The Internal Revenue Service (IRS) will intensify its scrutiny of the sports industry’s reporting of tax losses, as part of its reported crackdown on wealthy taxpayers.
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 the losses can be used to offset the individual tax dues of the wealthy owners.
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.”
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.
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.”
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.
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.
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.”
