractor status raises a different but related set of tax questions than presented in the players' case, it centers on whether compensation is received in exchange for services. Given the IRS's reliance on the independent contractor test in imposing employment taxes, the NLRB decision may inform the agency's examination of athletic scholarships.

In Nationwide, the Supreme Court established a multifactor control test to distinguish employees from independent contractors.41 Nationwide was an ERISA action to recover retirement benefits for an insurance agent who was treated as an independent contractor. Under ERISA, an employee is "any individual employed by an employer."42 The Supreme Court incorporated traditional agency law principles to interpret the ERISA definition of employee. In doing so, it found that the determination of who qualifies as an employee requires the examination of several factors, none of which is determinative on its own.

Relevant factors include the employer's right to control the manner and means used to accomplish the service, the amount of skill required, the source of instrumentalities and tools, the location of the work, the duration of the relationship, discretion over when and how to work, and the tax treatment of the hired party.43 As noted earlier, the NLRB concluded that the current tax-free treatment of the scholarships wasn't dispositive in determining the Northwestern players' employee status.44 However, the NLRB decision draws convincing parallels to the issues of control, duration, and discretion in order to establish the players as employees under the NLRA definition.

Those parallels may have important implications for the future tax treatment of athletic scholarships. To close the tax gap and ensure equitable treatment of taxpayers, the IRS has joined forces with the Department of Labor to correct the misclassification of workers. In a 2011 memorandum of understanding, they agreed to exchange information (to the extent permitted by privacy laws) to improve compliance with the laws and regulations administered by both institutions.45 A major purpose of the MOU is to "send a consistent message to employers about their duties to properly pay their employees and to pay employment taxes."46 In light of that collaborative initiative, the IRS may find the evolving labor law definition of employee helpful in interpreting tax law.

D. IRS Tests for Scholarship Recipients

Under current law, the test to determine if amounts received as scholarships are taxable income focuses on the compensatory nature of the relationship between the student and the educational institution.47 This differs from the test used in the NLRB decision because it doesn't directly implicate the employee-employer relationship. The test used by the IRS to assess income tax liability focuses on the narrower question of whether the payments represent compensation for services. That test is derived from Treasury regulations on the exclusion for qualified scholarships.48

1. Treasury regulations. The regulations elaborate on the limitation on qualified scholarships under section 117(c), which disallows an exclusion from gross income if the amounts are received as "payment for teaching, research, or other services by the student required as a condition of receiving the qualified scholarship." The regulations require that the payment enable academic studies and not represent compensation for services. This provides the basis for a primary purpose test and a quid pro quo test.49

The regulations contemplate the primary purpose test when studies or research are performed "primarily for the benefit of the grantor."50 That factor may not apply widely to all services provided by students. However, other regulations equate statutory terms of "teaching, research, and other services" to simply "services."51 Therefore, the purpose of a scholarship will be considered when examining if it's qualified for exclusion. Even so, the regulations won't disqualify a scholarship if the benefit to the grantor is only incidental.52 This may partially explain why application of the primary purpose test is limited.53

In outlining the quid pro quo test, the regulations say that the qualified scholarship exclusion won't apply to amounts that represent "compensation for past, present, or future employment services or . . . payment for services which are subject to the direction or supervision of the grantor."54 Thus, whether an amount represents compensation for services will depend on whether the university has control over the services provided by the student under the facts and circumstances.

The section 117 regulations more broadly disqualify any portion of a qualified scholarship received as "payment for services as a condition of receiving the scholarship."55 Therefore, any service performed by the student has the potential to create a compensatory relationship between the university and the student. In an example addressing part-time employment of students by universities, the regulations provide that only a portion of the qualified scholarship may be treated as taxable income if the student's services aren't an equal exchange of value for the exclusive performance of services. The regulations determine the amount received as taxable income by comparison with the amount "ordinarily paid for similar services performed by an individual who is not the recipient of a scholarship."56

That bifurcated treatment poses a separate problem for athletic scholarships because there are no "similar services" to use as a comparison. As such, it is likely the entire amount of grant-in-aid scholarships could be considered compensation for services because the scholarships are awarded exclusively for participation in the varsity sport.

