Heralded by some as the most significant overhaul of the Internal Revenue Code (IRC) in decades, the bill (now awaiting the President’s signature before becoming law) formerly known as “The Tax Cuts and Jobs Act” – its title removed pursuant to a special budget rule – could significantly impact the business of college athletics. The bill’s sweeping changes to the IRC range in scope from adopting a territorial tax system, a significant policy shift impacting international corporations, to the elimination of an individual’s itemized deduction for gambling losses.
This article, however, focuses on Section 4960 of the bill entitled: Excise Tax on Excess Tax Exempt Organization Executive Compensation (“§4960”). Section I of this article summarizes the fundamentals of the excise tax and considers its application and narrow but powerful effect. Section II posits potential responses to the excise tax. Among many, Section III identifies a notable residual consideration flowing from its enactment. And Section IV concludes with a projection.
I. The Excise Tax
For all taxable years beginning after December 31, 2017, §4960 imposes a new excise tax, at the rate of 21%, on tax-exempt organizations, including colleges and universities, and organizations that support them (e.g., most university athletic associations and foundations), to the extent that annual compensation paid to any of its five highest compensated employees exceeds $1,000,000. In any case in which remuneration from more than one employer is taken into account (e.g., the university and its athletic association), the tax is imposed pro-rata. This excise tax also applies to any excess parachute payments paid to such employees.
For purposes of the applying the excise tax, excess parachute payments are compensation paid upon the termination of the employee’s employment if the aggregate present value of such payment equals or exceeds three times the employee’s “base amount” (generally, the employee’s average annual compensation over the five year period preceding termination).
B. Confined But Dramatic Impact
Across all institutions participating in college athletics and individuals employed thereby, application of the tax is significantly limited by the relatively-restricted cluster of the top five highest paid employees receiving compensation in excess of the relatively high threshold of $1,000,000 annually. While the reach of this tax is restricted and seemingly immaterial to a large number of college sports industry participants overall, it represents a high-powered rifle shot to Autonomy 5 institutions.
Based on our most recent compensation analysis of college coach and executive compensation undertaken in partnership with USA Today, there are at least 240 coaches and athletics directors across the FBS that receive compensation in excess of $1,000,000 (bonuses and forfeitures affect this total). Not surprisingly, the majority of these individuals are employed by institutions in one of the Autonomy 5 conferences.
Numerous Autonomy 5 athletic departments currently employ at least two, and often three, individuals that exceed the $1,000,000 annual compensation threshold (perhaps not surprisingly, Alabama and Florida State each have at least six athletic department employees whose compensation may exceed $1,000,000). With limited exceptions, these individuals are among the five highest paid employees of their institutions.
Consider the University of Kentucky, which paid Head Coaches Calipari (MBB) Stoops (FB) and Mitchell (WBB) $7,435,376, $3,763,600 and $1,200,000, respectively during the contract years of their most recently completed seasons. Applying the 21% excise tax to those amounts results in an excise tax obligation of $1,973,785, exclusive of Athletic Director Barnhart’s total compensation that is scheduled to exceed $1,000,000 in the near future (and may top that threshold already with the inclusion of bonuses). The exponential impact of this tax on Autonomy 5 institutions is further illustrated when considering that the compound annual growth rate of Autonomy 5 head football coaches compensation alone over the last five years has been approximately 11%. §4960 could also have a regressive effect by imposing relatively more significant consequences on non-Autonomy 5 institutions, which don’t enjoy the option to off-load the compensation obligation to third parties (discussed below).
Now consider the application of the tax on “parachute payments.” Assume a coach is earning total annual compensation, exclusive of retirement contributions, of $500,000 and that such compensation amount would place that coach in the top 5 highest compensated employees of the employer. If her employment agreement prescribes a payout equal to the balance of her annual compensation due through the end of the agreement’s term upon a termination without cause, then the excise tax may be invoked, even though the coach is not receiving annual compensation in excess of $1,000,000. If the coach is terminated with four years remaining on her contract, the excise tax would apply to approximately $500,000 (the present value of the amount in excess of three times her “base amount”) resulting in a tax obligation to the university of $105,000.
