Taxing Student Athletes: An Explainer

By Sam Brunson

About a month ago, California Governor Newsom signed the Fair Pay to Play Act, which allowed California college athletes to be paid for the use of their image, name, and likeness. Other states, including Illinois, have proposed similar legislation. And today, the NCAA caved; though its concession is not entirely clear, it looks like the NCAA has paved the way to allow NCAA athletes to make money off of their image.

For some reason, this has provoked backlash by Senator Burr of North Carolina. On Twitter, he announced that he plans on introducing legislation that would tax college athletes who accepted payment for the use of their image, etc., on their scholarships.

If college athletes are going to make money off their likenesses while in school, their scholarships should be treated like income. I’ll be introducing legislation that subjects scholarships given to athletes who choose to “cash in” to income taxes. https://t.co/H7jXC0dNls

— Richard Burr (@SenatorBurr) October 29, 2019

The ensuing discussion following his tweet has evinced a lot of misunderstanding of what’s going on here, what the current tax treatment of scholarships is, and what “double taxation” means, among other things. So I thought I’d do a quick explainer:

Scholarships and Income

Are scholarships income? They certainly could be: the Code defines “gross income” as “income from whatever source derived.” And while it’s awkward to define “income” with the word “income,” scholarships represent an accession to wealth.

How? you might ask. After all, the scholarship recipient doesn’t get anything. Only that’s not true: the scholarship recipient gets an education, which has a fair market value, for less than the value. If they didn’t receive the scholarship, they would have to earn money to pay tuition, and they would be taxed on the money that they earned. So theoretically, there’s no reason scholarships couldn’t be taxed to recipients.

But the tax law provides an exception: under section 117, gross income doesn’t include qualified scholarships. What’s a qualified scholarship? In broad terms, it’s money received by candidates for degrees and used for the payment of tuition and certain other permissible expenses. Not everything styled a “scholarship” counts, though. Notably, if the scholarship recipient is required to provide services in exchange for the scholarship won’t be a qualified scholarship, and therefore won’t be excluded from gross income.

So What If They’re Required to Play Sports?

In Rev. Rul. 77-263, the IRS addressed this very question. (Thanks to Phil Hackney for pointing it out!) The IRS’s conclusion? It depends. The IRS said that if the scholarship can’t be terminated, even if the student-athlete can’t participate because of injury or even decides not to play, the athletic scholarship doesn’t count as a qualified scholarship.

So do any athletic scholarships qualify? I suspect they do: the Revenue Ruling’s language specifies that the non-cancellation applies “[o]nce an athletic scholarship is awarded for a given academic year.” So if I’m on a football scholarship and, just before the season starts, I decide not to play, the school can’t cancel my scholarship.

But it certainly doesn’t have to give me a scholarship the next year. And I suspect that incentive, and the intrinsic drive that many athletes have, will keep them on the team, even if the school can’t require them to play.

On the other hand, it’s clearly possible that schools are doing athletic scholarships wrong. In 2014, for instance, it appears like Northwestern was violating the Revenue Ruling.

But If They’re Making Money, It’s Not Fair That They Don’t Pay Taxes!

Absolutely. And this is an elision that many are making, and that Senator Burr is at least implying.

But it’s conflating two different things. To the extent that student athletes earn money by licensing their images, they will have to pay taxes on that money. And that’s true whether or not they’re on scholarship.

But what that stream of income has to do with their scholarship is beyond me. As people have pointed out, there’s no reason to think that a student on a music scholarship should suddenly be taxed on that scholarship if she makes money playing in a bar band. Or a student on a science scholarship should be taxed on her scholarship if she lands a paying summer job at a lab. Of course they’ll pay taxes on their income from performing or doing laboratory work. But it’s unclear what that has to do with their scholarships.

If Senator Burr is really offended by scholarship students profiting from what they get their scholarship for, he could certainly draft legislation that taxed scholarship income for anybody who earned money, but, while that would be fairer than singling out athletes, it would be just as inexplicable from a policy perspective.

Double Taxation!!!!1!

I saw one or two people raise the specter of double taxation. And that’s wrong. If Burr’s proposal were to be enacted, it would almost certainly violate horizontal equity, but it wouldn’t create double taxation. The athletes would be taxed once on the value of their scholarship, and once on the revenue from licensing their image. Those are two separate streams of income, each taxed once.

Maybe Tax All Scholarships?

If that were his proposal, I wouldn’t be writing. It may or may not be a good idea, but at least it would treat similarly-situated taxpayer similarly.

I’d consider it a bad idea, personally, both because paying taxes on scholarships would present a liquidity issue and because it risks imposing that liquidity issue on people who truly don’t have the assets to pay taxes. But there’s no theoretical reason why scholarships can’t be income; that’s purely a political choice.

Concluding Thoughts

Honestly, I really don’t get the reasons behind Senator Burr’s desire to tax student-athletes’s scholarships if they make money from their image. It’s not a new thing, though: five years ago, Treasury responded to a question he asked about the treatment of athletic scholarships in light of an NLRB decision that Northwestern football players were employees.

Unless and until he articulates a cogent reason why earning money should transform an untaxed scholarship into a taxable one, and why that reason should only apply to student-athletes, I’m going to assume that he actually doesn’t have a sound reason for it. I will continue to wonder, though, what constituency he’s trying to appeal to.