Courts primarily use the quid pro quo test to determine if a scholarship qualifies for the section 117 exclusion.57 The scholarship results in taxable income if the student must perform services as a condition of receiving the funds. This was the analysis used by the IRS in Rev. Rul. 77-263. The quid pro quo test was recently applied by courts to find that payments received by medical residents were compensation for services and taxable income. Although athletic scholarships haven't been reconsidered since Rev. Rul. 77-263, the quid pro quo test will likely serve as the standard, given its use in the revenue ruling and the medical resident cases.

2. Case law. When examining a challenged scholarship, the courts look first to the statute, then to the regulations to resolve ambiguities in the statute. As could be expected, the language "compensation for services" is the key ambiguity in application of the quid pro quo test. Courts thus undertake a facts and circumstances analysis to determine if a compensatory relationship exists between the student and the university.

An early case applying the quid pro quo test presents the only time the Supreme Court has considered the qualified scholarship exclusion.58 In Bingler,59 Westinghouse Electric Corp. continued to pay salaries to employees who took educational leave to complete doctoral theses under the company's fellowship program. Westinghouse reported those payments as qualified scholarships excluded from gross income. The employees continued to receive employee benefits and were required to return to work at Westinghouse for two years after completing their studies. The Court found that the relationship was primarily compensatory because the payments were conditioned on the employees' continued work at Westinghouse. The payments thus violated what the Court described as the "ordinary understanding" of scholarships and fellowships as "relatively disinterested 'no-strings' educational grants, with no requirement of any substantial quid pro quo from the recipients."60 The Court held that a scholarship would be qualified for exclusion from gross income only if it included no conditional strings and required no quid pro quo return of services from the student.

The compensatory nature of the student-university relationship has since been extensively litigated in the medical resident cases. Those cases are typically brought by the government to collect deficiencies or recover erroneous refunds of FICA taxes.61 In one case, a district court followed Bingler to apply the two-pronged primary purposes test to disqualify purported scholarships to medical residents who were required to provide quid pro quo patient services.62 Analyzing all the facts and circumstances of the parties' relationship, the court found that the payments weren't used for studies because the funds were used to pay living expenses, and the stipends were contingent on the performance of services.63

The Second Circuit has reached a similar conclusion.64 The Memorial Sloan Kettering Cancer Center argued that the payments made to medical residents were qualified scholarships and therefore exempt from FICA taxes. In examining the facts and circumstances, the court found the residency appointment letter, which conditioned the receipt of funds on the performance of services, particularly convincing. The letter said that the residents were expected to participate in "safe, effective, and compassionate patient care under supervision." The court concluded that "any reasonable finder of fact reading the appointment letter would understand it to require the residents to provide patient care as a condition of receiving funds."65 Under Bingler, that condition exacts a quid pro quo and disqualifies the payment from the scholarship exclusion regardless of any educational purpose of patient care.

In a related case, the Eighth Circuit declined to follow a portion of Sloan-Kettering when it deferred to Treasury regulations excluding medical residents from FICA's student exception.66 Without addressing the issue of qualified scholarships, the Eighth Circuit in Mayo looked to the facts and circumstances to decide that employment must be incident to education to meet the student exception.67 Although the Eighth Circuit limited that interpretation to the definition of student under FICA, it reiterated the Supreme Court's earlier statement that Treasury regulations may construe "words in tax statutes that may have a common or plain meaning in other contexts."68

Mayo also demonstrates the courts' increasing tendency to deny an exclusion for scholarships that are compensatory in nature. Although that trend has not yet been brought to bear against athletic scholarships, the intensity of the IRS's pursuit of employment taxes from teaching hospitals suggests that the agency may well turn its attention to other questionable "scholarship" practices. The NLRB decision may be all that's needed to trigger that new scrutiny.

