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Taking the Student Out of Student

Athlete: College Sports and the

Unrelated Business Income Tax
Erik M. Jensen*
A recent decision by a National Labor Relations Board regional
director, concluding that football players at Northwestern University are employees for purposes of the National Labor Relations
Act, could have spillover effects in tax law. This article considers
whether severing the connection between participation in athletics and the educational function of a universityi.e., ending the
pretense that athletes are student athletescould lead to imposition of the unrelated business income tax (UBIT) on the net revenue of some intercollegiate teams at big-time athletic colleges.

The sports pages have been filled with commentary on the March 2014 decision made by the director of Region 13 of the National Labor Relations
Board (NLRB).1 Regional Director Peter Sung Ohr concluded that football
players at Northwestern University are employees of the University, within
the meaning of the National Labor Relations Act, and are therefore eligible
to unionize.2 That decision is not the final word on the subject,3 of course, but
it was enough to get commentators thinking about the tax consequences that
might follow from the regional directors analysis.

* Erik M. Jensen is the Schott-van den Eynden Professor of Law at Case Western
Reserve University School of Law, and is Editor-in-Chief of the Journal. He may be contacted
by email at erik.jensen@case.edu.
Well, filled with commentary may be a bit of sports hyperbole, but there have been
many articles.
See Decision and Direction of Election, Northwestern University, Employer, and
College Athletes Players Assn, Petitioner, case 13-RC-121359 (Mar. 26, 2014), available at
On April 24, 2014, the Board granted Northwesterns Request for Review of the
Regional Directors Decision and Direction of Election and, on May 12, the Board invited
briefs on the issues raised in the case. See Notice and Invitation to File Briefs (May 12, 2014),
available on the NLRB website. See supra note 2.


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Nearly all of the tax discussion has focused on whether the logic of the
Northwestern decision means that some college athletes, even if not paid a
straightforward salary for their athletic services, might still be taxable on all
of the other benefits they receive, including what their schools call a scholarship. Although Section 117 of the Internal Revenue Code excludes the
amount of any qualified scholarship from gross income,4 an award is not a
scholarship if it is a quid pro quo for services.5
The possible taxation of some college athletes, for both income tax and
employment tax purposes, presents a wonderful set of issues, but this article
focuses on something else that might happen if we stop pretending that athletes in big-time college programs are students first: the football and basketball programs at mega-universities might be treated as businesses unrelated to
the educational function of those universities. If so, a universitys net income
from any particular sport might be subject to the unrelated business income tax
(UBIT). According to the NLRBs regional director, Northwestern reported
that its football team generated $235 million in revenue between 2003 and
2012, with expenses totaling only $159 million. For 2012-2013, the figures
were $30.1 million in revenue and $21.7 million in expenses.6 The tax revenue
generated by these numbers wouldnt erase the federal deficit, but real money
is at stake. Were talking about millions of dollars in potential tax liability.7

A qualified scholarship is limited to amounts used for qualified tuition and related
expenses. See IRC 117(b)(1), (2). Even if treated as a scholarship for tax purposes, a
full-ride athletic scholarshipi.e., one that covers room and board as well as educational
expenseswould therefore not be fully excludable under IRC 117(a). Unless stated otherwise, all references in the article to Sections are to sections of the Internal Revenue Code of
1986, as amended, and the regulations thereunder.
See IRC 117(c)(1) (providing that the exclusion does not apply to that portion of
any amount received which represents payment for teaching, research, or other services by the
student required as a condition for receiving the qualified scholarship); Treas. Reg. 1.1174(c) (providing that amounts paid as compensation for services or primarily for the benefit of
the grantor are not scholarships for these purposes). In a ruling from another eraindeed, by
todays standards it seems to have come from another planetthe Internal Revenue Service
ruled in 1977 that an athletic scholarship, the value of which does not exceed tuition, fees, and
necessary supplies, is excludable from a students gross income under IRC 117(a) when the
college (1) expects but does not require the students participation in a particular sport, (2)
requires no particular activity in lieu of participation, and (3) does not cancel the scholarship
if the student cannot participate. Rev. Rul. 77-263, 1977-2 CB 47. (The value of room and
board was also excludable under the law at that time; that is no longer even potentially the
case. See supra note 4.) In his classic article, Professor Kaplan called the ruling nave[,] since
athletic awards are made to secure the athletes services and generally are maintained subject
to his participation in college athletics. Richard L. Kaplan, Intercollegiate Athletics and the
Unrelated Business Income Tax, 80 Colum. L. Rev. 1430, 1462 (1980).

See Decision and Direction of Election, supra note 2, at 13.

With revenue of $8.4 million in 2012-13, Northwestern football might have been facing a tax liability of over $2.8 million (i.e., using a tax rate of 34 percent, see infra note 21) if
the football program is itself an unrelated trade or business.

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I first wrote about the UBIT issues in 1987, when the argument that
college athletes should be paid for their services was becoming common.8
Common though it was, almost no one except National Collegiate Athletic
Association (NCAA) officials, who were unalterably opposed to compensating athletes other than through traditional means like scholarships, paid much
attention to that issue or to the possible application of the UBIT to some college programs.9 But the Northwestern decision should bring new attention to
all of this.
This article first describes the largely mythical notion of the student
athlete in big-time college athletics; moves to a discussion of the UBIT as it
might apply to universities with athletic programs made up of professional
athletes; and, finally, focuses on a key UBIT issue: what the taxed activity or
activities might bei.e., a colleges athletic program as a whole or particular
revenue-generating sports within that program.