Importantly, a termination without cause frequently triggers the universities’ obligation to pay the coach/executive the balance of annual compensation due in the contracts of Autonomy 5 head football, head men’s basketball, and head women’s basketball coaches and athletics directors. And since the excise tax applies at the time the payment is no longer subject to forfeiture (in other words, immediately upon the termination), the benefits of mitigation are devalued as a result of the tax. Without termination payments originating from sources exempt from the excise tax (discussed below), the reasonably foreseeable outcomes of this situation are coach payouts at or below the excise tax threshold (the university’s demand), which are not subject to mitigation (the coach’s demand). This has the practical effect of limiting compensation guarantees to three years of average includible compensation.
II. Likely Responses
A. Cap Coach Compensation at the Excise Tax Threshold
Universities with relatively limited resources may simply decide to cap regular and contingent coach compensation at the $1,000,000 threshold, perhaps augmented by retirement or other benefits not includible within compensation subject to the tax. Notably, those universities may remain subject to the tax arising from parachute payments, which may in turn translate to job security and tenure for coaches at those universities.
B. Ante Up (For a While)
Other universities subject to the tax may simply choose to pay it, at least initially. Depending upon the university’s resources, this 21% increase may be preferred to coordinating mitigation strategies that require cooperation among the coach(es) contracts that trigger it and third-parties to whom compensation obligations may be off-loaded. At some point, however, the escalating arms race of coaches’ salaries multiplied by the tax are likely to push the opportunity costs of not installing mitigation strategies beyond every university’s means or at least sound business practice.
Among many, strategies for avoiding or mitigating this excise tax may include any or a combination of the following:
C. Limit University Compensation (from all applicable sources)
Up to the Excise Tax Threshold
The excise tax heightens the importance of annual cost certainty for those contracts at or near the tax threshold. Therefore it is logical to assume that the universities’ coach contracts approaching the $1,000,000 threshold will decrease or remove bonus provisions because of the uncertainty surrounding whether such payments may also trigger the tax. It also follows then that schools opting for bonus insurance must also secure coverage for the augmented costs, accompanied by augmented premiums, for bonuses paid that invoke the tax.
D. Coordinate University and Coach Contracts with Third Parties to
Supplement University Pay
It is reasonable to assume that Universities will renegotiate sponsorship agreements in a manner to allow the vendors/rights holders (including shoe and apparel companies, media partners and other licensing partners) to contract directly with and provide more cash directly to its coaches. In exchange for offloading compensation obligations to the vendors/rights holder, Universities may accept less favorable terms and/or lower product and in-kind discounts from its sponsors for their products and services.
For example, Virginia Tech’s current Nike Contract provides for $275,000 of Base (Cash) Compensation and a Supplied Product Limit of $1,625,000. A more efficient structure, in light of §4960, may be to (1) allow current coaches to contract directly with Nike, using university marks and other university property, and in exchange therefor, (2) agree to a lower Supplied Product Limit. Virginia Tech would then be able to use the increased cash available (from the offloaded coach compensation) to purchase additional product (presumably at an increase of less than 21%).
Importantly, this structure not only avoids or mitigates the excise tax it also commensurately decreases universities’ payroll taxes. And, the increased costs to and/or reduced discounts from such sponsors are not intensified by sales tax for which the colleges and universities remain exempt. Coaches that are independent contractor parties to these agreements, however, increase their income tax bill by the difference between the employee portions of income taxes relative to their increased exposure to self-employment tax for the off-loaded compensation.
Allowing a Coach to benefit from the university’s outside relationships is neither novel nor new. However, the manner in which these sources are coordinated and contracted may be of critical importance in determining their effectiveness relative to mitigation of the excise tax. Consider the following three examples:
- Michigan State University (“MSU”) Coach Tom Izzo has entered into a Basketball Coach Contract with Nike USA, Inc. wherein he grants exclusive rights to his rights of publicity (e.g. name, likeness, voice, etc.) for use in the marketing, promotion or sale of Nike products (the “Izzo Nike Contract”). The Izzo Nike Contract requires certain personal services (e.g. consulting), appearances (2 annually), Sponsorship Benefits (8 tickets to each MSU Conference/Big Ten tournament and NCAA tournament game and the opportunity to purchase 8 additional tickets for each such game) as well as his assistance in facilitating written advertisements in MSU’s media guide and P.A. announcements mentioning Nike at all home games.