E. A Question of Adequacy

Assuming the IRS reconsiders the treatment of athletic scholarships, it could easily follow the case law and regulations, which broadly disqualify medical resident stipends from tax exemption under the quid pro quo test. The question is whether those authorities are adequate for analyzing athletic scholarships, especially given the factually distinguishable compensatory relationship involved with the medical residents. The players are performing athletic services that the NLRB declared are unrelated to their education; however, a large part of the potential compensation is received in the form of tuition remission.

The courts in Bingler, Partners, Sloan-Kettering, and Mayo imposed taxation on payments the recipients weren't using for tuition. One could make the case, however, that payments for living expenses and other expenses unrelated to education are enabling the Northwestern football players to pursue their academic studies.69 Further, the benefit received by the university from football is arguably distributed to its non-revenue-generating varsity sports and the educational community as a whole.70 Those factors of purpose and benefit make the grant-in-aid athletic scholarships a novel issue for examination by the IRS. Unfavorable to the players, incidental yet legitimate educational purposes were insufficient to prevent taxation in the medical resident cases. The Northwestern players are facing a heavy burden given that the NLRB declared football an illegitimate educational purpose.

Regardless of those policy concerns, the Treasury regulations will likely control and disqualify the entire amount of the grant-in-aid scholarships if the NLRB affirms its decision and the IRS chooses to follow it. The weight given to the appointment letters in Sloan-Kettering would almost undoubtedly lead to a close examination of the Northwestern policies and scholarship documents. If the IRS determines that the players are required to provide athletic services, as the NLRB found and as the scholarship documents suggest, the players would no longer be able to exclude the grant-in-aid scholarships from gross income. If the relationship is compensatory in nature, the scholarships will be taxed, regardless of whether they enable the players to pursue academic studies.

The question then turns to how Northwestern and the players could plan for the tax consequences. Given the NLRB's finding of employee status, they could argue that all the other tax benefits given to employers and employees should apply.

V. Consequences of Disqualification

If the IRS decides the NLRB's declaration of employee status controls the tax treatment of the scholarships, Northwestern and the players should bargain for a comprehensive employee benefits package to ease their respective tax burdens. Much of the grant-in-aid scholarship could qualify for tax-exempt status under various tax provisions enacted to encourage employers to provide specified benefits to their employees. First among these is the qualified tuition reduction that universities are allowed to provide their employees for undergraduate education. The exclusions for employer-provided health insurance, working condition fringe benefits, meals and lodging furnished for the convenience of the employer, and educational assistance programs would also provide significant relief. It thus may be possible to exclude all, or nearly all, of the grant-in-aid 100 percent full-ride equivalency package.71

A. Qualified Tuition Reduction for Employees

Northwestern and the players could try to bargain for a qualified tuition reduction plan. Under that plan, the amount of any reduction in tuition provided to a university employee would be excluded from gross income.72 The qualified reduction includes amounts similarly allowed under the qualified scholarship, such as payments of tuition necessary for the enrollment and attendance of courses.73 However, because the exclusion doesn't apply to books, supplies, or related fees, those would need to be provided as a separate fringe benefit.

When Congress enacted the qualified tuition reduction, it did so to codify a Treasury regulation that excluded income received as scholarships in the form of tuition remission to university employees and their families.74 As such, Congress clearly intended this exclusion to apply when an educational purpose coexists with the compensation for services.

Northwestern already has a qualified tuition plan for its faculty and staff, providing up to a 75 percent reduction.75 However, the players' plan would need to be more generous to encompass the full amount of tuition received under the current athletic scholarship. Increasing the employee tuition reduction benefit to 100 percent for only the players shouldn't violate the statutory antidiscrimination provision of the qualified tuition reduction.