The Student Athlete

The idea that college athletes are all Frank Merriwells10 who, in the off
hours away from dedication to the books, happen to participate in organized
sports,11 probably began in the Garden of Eden (which is not the same as
Madison Square Garden), and it continues today, at least in some places. For
example, in its constitution, the the NCAA claims that
[t]he competitive athletics programs of member institutions are designed
to be a vital part of the educational system. A basic purpose of this Association is to maintain intercollegiate athletics as an integral part of the
educational program and the athlete as an integral part of the student

Erik M. Jensen, Taxation, the Student Athlete, and the Professionalization of College Athletics, 1987 Utah L. Rev. 35. See Colleges Majoring in Scandal, N.Y. Times, Apr.
17, 1985, at A26 (But if the country wont go cold honest, let it at least recognize that many
players are not serious students, need to be recruited with money and paid at least something
while in school.); Gary Becker, College Athletes Should Get Paid What Theyre Worth,
Bus. Wk., Sept. 30, 1985, at 18. Becker argued that the NCAA, through its restrictions on
scholarships and other compensation to athletes, reduce[s] the competition among colleges
for players in football and basketball, and, as a result, lowers the earnings of young black
and other athletes with limited opportunities. Id.

Certainly no one paid much attention to my article.


The creation of Gilbert Patten (using the pen name Burt L. Standish), Merriwell was
a fictional Yale student athlete, of unimpeachable characteri.e., a real goody-goodywhose
exploits Patten chronicled from 1896 until about 1913. (Just like today, athletes of that era
apparently had difficulty graduating on time, if at all.)

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Arthur Austin, Book Review, 58 N.C. L. Rev. 663 (1980).

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body and, by so doing, retain a clear line of demarcation between intercollegiate athletics and professional sports.12

The NCAA consistently hyphenates the term student-athlete, apparently

to emphasize how inextricably linked scholarly work and athletic activities
Yes, and storks bring babies. Little of what the NCAA says was true when
the fictional Mr. Merriwell starred on the athletic fields of Yale (before the creation of the NCAA).14 Reading that passage today can only cause guffaws.
To be fair, as the Journal always tries to be, the NCAAs model student
athlete can be found on all of the intercollegiate teams at most of the colleges and universities in the United States. The football players at Amherst or
Oberlin, say, arent employees of the colleges, and those football programs
are financial sinkholes, not money-makers. They generate no net revenue
that could be taxed. In addition, participants on many of the teams at Football
Universitythe fencer at Ohio State, say (if Ohio State has a fencing team),
are hardly income-generating employees. Those kids can be as devoted to
scholarship as other college students are.15 So there may be lots of real student athletes out there, but those arent the folks the NLRB or the IRS has
any reason to pay attention to.
The notion of the student athlete simply doesnt fit the same mold as
athletes in the big-time programsthe revenue-generating sports at the athletic powerhouses. Those athletes have no time to be serious scholars, even
if they were so inclined. (A real student athlete might come along every now
and then in those programs, but thats not the norm.) The myth of the student

NCAA Const. art. 1.3.1, reprinted in 2013-14 NCAA Division I Manual, at 1 (2013),
available at http://www.ncaapublications.com/p-4339-2013-2014-ncaa-division-i-manualjanuary-version.aspx?CategoryID=0&SectionID=0&ManufacturerID=0&DistributorID=0&
GenreID=0&VectorID=0&. To preserve the nonprofessional nature of college athletics, the
NCAA regulates the number and size of athletic scholarships an institution may offer and
the compensation that may be paid to athletes for summer employment. See NCAA Const.
arts. 12 (Amateurism), 13 (Recruiting), 15 (Financial Aid), 16 (Awards. Benefits
and Expenses for Enrolled Student-Athletes), reprinted in 2013-14 NCAA Manual, supra at
57-134, 191-226.
See, e.g., NCAA Eligibility Center, 2013-14 Guide for the College-Bound StudentAthlete (2013), available at http://www.ncaapublications.com/productdownloads/CBSA.pdf.
See, e.g., Frederick Jackson Turner, To the Alumni on Football, reprinted in Chron.
Higher Educ., July 9, 1986, at 56 (noting, in a 1906 speech to University of Wisconsin alumni,
that football has become a business, carried on far too often by professionals, supported by
levies on the public, bringing in vast gate receipts, demoralizing student ethics, and confusing the ideals of sport, manliness and decency); Howard James Savage, American College
Athletics (Carnegie Foundation for the Advancement of Teaching 1929) (criticizing commercialized sports).

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Which is to say, not very much.

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athlete nevertheless continues to shape views about what college athletics

should be. And the myth directly affects discussions about the level of legal
compensation for athletes andthe issue discussed herethe possible application of the UBIT to college athletics.
The myth has obvious advantages to the colleges (if not the athletes
themselves, many of whom come from poor backgrounds). Not having to
compensate the athletes, other than through scholarships, has nice effects on
a colleges bottom line. Furthermore, many colleges have become dependent
on the revenue that is generated, or believed to be generated, from big-time
athletic programs:16 the direct revenue from ticket sales, sales of broadcasting
rights, and sales of college paraphernalia, and the contributions from loyal
alums and friends who care more about what happens on the gridiron than in
the library.17
The popularity of college athletics may depend on the hypocrisy. Who
knows what would happen if we were to stop pretending that the people wearing the helmets or short pants are common, everyday college students?18
One thing that might happen is that the UBIT would come into play. As
the rest of this article will demonstrate, the idea that colleges should not be
taxed on the net revenue from their money-making athletic teams is dependent on the idea that those engaged in athletic contests are student athletes.
Do away with that pretense, and the case for protection from the UBIT
never very strong to begin withcollapses.