- Coach Izzo receives $400,000 in Annual Base Compensation for the foregoing services as well as the opportunity to earn annual bonuses totaling $60,000 along with a one-time signing bonus of $50,000. The Izzo Nike Contract expressly denounces an employer/employee relationship and solely obligates Coach Izzo for the payment of taxes received pursuant to the Contract. Not surprisingly, as the source for various forms of Sponsorship Benefits, MSU executed an Acknowledgement and Confirmation of the Izzo Nike Contract. This acknowledgement includes a representation that MSU shall not enter into any oral or written agreement or take any other action during the term of the Izzo Nike Contract that is inconsistent with or would prevent, limit or interfere with Coach Izzo’s performance of his obligations therein.
- The topic of Roy Williams’ compensation at the University of North Carolina generates headlines every year when the USA Today survey is published. In 2017, we identified Coach Williams’ total university compensation as $2,088,577. It is obvious, however, that Roy Williams is not the 44th highest paid men’s college basketball coach, as that amount would indicate. Instead, a significant portion of Coach Williams’ income is earned from outside sources with significant interests in Tar Heel athletics. In 2015, Coach Williams filed “Notices of intent to earn outside income” with the University, indicating compensation arrangements with each of Sirona Dental Systems, Nike Championship Clinics, Raleigh Sports Club, Learfield Sports — Tar Heel Sports Properties, Nike and RWW Enterprises. Notably, reference to these outside income sources are nowhere to be found in Coach Williams’ most recent university contract.
- Across the border, the employment agreement for South Carolina’s head basketball coach, Frank Martin, explicitly contemplates that Coach Martin may receive additional income from outside sources ($475,000 on March 1, 2017). Coach Martin’s employment agreement further provides that:
“In the event that Employee does not receive the specified amount in any full Contract Year he is employed under this Employment Agreement, or a prorated amount thereof for any partial Contract Year Employee is employed under this Employment Agreement, directly from outside rights holders, collectively, selected by the University, for his services in connection with television and radio shows and commercial endorsements, the University agrees to pay Employee the difference between the amount received by Employee from such outside rights holders, collectively, and the specified amount, or a prorated amount thereof for any partial Contract Year Employee is employed under this Employment Agreement.”
Subpart (d) of §4960 includes the following:
‘‘(d) REGULATIONS.—The Secretary shall prescribe such regulations as may be necessary to prevent avoidance of the tax under this section, including regulations to prevent avoidance of such tax through the performance of services other than as an employee or by providing compensation through a pass-through or other entity to avoid such tax.’’
Some are interpreting this provision to predict that regulations may be adopted to prohibit the exact measures we’ve proposed above. If that is the case, the guarantee of outside income from third parties, a la South Carolina, is likely to be squarely in the cross-hairs of such provision. However, we believe that the Internal Revenue Service would be hard-pressed to demonstrate that the income payable to Coaches Izzo or Williams from Nike, et. al, should be considered income from their university employer for purposes of the excise tax, as there is no such guarantee nor is there, to our understanding, any contractual right of the university to exercise any level of control over the amount or manner of payment of such compensation by unrelated parties.
The foregoing assumes of course, a meaningful measure of cooperation from the coaches. Consequently, universities should expect that coaches and/or their representatives will require compensation increases sufficient to at least cover the difference in net pay lost as a result of the payment of self-employment taxes on the coaches’ increased 1099 income. It’s also prudent to anticipate that successful coaches (read: coaches with leverage) will attempt to negotiate for a portion of the tax savings their cooperation helps to generate.
Finally, it is worthwhile to consider that the foregoing concept is at cross-purposes with the NCAA’s efforts to wean its member institutions from the influence of shoe and apparel companies – particularly in the wake of the recent scandal in men’s basketball.
E. Game / Venue Revenue-Sharing
Game contracts, particularly neutral site game contracts wherein universities concurrently contract with venues, local organizing committees and production companies (“Game Sponsors”), represent another vehicle for off-loading coaches’ salaries. Adding promotional responsibilities for coaches in consideration for direct payments from the Game Sponsors is a relatively easy amendment to existing or prospective game contracts and does not require the same level of contract coordination to accomplish. Importantly, however, the consideration received by the coach should be commensurate with the services provided. Yet, even at a fraction of the university’s “guarantee” for playing in the game, this could represent a meaningful sum. For example, this season’s University of Florida vs. University of Michigan non-conference football game, for which each team’s coach participated in the pregame promotions, generated in excess of $6,000,000 for each university.