That provision allows the exclusion from gross income only if (1) the tuition reduction is "available on substantially the same terms to each member of a group of employees," and (2) the group of employees is defined "under a reasonable classification [that] does not discriminate in favor of highly compensated employees."76 With the bargaining unit status granted by the NLRB, the players should pass both of those requirements. Bargaining units are considered reasonable classifications for purposes of the antidiscrimination provision, which will allow the players to negotiate their own qualified tuition reduction if it's available to each member of the bargaining unit.77

However, the IRS could challenge the qualified tuition reduction exclusion on the same grounds as the qualified scholarship because of a lack of other reasonable compensation to the players.78 If it's found that the tuition reduction is conditioned on the performance of services, the exclusion would be limited to the difference between the amount received as tuition reduction and what the player should receive as reasonable compensation, as determined by a comparison with similar service providers.79

This again highlights the problem of determining the fair market value of the players' athletic services. If that value is the amount of the 100 percent full-ride equivalency grant-in-aid packages, it may be impossible for the players to receive any tuition reduction without tax consequences. However, that application of the Treasury regulations contradicts the congressional intent to create certainty and consistency in use of the qualified tuition reduction. Also, proposed regulations on bifurcation of the qualified tuition reduction were never adopted in final form.80 Given the inconsistency of those regulations with Congress's intention that compensation and qualified tuition reductions coexist, the players and Northwestern should seek a private letter ruling while creating a tuition reduction plan.

B. Employer-Provided Insurance

As employees, the players could receive health and accident insurance tax free, which they could not do as student-athletes. Under the qualified scholarship paradigm, Northwestern couldn't provide health insurance tax free because it wasn't a related educational expense.81 But employees' gross income doesn't include amounts employers pay for coverage under an accident or health plan.82 For medicines, that amount would be limited to drugs prescribed to the players.83 That could be a surprising tax benefit of the football players becoming employees, although less valuable than keeping the tuition exclusion.

C. Working Condition Fringe Benefit

The working condition fringe benefit could be used to pass a wide array of tax-free benefits to the players. The catch here is that for the exclusion to apply, the benefit must be related to the employee's job.84 Because Northwestern and the NCAA require the football players to be students,85 it may be possible to claim tuition, fees, books, meals, and lodging as required expenses, subject to some limitations. For instance, only half the cost of meals would be excluded unless provided at an employer-operated eating facility that was considered a de minimis fringe benefit.86

The real challenge in claiming this exclusion is in proving that the benefits are related to employment. The educational expenses must also meet the regulatory requirements for the deduction of business expenses.87 Further, if ineligible, these amounts will be subject to FICA taxes.88 The IRS would conduct a facts and circumstances analysis to determine whether the expenses paid by the scholarships are eligible expenses. The burden would be on Northwestern and the players to prove that the benefits the players receive are sufficiently related to the performance of athletic services.

D. Benefits for Convenience of the Employer

Section 119(a) allows the full exclusion of meals and lodging provided through facilities the employer owns and operates under specified conditions. This provision could allow Northwestern to continue to provide room and board through its dormitories tax free, although it wouldn't apply to any stipend for off-campus living. Section 199(a) applies only if two conditions are met: (1) the meals must be provided on Northwestern premises, such as dormitory cafeterias; and (2) the players must be required to accept on-campus housing as a condition of employment, which is already required of underclassmen.89 In fact, section 119(d) specifically contemplates tax-exempt lodging for university employees.

E. Educational Assistance Program

Northwestern could also use an educational assistance program to provide the players other tax-exempt benefits. However, an educational assistance program is limited to $5,250 a year.90 That greatly reduces the practicality of that program in light of the other options given to Northwestern as an educational institution.