The Tax on Unrelated Business Income

Even in those unusual fiscal years in which a tax-exempt college has net
revenue,19 the college does not pay federal tax on tuition and other income

On the other hand, the physics department probably doesnt see any benefit from that
revenue. At many institutions the direct revenue from football and mens basketball (the only
serious revenue-raisers for most) merely supports the rest of a bloated athletic program. If the
physicists benefit at all, it is through increased alumni donations, student applications, and
legislative appropriations.

If a library even exists.


Of course we have stopped pretending in some casesas with the University of Kentucky basketball team, now made up overwhelmingly of freshmen for whom Lexington is a
one-year stop on a trip to the NBA.
This assumes that the concept of net revenue has meaning in this context. Measuring the net revenue of a nonprofit enterprise is a difficult conceptual task because basic
accounting principles rest on the premise that the organization seeks to maximize its profit.
Boris I. Bittker & George K. Rahdert, The Exemption of Nonprofit Organizations From Federal Income Taxation, 85 Yale L.J. 299, 307 (1976). What expenses should be deductible, for
example, to an organization that by definition does not have ordinary and necessary business
expenses? Id. at 309-12.

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attributable to its educational activities.20 Like other tax-exempt institutions,

however, a college is supposed to be taxed, at the rates applicable to corporations, on unrelated business taxable income.21 Unrelated business taxable income in general is income from (1) a trade or business that is (2)
regularly carried on, but that is (3) not substantially related to the institutions exempt purposes (other than by generating revenue).22 For a college, its
exempt purposes are its educational purposes.23

Purposes of UBIT. The UBIT is generally understood to have two overlapping purposes. It is intended to protect the Treasury from loss of revenue and
to protect taxpaying entities from unfair competition.

IRC 501(a) provides generally that certain organizations are exempt from federal income
tax, and most colleges would meet the requirements of IRC 501(c)(3), a category that includes

[c]orporations [or other organizations] . . . organized and operated exclusively for

religious, charitable, scientific, testing for public safety, literary, or educational
purposes . . ., no part of the net earnings of which inures to the benefit of any private
shareholder or individual, no substantial part of the activities of which is carrying
on propaganda, or otherwise attempting, to influence legislation, . . . and which
does not participate in, or intervene in, . . . any political campaign on behalf of (or
in opposition to) any candidate for public office.
IRC 501(c)(3) (emphasis added). The effect of 501(c)(3) status is not merely to make an institution generally tax-exempt. (The typical college pretty much spends what it takes in, so it generally
wouldnt have net revenue anyway. Because of timing issues, however, such as those arising from
capital expenditures, a college that spends every nickel it gets on legitimate educational projects
might still have net income.) More important, contributions made to 501(c)(3) institutions will be
deductible to the donors, subject to certain statutory limitations. IRC 170(a)-(e).
If a substantial part of an institutions revenue comes from sources unrelated to its
exempt purposes, either the institution may not qualify as a 501(c)(3) organization in the first
place, or its exempt status may be subject to revocation. This article assumes that the level of
professional athletic activity at any college will not be so great that denial or revocation of
tax-exempt status is likely.
IRC 511(a)(1). The rates set out in IRC 11 would apply to the unrelated business
taxable income of the otherwise tax-exempt organization. Although IRC 11 starts out with
fairly low rates, they go up quickly, and the benefit of the lower rates is eliminated for higher
income corporate taxpayers. If a colleges football team were an unrelated trade or business,
and if it generated $1 million in net income, the college would pay tax on that income at a 34
percent rate. Thats $340,000, which could cover the salaries for a lot of English professors.
IRC 511(a), 512(a)(1), 513(a). The statute, subject to certain modifications, requires
computing the gross income derived from the unrelated trade or business and subtracting those
deductions directly connected with the unrelated trade or business. IRC 512(a)(1). The modifications provided in IRC 512(b) protect college endowment income from application of the
tax by excluding most passive investment income (among other things) from the computations
of a 501(c)(3) organization. But see IRC 514 (including unrelated debt-financed income in
unrelated business income).
Educational is defined in the regulations as relating to [t]he instruction or training of the individual for the purpose of improving or developing his capabilities; or . . . [t]he
instruction of the public on subjects useful to the individual and beneficial to the community.
Treas. Reg. 1.501(c)(3)-1(d)(3)(i).

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Prevent Loss of Tax Revenues. First, the tax is intended to prevent otherwise taxable activities from being insulated from taxation. When Congress considered this provision as part of the Revenue Act of 1950,24 it was influenced by
the close economic ties between New York University (NYU) and various commercial enterprises, particularly the C.F. Mueller Company,25 then reportedly the
countrys largest producer of pasta products. Mueller assigned all of its income
to the benefit of the NYU law school. Because, as a so-called feeder organization, Mueller transferred its net income to a tax-exempt educational enterprise,
Mueller took the position that it, too, was not subject to federal income taxation.
Although Mueller lost in the Tax Court,26 it won in the Third Circuit in 1951.27
While Mueller was working its way through the courts, many congressmen became concerned about the effect of a decision adverse to the government. In the words of the first Representative Dingell (whose son is now
retiring after serving in Congress since 1955), if such feeder organizations
were tax-exempt,28 eventually all the noodles produced in this country will
be produced by corporations held or created by universities . . . and there will
be no revenue to the Federal Treasury from this industry.29 The 1950 Act
took two steps to guard the Treasury from a significant loss of revenue. First,
it eliminated the tax protection of feeder organizations.30 Second, to keep an


P.L. 81-814, 301, 331, 64 Stat. 906, 947, 957.


