Buying and running sports teams come with certain tax breaks (from tax losses).
The Internal Revenue Service (IRS) will intensify its scrutiny of the sports industry’s reporting of sports teams' tax losses, as part of its reported crackdown on wealthy taxpayers.
On Jan. 16, the IRS announced the “Sports Industry Losses campaign” which is “designed to identify partnerships within the sports industry that report significant tax losses and determine if the income and deductions driving the losses are reported in compliance” with the agency’s code. The IRS provided no further information in the announcement.
Owning a team comes with significant tax benefits
The agency’s focus on the industry could be the result of lucrative tax benefits that come with owning teams. Existing rules allow teams to write off intangible assets like TV rights and player contracts over several years. This accounting adjustment can enable team owners to report losses on their operations every year.
If the ownership is structured as a partnership, then a sports team's tax losses can be used to offset the individual tax dues of the wealthy owners.
Which can put the owner under much greater IRS scrutiny
A wealthy individual who has a multi-million dollar tax bill and offsets it with losses from owning a sports team “would draw the attention” of the IRS, Eric Nemeth, Varnum LLP partner, told Bloomberg. The IRS can even use the campaign to boost its image, he said.
“Frankly, it could be good politics, too. ‘Look what we’re doing. We’re really examining the ultra-rich here,’” Mr. Nemeth said. “And don’t rule out the possibility that the IRS uses this information, provides information to Congress, and Congress possibly writes some statutes to address certain areas, too.”
Mark J. Weinstein, a tax expert and partner at Hogan Lovells, said that the way a potential owner buys a team also comes with tax benefits.
For instance, “if the purchase is financed with other people’s money (i.e., debt), then, subject to certain limitations on the deductibility of interest, the tax advantages to the team owners (and investors) is even greater.”
But Congress implemented "the system"
He isn’t convinced that the tax write-off rules for the sports industry “is being gamed,” pointing out that it was Congress that implemented the system and put in place many of these benefits.
“You buy goodwill, you get to amortize the cost over say 15 years, and if the end result is a loss; so be it … This is the law. If the IRS wants to change it, they need an act of Congress,” he wrote in a note.
The new IRS campaign targeting sports industry partnerships follows months of increased scrutiny of such entities by the agency.
On Sept. 20, the IRS announced it would establish a new division to target “pass-through” entities in a bid to hold America’s wealthiest tax filers “accountable.”
A pass-through entity is a business that does not pay tax on its revenues. Instead, its income is passed on to owners of the business, who then file taxes based on their individual tax rates. At the time, IRS Commissioner Danny Werfel said that pass-throughs are used by some partnerships to “intentionally shield income to avoid paying the taxes they owe.”
General partnerships, sole proprietorships, limited partnerships, limited liability partnerships, limited liability companies, and S Corporations are all considered to be pass-through business entities.
Sports team tax benefits
A 2021 report by the nonprofit newsroom ProPublica detailed the prevalence of tax-saving strategies implemented in the sports industry.
ProPublica reviewed tax data from dozens of owners across four of the biggest professional sports leagues in the United States. They found that these owners frequently reported team incomes significantly lower than their real-world earnings.
Records reviewed by the nonprofit showed that Steve Ballmer, the former CEO of Microsoft, paid only $78 million in taxes from his $656 million in earnings for 2018. This was an effective income tax rate of only 12 percent.
Such a tax rate is made possible because Mr. Ballmer owns the NBA team, the Los Angeles Clippers. The U.S. tax code allows individuals who purchase businesses to deduct almost the entire cost of the purchase from their income in the following years.
Do the assets of a team purchase degrade over time or increase in value?
The reasoning is that since the purchase is composed of assets like buildings, equipment, and such, the value degrades over time, and the price paid to buy the assets should be counted as an expense.
Mr. Ballmer spent almost $2 billion to buy the Los Angeles Clippers.
Some have criticized the rules, pointing out that several assets of sports teams, like player contracts and TV deals, are likely to increase in value over time rather than degrade. There is little risk that a popular sport would suddenly stop being popular and thus make massive losses on TV deals or player contracts.
As the IRS has been infused with billions of dollars from the Inflation Reduction Act (IRA), its stringent actions against partnerships are intensifying. The agency has indicated its intention to use part of these funds to boost enforcement measures against large businesses, and with focus on sports teams using tax losses for deductions.
With new money, the IRS is ramping up its audit rate for larger partnerships because it has been lax in the past
A July 2023 report from the U.S. Government Accountability Office (GAO) revealed that the IRS only audited 54 large partnerships in 2019, which was just 0.26 percent of the 20,052 such entities in operation that year.
Since 2007, the IRS' audit rate for large partnerships has declined, a trend the agency attributes to “resource constraints,” according to the report. This was noted in the context of the recent funding infusion received by the agency from the IRA.
“As part of its audit selection process, IRS uses statistical models to help review partnership returns for potential noncompliance, but the models were developed without using representative samples of returns and with untested assumptions,” the report said.
“Additionally, IRS has not developed a plan to incorporate feedback from audit results into the models. Addressing these modeling issues could improve IRS’s ability to better identify and audit noncompliant partnerships.”
Even if you don't own a sports team...
(Which is 99.9% of you reading this) Lots of "smaller" businesses can be considered as pass-through entities, and many of our clients actually do fall into that category.
The entire scenario is not as cut and dried (high-wealth only) as the IRS would portray, so you may find yourself on the receiving end of things you might assume only apply if you own a sports team – or fall outside the category of "wealthy taxpayer".
Just remember, if you have tax problems of any kind, don't hesitate to contact us for help and guidance. That's what my team and I are here for.
You can contact me by one of the methods below in the blue box, or email me at Larry@TaxProblemSolver.com and we can review your specific issues and solve them. You can also click here to book a free consultation.