VI. FICA Withholding Tax

Following the holdings of Sloan-Kettering and Mayo, a determination that the players' grant-in-aid scholarships are conditioned on the performance of athletic services and are not qualified scholarships will expose those amounts to FICA withholding tax. The court found in Sloan-Kettering that because the medical resident stipends weren't qualified scholarships, those amounts were wages subject to FICA taxes.91 Although Mayo didn't examine the issue of qualified scholarships, the court of appeals found that compensation for services that weren't "incident to and for the purpose of pursuing a course of study" are wages subject to taxation under FICA.92 As such, any amount of the grant-in-aid scholarship amounts that can't otherwise be excluded from gross income will become subject to FICA tax. The resulting employment tax liability would be significant for Northwestern, which has 88 grant-in-aid football players with a total of at least $441,073 (up to $504,900) in taxable wages annually. Consider also that the statute of limitations allows the IRS to seek back taxes for the prior three years.93

VII. Seek Guidance or Tax Reform

Given the overarching and expensive effect the NLRB decision could have on the relationship of Northwestern and its football players, it's in the interest of both parties to seek guidance or lobby to preserve the exclusion of grant-in-aid scholarships. Although guidance from the IRS could provide certainty, it is likely that neither party will favor the strict application of tax law. Because CAPA and a former player have already met with members of Congress,94 the best way to guarantee the exclusion is to seek certainty and consistency through a specific statutory exemption for athletic scholarships.

If the parties seek guidance from the IRS, they are counting on it following Rev. Rul. 77-263's conclusion that athletic scholarships aren't compensation for services and are still primarily for educational purposes -- despite the change in circumstances reflected by the NLRB decision. That premise is threatened by the public filings quoting policy and scholarship award documents that explicitly link the requirement to play football and provide athletic services as a condition of receiving scholarship funds.95 The documents contradict the guidance of Rev. Rul. 77-263 by permitting the immediate termination of financial aid if a player withdraws from service. If the IRS follows a technical application of the code, case law, and regulations, it will likely withdraw Rev. Rul. 77-263 and tax the grant-in-aid scholarships. Given all the public calls to close the tax gap and reduce the deficit, overturning the athletic scholarship exclusion is a lucrative proposition for the IRS.

However, the IRS sometimes follows popular sentiment.96 When tax law results in unexpected, inconsistent, or unpopular tax consequences, the IRS retains the discretion to not pursue the taxpayer. This appears to be the situation with the athletic scholarships, which the IRS seems to be uninterested in examining. If that continues to be the case, the IRS would simply honor Rev. Rul. 77-263 as a categorical exclusion for athletic scholarships. However, the IRS would likely need to provide greater justification in light of the changing circumstances of collegiate athletics.

Given the current tax reform debate, Northwestern and the NCAA may also want to join the players as they make their case to Congress.97 Perhaps before the parties challenge each other in the courts over labor law claims, they should all lobby for a statutory tax exemption for athletic scholarships as a subset of qualified scholarships. That would provide the tax certainty needed to equitably evaluate the fairness of the labor conditions without the potentially disastrous economic fallout both sides could face from income and employment taxes. Congress is also the body of government most likely to lend an ear to the social policy implications of imposing income tax on collegiate football players without other income and related FICA taxes on both parties. If Congress supports the players' efforts to bargain for their rights, a statutory athletic scholarship exemption would help open the door for players nationwide.

VIII. Conclusion

Taxes could be imposed on the grant-in-aid scholarships regardless of whether the IRS decides to follow the NLRB's decision on employee status. Enough evidence may have surfaced in the public filings to warrant an IRS examination that will likely lead to disqualification under the quid pro quo test. Even if it doesn't, the compensatory nature of the relationship between Northwestern and the players will draw closer scrutiny that will likely disqualify the scholarships anyway. If there is no sufficient method to distribute these benefits tax free to the newly minted employees, the relationship between Northwestern and the players could become increasingly costly.

This leaves a few important questions unresolved. If the Northwestern scholarships are subject to taxation, will all grant-in-aid athletic scholarships be taxed? There are substantial equity interests in the government pursuing like treatment of similarly situated taxpayers. It certainly seems unfair to impose taxes on only a few players because they want a say in their long-term health and safety, especially when their ability to pay income taxes is extremely limited. Also, is there a legitimate policy purpose to taxing these scholarships? For the past 37 years, the government hasn't changed its position on athletic scholarships. Has the relationship between players and universities changed sufficiently to warrant the recharacterization of athletic scholarships?