See U.S. v. Am. Bar Endowment, 477 U.S. 105, 120 (1986) (Stevens, J., dissenting); Bittker & Rahdert, supra note 19, at 318-19; Note, The Macaroni Monopoly: The Developing Concept of Unrelated Business Income of Exempt Organizations, 81 Harv. L. Rev. 1280, 1281 (1968);
Comment, Colleges, Charities, and the Revenue Act of 1950, 60 Yale L.J. 850, 850 (1951).

C.F. Mueller Co. v. Commr, 14 TC 922 (1950).


C.F. Mueller Co. v. Commr, 190 F2d 120 (3d Cir. 1951). In effect, the Third Circuit
applied the destination of income test of Trinidad v. Sagrada Orden de Predicadores, 263
U.S. 578, 581 (1924) (concluding that statutory provision says nothing about the source of
income, but makes destination the ultimate test of exemption). The Tax Court said that it
would not follow the Third Circuits decision in Mueller. See Joseph B. Eastman Corp. v.
Commr, 16 TC 1502, 1509 (1951).
Prior to the Revenue Act of 1950, a number of courts had held that an organization feeding a tax-exempt organization was itself exempt from federal income tax. See, e.g.,
Roches Beach v. Commr, 96 F2d 776 (2d Cir. 1938) (holding that income of bathing beach
corporation fed to exempt foundation was exempt). The Third Circuit in Mueller followed the
decision in Roches Beach. Mueller, 190 F2d at 122.
Revenue Revision of 1950: Hearings Before the House Comm. on Ways and Means,
81st Cong., 2d Sess. 580 (1950).
IRC 502(a) provides that an organization operated for the primary purpose of carrying on a trade or business for profit shall not be exempt from taxation . . . on the ground that
all of its profits are payable to one or more organizations exempt from taxation. Although
a feeder corporation that transfers funds to a 501(c)(3) organization might be entitled to a
deduction for charitable contributions, IRC 170(b)(2) limits a corporations deduction to 10
percent of its taxable income. If there were no such percentage limitation, a nominally taxable
feeder could effectively achieve exempt status through the charitable deduction.

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institution like NYU from moving macaroni production in-house to avoid

taxation,31 the Act provided for theoretically identical treatment for unrelated
trades or businesses that are operated directly by tax-exempt organizations.
Macaroni profits would be taxed whether produced by a separate legal entity
or by the otherwise tax-exempt organization itself.32
Prevent Unfair Competitive Advantage. The UBIT was also intended
to prevent tax-exempt organizations from gaining a competitive advantage. If, for example, NYU were able to operate a department store and
pay no federal tax on the income from the store, it might be able to undercut Macys and Saks Fifth Avenue. Whether price undercutting would
in fact occur in a competitive market is not clear.33 But even if NYUs
store did not lower its prices, it would still be able to accumulate capital
more rapidly than its nonexempt competitorsto use its profits tax-free
to expand operations.34 The UBIT is intended to eliminate this possible
competitive advantage.

Convoluted Reasoning Behind Conclusion That a Schools Sports

Income Is Not Subject to UBIT. Would income from professional athletics be unrelated business income to a college? Of the three statutory requirements for imposition of the tax, only one seems to have any serious doubt.
Even without open professionalism, it is reasonably clear that all or part of
the athletic program today at some colleges rises to the level of a trade

That would make it possible for NYU to provide lavish perks to faculty and administrators . . . . Oh, that has happened anyway?
The congressional committee reports make it clear that tax results should not depend
on whether income is earned by a charitable organization directly or earned by a distinct legal
entity and fed to the charitable organization. H.R. Rep. No. 2319, 81st Cong., 2d Sess.
(1950), reprinted in 1950-2 CB 380, 409; S. Rep. No. 2375, 81st Cong., 2d Sess. (1950),
reprinted in 1950-2 CB 483, 505.
Pricing decisions are subject to complex economic considerations beyond the scope of
this article. A number of commentators have suggested that price cutting is unlikely. See, e.g.,
Bittker & Rahdert, supra note 19, at 319 & n.47; Kaplan, supra note 5, at 1465-66.
H.R. Rep. No. 2319, supra note 32, 1950-2 CB at 409; S. Rep. No. 2375, supra
note 32, 1950-2 CB at 504. See Treas. Reg. 1.513-1(b); Am. Bar Endowment, 477 U.S. at
119 & n.1 (Stevens, J., dissenting); U.S. v. Am. Coll. Physicians, 475 U.S. 834, 838 (1986)
(Congress perceived a need to restrain the unfair competition fostered by the tax laws.);
H.R. Rep. No. 413, 91st Cong., 1st Sess. (1969), reprinted in 1969-3 CB 200, 231 (stating
that a business competing with taxpaying organizations should not be granted an unfair
competitive advantage by operating tax free unless the business contributes importantly to
the exempt function). Indeed, it may be that nonprofit institutions have competitive advantages even without favorable tax treatmentbecause of favorable public images, lower
labor costs, and subsidies through government grants and private donations. See Jensen,
supra note 8, at 47-48.