Universities with on campus stadia may have be advantaged in generating outside income for their coaching staffs through signage and game-day opportunities with outside sponsors. Correspondingly, Autonomy 5 programs that lease game day venues (e.g., Pitt football, University of Kentucky basketball) may be more aggressive in the negotiation of pass through benefits from their landlords for program sponsors.
F. Insurance, Annuities and other Forms of Deferred Compensation
Compensation shortfalls may be made up by insurance based alternatives, such as split dollar arrangements, that permit meaningful payments to coaches in the form of non-taxable loans. These arrangements are increasingly common and, with some variation, generally center around the making of a loan by the university to the coach, the proceeds of which are used to purchase a policy of universal (or similar permanent / cash-value form) life insurance. This structure has gained popularity within the industry following the well-publicized arrangement between the University of Michigan and Jim Harbaugh.
In 2016, UM agreed to make a series of “below-market split-dollar term loan advances” to Coach Harbaugh, in the amount of $2,000,000 per year, from which Coach Harbaugh was able to procure a sizeable life insurance policy (the policy details are not known; Darren Rovell estimated the death benefit to be nearly $35 million). During Coach Harbaugh’s lifetime, he may be permitted to recognize the cash value by taking one or more loans from the policy. At Coach Harbaugh’s death, the proceeds of the policy will be used to repay the loans to Michigan, with the remainder flowing to Coach Harbaugh’s estate, tax-free. The proceeds from such a loan arrangement are not taxable to the employee and would not be includible as compensation subject to the excise tax (however, to the extent that the loan interest is forgiven or below-market, the coach would recognize income), yet the benefits to the coach from the university are substantial.
III. A Notable Residual Consideration
The NCAA recently repealed Bylaw 184.108.40.206. This bylaw required each institutional staff member to provide a detailed written account annually of all athletically related income from sources outside the institution. These outside income reports (OIRs) captured payments to coaches from shoe, apparel and equipment companies as well as sums received by coaches for speaking engagements and coach-owned summer camps. If universities successfully off-load compensation obligations to private companies and are not signatories to such agreements, the compensation market for colleges and universities goes dark because open records requests do not apply to such agreements and the absence of market checks renders it inefficient. In this circumstance, coaches represented by large agencies, with multiple coach clients in a given market, gain even more leverage – in the form of a monopoly on market information – over their client’s employers and potential employers.
The use of third-party payors places a premium on the temporal, economic and structural coordination of their contracts relative to the coaches’ employment contracts with the university. Among numerous contract provisions requiring coordination, some of the more obvious provisions include: (i) compensation, fees and bonuses; (ii) term and termination (ensuring that all related contractual agreements are coordinated and coterminous); (iv) duties (ensuring no overlap or duplication of duties which may support a claim that suggests that such arrangements are merely for the avoidance of tax); and (v) grants pertaining to university trademarks and coaches’ rights of publicity. The application, effect and permissible response to § 4960 will be shaped by federal regulations interpreting it, as well as the creativity and cooperation among institutions affected by the tax and their highest-paid employees.
 § 4960(a)
 § 4960(b)
 § 4960(c)(5)(D) defines “base amount” by reference to IRC § 280G(b)(3) (Golden parachute payments). In that section, by reference to Code § 280G(d)(1), the “base amount” is defined as “the average annual compensation which – (A) was payable by the corporation with respect to which the change in ownership or control described in paragraph (2)(A) of subsection (b) occurs, and (B) was includible in the gross income of the disqualified individual for taxable years in the base period.” “Base period” is defined in IRC § 280G(d)(2) as “the period consisting of the most recent 5 taxable years ending before the date on which the change in ownership or control described in paragraph (2)(A) of subsection (b) occurs (or such portion of such period during which the disqualified individual performed personal services for the corporation)”. It is not clear whether, for purposes of determining “base amount” for an employee with less than five years’ tenure at the institution, whether such employee’s compensation at his/her prior institution is considered.