1 Northwestern University and College Athletes Players Association (CAPA), No. 13-RC-121359 (Mar. 26, 2014) (NLRB decision).

2 Brief to the Regional Director on Behalf of Northwestern University, at 61, Northwestern University and CAPA, No. 13-RC-121359 (Mar. 17, 2014) (Northwestern brief); Patrick T. Harker, "Student Athletes Shouldn't Unionize," The New York Times, Apr. 1, 2014. See also Northwestern University's Brief to the Board on Review of Regional Director's Decision and Direction of Election, at 29-30, Northwestern University and CAPA, No. 13-RC-121359 (Northwestern appellate brief).

3 Northwestern brief, supra note 2, at 59.

4 For their part, the football players did not address taxes and presumably haven't considered the full effect of the interaction of these federal regulatory structures. See Brief for College Athletes Players Association, Northwestern University and CAPA, No. 13-RC-121359 (players' brief).

5 Section 501(c)(3).

6 Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).

7 Only football players recruited by Northwestern receive grant-in-aid scholarships, the arrangement examined by the NLRB. They are therefore the only players allowed in the bargaining unit. Walk-on athletes at Northwestern, by contrast, may receive only need-based aid, which is available to the general student body. See NLRB decision, supra note 1, at 20.

8 Joseph M. Dodge, "Scholarships Under the Income Tax," 46 Tax Law 697, 714 (1993).

9 Reg. section 1.451-2(a).

10 Id.

11 Section 117(b)(1) and (b)(2).

12 Joint Committee on Taxation, "General Explanation of the Tax Reform Act of 1986," at 42 (1987).

13 Id. at 40.

14 Players' brief, supra note 4, at 22.

15 Northwestern brief, supra note 2, at 59.

16 Northwestern Financial Aid, available at

17 Northwestern brief, supra note 2, at 59; see also Thomas R. Hurst, "Payment of Student-Athletes: Legal & Practical Obstacles," 7 Vill. Sports & Ent. L.J. 55, 74 (citing Michael Schinner, "Touchdowns and Taxes: Are Athletic Scholarships Merely Disguised Compensation," 8 Am. J. Tax Pol'y 127, 147 (1989)).

18 Robert W. Lee, "The Taxation of Athletic Scholarships: An Uneasy Tension Between Benevolence and Consistency," 37 U. Fla. L. Rev. 591, 609 (citing Richard L. Kaplan, "Intercollegiate Athletics and the Unrelated Business Income Tax," 80 Colum. L. Rev. 1430, 1462 (1980)). See also Schinner, supra note 17, at 155.

19 Players' brief, supra note 4, at 24.

20 Id.; Northwestern appellate brief, supra note 2, at 41-42.

21 Rev. Proc. 68-4, 1968-1 C.B. 761 (taxpayers are required to furnish the terms and conditions of grants and describe activities required as "a condition to receiving the grant").

22 Northwestern Financial Aid, supra note 16. See Table 1.

23 CAPA: "College Athletes Players Association: What We're Doing," available at

24 Id.

25 Northwestern brief, supra note 2, at 61; Harker, supra note 2.

26 Players' brief, supra note 4, at 24; Northwestern appellate brief, supra note 2, at 27.

27 NLRB decision, supra note 1, at 13.

28 29 U.S.C. section 2(3).

29 NLRB decision, supra note 1, at 13 (citing NLRB v. Town & Country Electric Co., 516 U.S. 85, 94 (1995)).

30 NLRB decision, supra note 1, at 13 (citing Brown University and International Union, United Automobile, Aerospace and Agriculture Implement Workers of America, UAW AFL-CIO, 342 NLRB 483, 490, n.27 (2004) (hereinafter Brown University); and NLRB v. Town & Country Electric, 516 U.S. 85 (1995)).