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or business, characterized by a search for profit,35 and that the constituent

parts of a full-fledged athletic program are regularly carried on.36 The critical inquiry, therefore, will usually be whether the activity is substantially
related to the institutions exempt purposes. Under regulations issued in
1967, the key question is whether the trade or business, although motivated
in part by a desire for income, contribute[s] importantly to the accomplishment of the exempt purposes of an organization.37

[T]rade or business includes any activity which is carried on for the production
of income from the sale of goods or the performance of services. IRC 513(c). [F]or
purposes of section 513 the term trade or business has the same meaning it has in section
162that is, the ordinary and necessary business expense section. Treas. Reg. 1.5131(b). The critical test for trade or business under IRC 162 is profit motive. Brannen
v. Commr, 722 F2d 695, 704 (11th Cir. 1984). See also Am. Bar Endowment, 477 U.S. at
110 & n.1.
Passive investment income may not be attributable to a trade or business because
neither the sale of goods nor the performance of services is involved. Passive income is in
any case generally removed from the tax computations of a 501(c)(3) organization by IRC
512(b). See supra note 22. The statute also specifically excludes from taxation certain activities that rise to the level of a trade or business but that Congress nonetheless thought were
entitled to protection: those activities (1) in which substantially all the work is performed
without compensation; (2) that are carried on primarily for the convenience of the organizations members, students, patients, officers, or employees, such as a colleges operation of a
laundry to wash dormitory linen; or (3) that involve the selling of merchandise, substantially
all of which was received by the organization as gifts or contributions. IRC 513(a); Treas.
Reg. 1.513-1(e). Only the first exception can even arguably apply to intercollegiate athletics
and student athletes, and its application is unlikely. Athletic scholarships may not constitute
taxable compensation to the recipients to the extent they are for qualified tuition and related
expenses, see supra note 4, but they may well constitute compensation for purposes of IRC
513(a). Even if the scholarships are not compensation, any college athletic department has
other clearly compensated employees among its coaches, administrators, and support staff.
See Kaplan, supra note 5, at 1460-63.
The regulations state that ordinarily a trade or business will be treated as regularly
carried on if the business activities manifest a frequency and continuity, and are pursued in a
manner, generally similar to comparable commercial activities of nonexempt organizations.
Treas. Reg. 1.513-1(c)(1). The fact that a football teams season is limited to a less-thanannual period should not affect the conclusion that the teams operations are regularly carried
on. See Kaplan, supra note 5, at 1449-50. (In any event, the seasons for the various sports
seem to be getting close to full years anyway.)
Treas. Reg. 1.513-1(d)(2). For taxable years beginning prior to December 13,
1967, the regulations provided that an activity was substantially related only if the principal purpose of such trade or business is to further . . . the purpose for which the organization is granted exemption. Treas. Reg. 1.513-2(a)(4) (emphasis added). Under this
standard, an activity was unrelated unless its primary objective was furthering the exempt
purpose. See Iowa State Univ. v. U.S., 500 F2d 508, 520 (Ct. Cl. 1974) (stating that the
commercial aspects and the emphasis on revenue maximization were the overwhelming
goals of the operation of the [television] station; and, thus, the business was not substantially
related to the educational purposes of the University); Kaplan, supra note 5, at 1450-51.
The amended regulatory standard liberalized the protection for profit-making activities of
exempt organizations.

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Determining whether a trade or business contributes importantly

requires one of those irritating facts-and-circumstances analyses.38 Significant facts include:
The level of profits (the larger the profits, the more likely the trade
or business is unrelated);39
The scope of the activity in comparison with the organizations
exempt purposes (the more the activity overwhelms the clearly
exempt functions of the enterprise, the greater the problem);40 and
The content of the activity (the less the educational or other taxexempt component, the more likely the imposition of the tax).41
If big-time intercollegiate athletic programs were to be carefully analyzed
under these principles, many would fare poorly. (Indeed, coming to that
result doesnt require very careful analysis.) As Professor Kaplan put it 34
years ago:
The available evidence does show . . . that a great many athletic programs probably do have the characteristics of an unrelated trade or
business. . . . [T]hese programs are profit-motivated, at least in part;
they are regularly carried on; and they have ventured far beyond the club
sports model generally thought to promote educational values.42
Treas. Reg. 1.513-1(d)(1). See Am. Coll. Physicians, 475 U.S. at 849 ([T]he statute
provides that a tax will be imposed on any trade or business the conduct of which is not substantially related, . . . directing our focus to the manner in which the tax-exempt organization
operates its business. (emphasis in the original)).

See, e.g., Carle Found. v. U.S., 611 F2d 1192, 1198 (7th Cir. 1979).


Treas. Reg. 1.513-1(d)(3) provides:

[T]he size and extent of the activities involved must be considered in relation to the
nature and extent of the exempt function which they purport to serve. Thus, where . . .
activities . . . are conducted on a larger scale than is reasonably necessary for performance of such functions, the . . . portion . . . in excess of the needs of the exempt
functions constitutes . . . [an] unrelated trade or business.
For example, a university that sponsors professional theater companies and symphony
orchestras will not have unrelated business income from the activities even though the productions are open not only to students and faculty but also to the general public. [T]he presentation of such drama and music events contributes importantly to the overall educational
and cultural function of the university. Treas. Reg. 1.513-1(d)(4)(iv), ex. (2). However,
activities performed in a commercial manner may be treated as unrelated trades or businesses.
See, e.g., Treas. Reg. 1.513-1(d)(4)(iii) (noting that an asset or facility necessary to the
conduct of exempt functions may also be employed in a commercial endeavor and thus may,
depending on the circumstances, generate unrelated business income); cf. Rev. Rul. 85-110,
1985-2 CB 166 (holding that revenue from laboratory testing performed for private patients of
exempt hospitals staff physicians was unrelated business income if laboratory services were
otherwise available in community).

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Kaplan, supra note 5, at 1471.

