IRS denies pass-through deduction for sports franchises

Proposed regulations offer opportunities for ancillary activities

Man signing contract in sports hallThe proposed regulations for the new pass-through deduction under Section 199A generally categorize the ownership of sports franchises as a disqualified activity, but the rules may allow owners to qualify related business activities.

The IRS decision to interpret “athletics” to include sports team ownership as a disqualified activity is a blow to owners, who will be denied the pass-through deduction on core franchise income if the rules are finalized without change. However, the proposed regulations potentially offer the deduction for related activities in a separate trade or business, such as broadcasting or operating arenas and other facilities. A series of anti-abuse rules for entities with common ownership complicate the potential opportunity.

Deduction for owners of sports teams Section 199A was enacted as part of H.R. 1, commonly known as the Tax Cuts and Jobs Act, to allow pass-through owners a deduction of up to 20% against qualifying income. If allowed in full, the deduction creates an effective rate of 29.6% for income subject to the top rate of 37%. Taxpayers with taxable income above a certain threshold are not allowed the deduction for a list of specified service trades or businesses (SSTBs), which includes “athletics.” (For more information on the general rules, read our full Tax Flash on the proposed regulations.)

The proposed regulations define athletics to include services performed “by individuals who participate in athletic competition such as athletes, coaches, and team managers,” and provide an expansive but non-exclusive list of covered sports as examples. The regulations then clarify that the income owners receive from an SSTB is considered to be nonqualified regardless of whether the owners participate in running the business, specifically using owners of sports franchises as an example of who would be denied a deduction.

The regulations are only proposed, though taxpayers can generally rely on them until final regulations are issued. Extensive comments are expected, and the IRS has scheduled a regulatory hearing on Oct. 16, 2018.

Grant Thornton Insight: The IRS and Treasury will be pushed hard on many aspects of these proposed rules, both by taxpayers and members of Congress. Comments are due Sept. 30, 2018, and sports franchises could use the comment period to advocate for a more favorable interpretation. It is unclear how receptive the government will be to such efforts. The IRS and Treasury received comments asking for a different interpretation before the proposed regulations were issued. The inclusion of sports franchise owners as an example seems to indicate the government specifically considered this issue and chose to make its determination explicit.

Deduction for ancillary activities The proposed regulations clarify that the term athletics does not include services that do not require skills unique to athletic competition. The regulations specifically cite broadcasting and operating or maintaining facilities for athletic events as examples of businesses that are not SSTBs. Team owners who have broadcast, arena, real estate, or other activities operating in truly separate trade or businesses may have the potential to receive deduction on income from these activities. But the IRS was concerned about businesses dividing SSTB activities into qualifying parts and proposed several anti-abuse rules that could make planning difficult.

The anti-abuse rules apply to otherwise qualifying businesses that share at least 50% ownership with an SSTB. These businesses can be re-characterized as non-qualifying if they provide at least 80% of their goods and services to a related SSTB or if they share expenses with the SSTB and their gross receipts represent 5% or less of combined gross receipts. Even if an otherwise qualifying business does not exceed these thresholds, the deduction is not available for any income for providing goods and services to the related SSTB.

Next steps Sports teams should consider the potential for related activities to qualify when structuring activities and investments. The determination will hinge not only on the proportion of total income arising from the other activities and how much income derives from providing services and goods to the disqualified athletic activity, but also on whether the other activities are conducted as separate trades or business. The trade and business determination can depend on a variety of factors, including whether the activity is conducted in a separate entity respected for tax purposes. In addition, team owners should remember that the rules are proposed and could change when finalized.

Contacts Mark Margulies
National Tax Leader, Private Client Services
Washington National Tax Office
T +1 954 331 1116

Dustin Stamper
Managing Director
Washington National Tax Office
T +1 202 861 4144

About Grant Thornton’s Private Client Services Our practice focuses on the business, tax, and industry issues impacting mid-to-large private organizations as well as their owners. Whether you are a closely-held business, a private equity firm, or an individual or family that owns a private enterprise, we’re committed to driving excellence throughout your business. Grant Thornton has been serving this market for over 90 years and is uniquely positioned to provide service leadership to private clients. Our hallmark attributes include the delivery of high quality client service through our most experienced professionals, and being advisors who provide flexible, collaborative, innovative solutions built for you.

Tax professional standards statement This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.