31 NLRB decision, supra note 1, at 14.

32 Id. at 15.

33 Id. at 20.

34 Id. at 15.

35 Id. at 15-16. The players spend extensive amounts of time on football activities -- 50 to 60 hours per week during training camps and 20 hours per week during the football season.

36 Id. at 18.

37 Id.

38 Id. at 19.

39 Id. The NLRB noted that the players undoubtedly learn important values like character, dedication, perseverance, and teamwork from coaches.

40 Id. at 20.

41 Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 323-324 (1992).

42 29 U.S.C. section 1002(6).

43 Nationwide, 503 U.S. at 320 (quoting Community for Creative Non-Violence v. Reid, 490 U.S. 730, 751-752 (1989), in which the Court held that a sculptor was employed as an independent contractor and therefore retained copyright ownership of a sculpture because it was not a work for hire).

44 NLRB decision, supra note 1, at 14.

45 "Memorandum of Understanding Between the Internal Revenue Service and the Department of Labor," at section 1 (Sept. 19, 2011).

46 Id. at section 3.

47 Marci Kelly, "Financing Higher Education: Federal Income-Tax Consequences," 17 J.C. & U.L. 307, 323 (1990-1991).

48 Reg. section 1.117-4.

49 Lee, supra note 18, at 598.

50 Reg. section 1.117-4(c)(2).

51 Compare reg. section 1.117-2(a)(1) with reg. section 1.117-4(c)(1).

52 Reg. section 1.117-4(c).

53 Lee, supra note 18, at 598.

54 Reg. section 1.117-4(c)(1) (emphasis added).

55 Reg. section 1.117-2(a)(1).

56 Id.

57 Lee, supra note 18, at 600.

58 Id. at 598.

59 Bingler v. Johnson, 394 U.S. 741, 742 (1969).

60 Id. at 751.

61 See generally United States v. Mount Sinai Med. Ctr. of Fla. Inc., 486 F.3d 1248, 1251-1253 (11th Cir. 2007); accord United States v. Mem'l Sloan-Kettering Cancer Ctr., 563 F.3d 19, 27 (2d Cir. 2009); United States v. Detroit Med. Ctr. 557 F.3d 412, 417-418 (6th Cir. 2009); Univ. of Chi. Hosps. v. United States, 545 F.3d 564, 567 (7th Cir. 2008).

62 United States v. Partners Healthcare System Inc., 591 F. Supp.2d 116, 122 (D. Mass. 2008).

63 Partners Healthcare System, 591 F. Supp.2d 116.

64 Sloan-Kettering, 563 F.3d 19.

65 Id. at 32.

66 Mayo Foundation for Medical Education and Research v. United States, 568 F.3d 675 (8th Cir. 2009), aff'd, 131 S. Ct. 704 (2011).

67 Mayo, 568 F.3d at 683. See also section 3121(b)(10) and reg. section 31.3121(b)(10)-2(c) (providing the exception to FICA tax to university employees if their work is "incident to and for the purpose of pursuing a course of study").

68 Mayo, 568 F.3d at 679 (citing Treasury's uncommon definitions of "acquisition" in Helvering v. Reynolds, 313 U.S. 428 (1941); "carrying on or doing business" in Magruder v. Washington, Baltimore & Annapolis Realty Corp., 316 U.S. 69, 73 (1942); and "disposition of property" in Cottage Savings Ass'n v. Commissioner, 499 U.S. 554, 559-561 (1991), among others).

69 Commentators arguing for the taxation of athletic scholarships often argue that low graduation rates entirely undermine the educational purpose; however, the Northwestern case is factually dissimilar given the 97 percent graduation rate for the players. See Lee, supra note 18, at 610; NLRB decision, supra note 1, at 13.