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Concluding otherwise would require giving extraordinary weight to

some conclusory, and otherworldly, language in the legislative history of the
Revenue Act of 1950. When the unrelated-business taxing scheme was being
implemented, Congress paid almost no attention to intercollegiate athletics.
The House Ways and Means Committee and the Senate Finance Committee heard no testimony on the issue, but reports of both committees baldly
assertedas if there were no doubtthat [a]thletic activities of schools are
substantially related to their educational functions.43 With no apparent reservations, the committees concluded, Of course, income of an educational
organization from charges for admissions to football games would not be
deemed to be income from an unrelated business, since its athletic activities
are substantially related to its educational program.44
Of course?! That conclusion should not have been easy even in 1950.
Nevertheless, as a result of this legislative history, college sports have enjoyed
an exalted tax position. In 1977 the Internal Revenue Service briefly tried to
carve out an area of taxability for revenues from broadcasting sports events,45
but the Service was bombarded with protests. (Its not nice to challenge
the football gods.) Quickly backing down, the Service decided, in several
1978 technical advice memoranda,46 that there is no meaningful distinction
between exhibiting the game in person to 100,000 people and exhibiting the
game on television to a much larger audience where both groups of people
may be made up not only of students.47 With these TAMs and two revenue

H.R. Rep. No. 2319, supra note 32, 1950-2 CB at 409; S. Rep. No. 2375, supra note
32, 1950-2 CB at 505.
H.R. Rep. No. 2319, supra note 32, 1950-2 CB at 458 (emphasis added); S. Rep. No.
2375, supra note 32, 1950-2 CB at 559 (emphasis added). Moreover, a college would not be taxable on income derived from a basketball tournament sponsored by it, even where the teams were
composed of students of other schools. H.R. Rep. No. 2319, supra note 32, 1950-2 CB at 409;
S. Rep. No. 2375, supra note 32, 1950-2 CB at 505. The committees perhaps considered college
athletic events to be like the presentation of plays and musical events by students and faculty,
activities now specifically protected by regulations. See Treas. Reg. 1.513-1(d)(4)(i), ex. (1).
The Service notified several universities and the Cotton Bowl Athletic Association, a
tax-exempt entity that presents the annual Cotton Bowl football game, that revenue from the
broadcasting rights to the game would constitute unrelated business income. Feeling bound by
the legislative history, the Service conceded that gate receipts were not subject to the tax. The
committee reports were silent on the broadcasting issue, however, presumably because revenues from such sources were inconsequential in 1950, see TAM 78-51-002 (no date given),
and the Service tried to take advantage of this gap in the legislative history.
The TAMs held that unrelated business income was not created by university sales of
broadcast rights to football and basketball games, TAMs 78-51-002 (no date given), 78-51005 (no date given), and 78-51-006 (no date given); by the sale of broadcasting rights by an
amateur athletic union, TAM 78-51-003 (no date given); and by the sale of broadcasting rights
by a football bowl association, TAM 78-51-004 (Aug. 21, 1978).

TAMs 78-51-002 (no date given), 78-51-004 (Aug. 21, 1978), and 78-51-006 (no date


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rulings published in 1980,48 the Service was in full retreat, for a while at least,
adopting a hands-off position toward intercollegiate athletics.
The concession on broadcasting revenue, like the longtime exemption
of gate receipts, was premised on the student nature of the activities. In one of
the published rulings, the Service stated, An athletic program is considered
to be an integral part of the educational process of a university, and activities
providing necessary services to student athletes and coaches further the educational purposes of the university.49 Moreover, the 1978 technical advice
memoranda reverently extolled the student athlete in providing justifications,
which the 1950 legislative history had not done, for connecting intercollegiate athletics with education:
[A]n audience for a game may contribute importantly to the education
of the student-athlete in the development of his/her physical and inner
strength and to the education of the student body and the community-atlarge in heightening interests in and knowledge about the participating
schools. In regard to the student-athlete, the knowledge that an event is
being observed heightens its significance, which raises the levels of both
competitive effort and enjoyment. Attending the game enhances student
interest in education generally and in the institution because such interest is whetted by exposure to a schools athletic activities. Moreover,
the games (and the opportunity to observe them) foster those feelings of
identification, loyalty, and participation typical of a well-rounded educational experience.50

Accepting that passage requires one to suspend disbeliefbig-time.

Ive not seen enhanced student interest in education at college football games,
except the efforts devoted to comparative mixology and sex education. We
must pretend that the state of major college athletics is something other than
what we know to be the case. The pretense is nevertheless quite valuable for
supporters of college athletics because it helps insulate the institutions from
the inquiries of the Internal Revenue Service. The effect of openly professionalizing college athletics would be to undo those 64 years of favorable

Rev. Rul. 80-295, 1980-2 CB 194 (ruling that sale of broadcasting rights by amateur
athletic union not unrelated trade or business; Rev. Rul. 80-296, 1980-2 CB 195 (ruling that
sale of broadcasting rights to annual intercollegiate event by tax-exempt body not unrelated
trade or business).
Rev. Rul. 80-296, supra note 48, at 195 (emphasis added). See also Rev. Rul. 67-291,
1967-2 CB 184 (holding that nonprofit organization which subsidizes training table for universitys athletic teams furthers educational program of university and may be a 501(c)(3)
TAMs 78-51-002 (no date given), 78-51-004 (Aug. 21, 1978), 78-51-005 (no date
given), and 78-51-006 (no date given).

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history. If colleges stop pretending that their athletic programs are related to
the greater educational enterprisethat is, if the athletic teams are composed
of acknowledged professionals, with no direct educational connection to the
colleges except revenue-raisingthe UBIT will necessarily come into play.
A college establishing a professional team, either because it wants to
or because the NLRB says it has to, would have little in the way of defenses
against a UBIT challenge.51 To be sure, the revenue might be used for educational purposes52 but that could be said about the revenue from any profitmaking activity undertaken by a collegeNYUs macaroni operation and
hypothetical department store, for example. That revenue will be put to
good use, and that the burden of any tax would therefore fall on deserving
persons,53 doesnt protect a college from the UBIT.54 Neither of the purposes
behind the tax, protecting the Treasury and preventing unfair competition,
would be served if the tax could be so easily circumvented.
Nor will a college that establishes a professional sports program be able
to successfully defend against UBIT liability on the ground that there are no
other, competing professional teams in the vicinity of the campus. It will not
work, that is, to argue that one of the purposes behind the tax, preventing
unfair competition, would not be served by the taxs application. To begin
with, the no competition model is probably not accurate: regardless of location, a college team does, in fact, compete with professional teams through

Certainly the college would have forfeited any argument that its athletic program was
not an unrelated trade or business because substantially all the work in carrying on such trade
or business is performed . . . without compensation. IRC 513(a)(1). Even without open
professionalization, however, that argument was unlikely to prevail.

Or it might not.


Bittker and Rahdert point out that

[b]y reducing the amount that the exempt organization can apply to its charitable . . .
purposes, the tax necessarily burdens the beneficiaries of these activities, and their
ability to pay ought to be considered in deciding whether and to what extent to
impose the tax. Yet it was evidently never suggested during the 1950 and 1969
debates that the tax on the unrelated business income of charitable organizations
reflected the ability to pay of those affected by it. Almost certainly . . . it does not,
and thus made the income tax more regressive.
Bittker & Rahdert, supra note 19, at 325-26 (footnote omitted).
The statute requires determining whether the conduct of the activity is not substantially related to the organizations tax-exempt purpose without regard to the need of such
organization for income or funds or the use it makes of the profits derived. IRC 513(a).
If the organization uses unrelated funds to further related projects, it might seem
that the unrelated business income should be reduced by the amount of a deemed charitable
contribution. However, it is unclear that such a deemed transfer constitutes a contribution.
See IRC 170(c). Even if it does, the amount of any deductible charitable contribution may
not exceed 10 percent of the unrelated business taxable income (computed without regard to
the contribution). IRC 512(b)(10).

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broadcasting. More important, nothing in the Internal Revenue Code requires

that actual competitors exist for the tax to apply, and, in any event, the regulations suggest that the likelihood of unfair competition can be inferred if the
statutory requirements are met.55 Judicial authority is to the same effect: the
UBIT is not limited to income earned by a trade or business that operates in
direct competition with taxpaying entities.56
Under existing law, colleges have no clear protection from taxation of
income attributable to intercollegiate sports. A college facing the creation
of an openly professional sports team, whether voluntarily or involuntarily,
should be aware, therefore, that the step may have undesirable tax consequences. And, as the next section discusses, the consequences are not fully
predictable. What are the dimensions of the unrelated trade or business to
which the tax applies?

What Is the Taxable Activity?

A college that establishes an openly professional sports program will have
a trade or business that is regularly carried on and that is not substantially
related to the colleges exempt educational purposes. Accordingly, a tax will
be imposed on any unrelated business taxable income of the activity. That
does not, however, end the analysis. The identity of the taxable activity is not
so clear, particularly if a college does not professionalize its entire athletic
program. (Since few sports are money-makers, even at the most athletically
inclined institutions, it is hard to imagine any colleges willingly professionalizing everything. And it is hard to imagine that the NLRB regional directors analysis in the Northwestern case would extend to all intercollegiate
sports offered by a university.)

Entire Athletic Program vs. Solely Revenue-Raising Teams. If the

appropriate trade or business is deemed to encompass the schools entire
athletic program, the losses and other deductions attributable to nonrevenue
sports may be used to offset income from the revenue-raisers.57 Most big-time
Treas. Reg. 1.513-1(b) (stating that activity meeting statutory requirements presents sufficient likelihood of unfair competition to be within the policy of the tax). Indeed, as
the Supreme Court noted, the lack of competitors may evidence the competitive advantages
provided the exempt entity. See Am. Bar Endowment, 477 U.S. at 113 & n.2 (noting that
ABEs tax-exempt status would make it difficult for private firms to compete).
See, e.g., Smith-Dodd Businessmans Assn v. Commr, 65 TC 620, 624 (1975) (noting that unfair competition plays a relatively insignificant role in the application of the . . .
unrelated business tax).
See IRC 512(a)(1); Treas. Reg. 1.512(a)-1(a). This assumes that the losses
and deductions would be treated as directly connected with the carrying on of the trade
or business, and that deductions are not deferred because some or all of the costs must be

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schools expend all or substantially all of their athletic revenues to support

athletics generally, and any tax liability might therefore disappear. If this
is the proper analysis, the UBIT would merely be an irritant to a college,
resulting in no additional dollars flowing to the Treasury. Moreover, because
all unrelated trades and businesses are aggregated in computing unrelated
business income,58 a college with an overall loss from an athletic program
in a particular year could use the loss to offset income from other unrelated
enterprises. Treating the entire athletic program as an unrelated trade or business in these circumstances could therefore provide a temporary benefit to
a college.59
If, however, the unrelated trade or business is determined to be only
a single revenue-raising team or a group of revenue-raising teams, the tax
results are quite different. Football teams by themselves are often hugely
profitable; a tax imposed on the revenue of such an enterprise could severely
deplete university coffers.
Determining the boundaries of a trade or business requires another
facts-and-circumstances analysis, and it is therefore impossible to state a
conclusion applicable in all situations. Nevertheless, there is little doubt that
the Internal Revenue Service, if it were unconstrained by political pressures,
would seek to treat a profitable component of a larger athletic program as a
separate trade or business, and would therefore measure the tax by the net
revenue of that component alone.