70 Northwestern brief, supra note 2, at 84.

71 See Table 2.

72 Section 117(d).

73 Id.

74 Tax Reform Act of 1984, 88 H.R. 432, pt. 2, 1604 (1982); reg. section 1.117-3(a).

75 Northwestern University: Employee Reduced Tuition Benefits, available at

76 Section 117(d)(3).

77 LTR 200403050 (citing reg. section 1.410(b)-4).

78 Section 117(c).

79 Reg. section 1.117-2(a)(1).

80 Prop. reg. section 1.117-6(d).

81 Section 117(b).

82 Section 106(a).

83 Section 106(f).

84 Section 132(d); reg. section 1.132-5 (the exclusion is allowed only if the employee could deduct the benefit received as a business expense if paid for by the employee).

85 NCAA, "NCAA 2013-2014 Division I Manual," section 1.3 Fundamental Policy (2013).

86 Section 132(e)(2).

87 Rev. Rul. 76-352, 1976-2 C.B. 37 (requiring courses be related to the employee's job).

88 Rev. Rul. 78-184, 1978-2 C.B. 304.

89 Section 119(a)(1); NLRB decision, supra note 1, at 3.

90 Section 127.

91 Sloan-Kettering, 563 F.3d 19.

92 Mayo, 568 F.3d 680.

93 See Table 3.

94 Tom Farrey, "NW Union Reps Off to Congress," ESPN (Mar. 31, 2014), available at

95 Players' brief, supra note 4, at 24.

96 IR-98-56. Following speculation in the press, the IRS declined to impose taxes when a baseball fan returned a record-breaking baseball to Mark McGwire. See also CNN Sports Illustrated, "Tax Man Won't Go After Fans Who Return Historic Homers" (Sept. 8, 1998), available at; David van den Berg, "Push to Unionize Student Athletes Raises UBIT Questions for Schools," Tax Notes, Feb. 24, 2014, p. 810 (speculating that "the Service might well hesitate to do battle with lawmakers from states in the South and Midwest, where college sports are especially popular," regarding unrelated business income implicated by the NLRB decision).

97 Unless Northwestern is certain it will win its appeal to the full board of the NLRB and maintain the current full exclusion from income.


                    Table 1. Potential Individual Income Tax

 Type of                 Dollar     Tax Liability --          Tax Liability --
 Compensation            Value      Unrelated Expenses        Full Inclusion

 Tuition                $46,836   Compensation   $16,354     $65,519    $75,000
 Fees                      $415   Taxes due       $2,010     $12,298    $14,685
 Books and supplies      $1,914
 Room and board         $14,389
 Personal expenses       $1,965
 Total                  $65,519

                        Table 2. Fringe Benefit Package

 Benefit                   Code             Exclusion        Conditions

 Tuition       Section 117(d) -- Qualified     100%    Cannot discriminate in
               Tuition Reduction for                   favor of highly
               Employees                               compensated employees

 Health        Section 104 -- Employer         100%
 insurance     Provided Health and Accident

               Section 62 -- Income              0%    Property received

 Housing       Section 119 -- Meals and        100%    Provided on premises
               Lodging for Convenience of              and required as a
               the Employer                            condition of employment

 Meals         Section 119 -- Meals and        100%    Provided on premises
               Lodging for Convenience of
               the Employer

               Section 132 -- Working           50%    Must be work related
               Condition Fringe

 Books         Section 132 -- Working          100%    Must be work related
               Condition Fringe

               Section 127 -- Educational      100%    Limited to $5,250 per
               Assistance Program                      year

 Workout       Section 132(j) -- On-Premises   100%    Must be on premises,
 facilities    Gyms                                    operated by employer,
                                                       and substantially used
                                                       only by employees

 Travel/       Section 132 -- Working          100%    Must be work related
 lodging       Condition Fringe

 Tutors        Section 132 -- Working            0%    Services are disallowed
               Condition Fringe

                  Table 3. Potential Employer-Owed FICA Taxes

                               Tax Liability --       Total Tax Liability
 Wages              FICA       Per Player             (88 players)

 $65,519.00         7.65%         $5,012.20                $441,073.91
 $75,000.00         7.65%         $5,737.50                $504,900.00

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