Fragmentation by Activity. Each activity of an exempt organization

is potentially a trade or business. Under an amendment made by the Tax
Reform Act of 1969, the Internal Revenue Code gives the Service authority
to fragment the activities of an otherwise exempt organization: an activity
does not lose identity as a trade or business merely because it is carried on
within a larger aggregate of similar activities or within a larger complex of
other endeavors which may, or may not, be related to the exempt purposes


Treas. Reg. 1.512(a)-1(a) provides:

In the case of an organization which derives gross income from the regular conduct
of two or more unrelated business activities, unrelated business taxable income is
the aggregate of gross income from all such unrelated business activities less the
aggregate of the deductions allowed with respect to all such unrelated business
The fact that other income may be offset by athletic program losses in particular taxable years does not permit a college to shelter such income forever. Because a trade or business
is characterized by a search for profit, an athletic program generating perpetual losses might
not be treated as a trade or business.

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of the organization.60 Thus, the Service may break down even an apparently
integrated operation into smaller parts.
For example, the Service has ruled that an exempt blood banks commercial sales of blood plasma had to be subdivided: plasma acquired for resale
generated income from an unrelated trade or business, but plasma produced
as a by-product of providing blood products to hospitals did not.61 Similarly,
sales made by university bookstores must be broken into educational and
noneducational components.62 Sales made by a museums store also must be
broken down into utilitarian and nonutilitarian categories.63
If sales made by an exempt organizationeven sales of fungible items
such as blood plasmado not constitute a single trade or business, there
is no reason to believe that a colleges athletic program could (or should)
avoid fragmentation. The teams themselves provide one obvious basis for
an accounting breakdown, and other components (such as broadcasting) can
also be imagined. The Service could reasonably single out certain teams
(those concerned with revenue-raising) as unrelated trades or businesses and
consequently impose the tax on the net revenue attributable to those teams.
The colleges would not be permitted to offset that income with the expenses
and losses attributable to other parts of the athletic program (that is, those
deemed to be substantially related to the educational enterprise). Under
this analysis, a college that chose to professionalize a part of its athletic program, or that was effectively forced to do so by the unionization of the players, would be subject to the most painful application of the taxto the net
revenue of its money-making sports.

IRC 513(c) (as added by Tax Reform Act of 1969, P.L. 91-172). The Code was
amended to clarify that advertising revenues from publications of exempt organizations were
potentially subject to tax.
The fragmentation approach was first promulgated in regulations in 1967, Treas. Reg.
1.513-1(b), but the regulations were held invalid under the then existing form of the statute.
See Mass. Mutual Med. Socy v. U.S., 514 F2d 153 (1st Cir. 1975); Am. Coll. Physicians v.
U.S., 530 F2d 930 (Ct. Cl. 1976). Congress subsequently validated the fragmentation approach
by amending the Code in 1969. See Am. Coll. Physicians, 475 U.S. at 844.

Rev. Rul. 78-145, 1978-1 CB 169.


See Bruce R. Hopkins, The Law of Tax-Exempt Organizations 777-78 (8th ed. 2003).
The required fragmentation would in fact lead to three categories of businesses. The sale of
directly educational material, such as books and supplies, would be treated as substantially
related to the exempt purposes; the sale of some other items, such as sundry goods, would
probably be protected from tax under the convenience doctrine, see supra note 35; and the sale
of still other items, such as clothing and plants, would generate unrelated business income.
See Hopkins, supra note 62, at 788. Hopkins cites GCM 38949 (July 16, 1982) (holding that, [i]f the primary purpose of the article is utilitarian and utilitarian aspects are the
predominant reasons for the production and sale of the article, it should not be considered
related). See also Rev. Rul. 85-110, 1985-2 CB 166 (holding that laboratory work done at
exempt hospital for private patients of staff physicians is unrelated trade or business).

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A college is placed in a strategic quandary if application of the UBIT

becomes a real possibility. The college will generally prefer that no part of
the athletic program be treated as an unrelated trade or business and it will
frame its litigation position accordingly. Once a determination is made that a
revenue-raising sport is an unrelated trade or business, however, the college
has an incentive to argue that the nonrevenue-raising sports are also unrelated trades or businesses. Only then could losses from those sports offset
income from the revenue-raisers. Yet the arguments in support of this alternative position are diametric to those the college must advance in support of
its primary litigation position; the college cannot press the alternative without undercutting its primary contention. When application of the UBIT to a
colleges athletic program becomes more than a theoretical possibility, the
effects are impossible to escape and difficult to contain.

If athletes participating in revenue-generating sports at big-time sports
schools are considered to be employees, we will have moved a long way from
the ideal of the student athlete (an ideal that probably didnt exist anyway).
An openly professional system, in which colleges hire athletes to represent
them in competition, would open the door to the Internal Revenue Services
reconsideration of the tax status of major college athletics.
An end to hypocrisy has much to recommend it, but, if this happens,
colleges may be subjected to the UBIT. The unrelated trades or businesses
that will be taxed may be limited to the profitable portions of the overall athletic enterprise, not a good thing for the colleges.
Of course, none of this necessarily means that a big-time athletic college should not establish a professional football or basketball team. The
UBIT is only one of a number of factors for a college to consider, and other
considerationssuch as the purpose of the institutionare ultimately far
more important than the effects of the Internal Revenue Code. Nevertheless,
the effects of the tax should not be ignored.

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