IRS Announces Heavyweight Bout with Sports Partnerships

On January 16, 2024, the Internal Revenue Service’s (“IRS”) Large Business and International Division directed its aim at the sports world by announcing its Sports Industry Losses campaign designed to specifically identify partnerships within the sports industry that take advantage of the substantial deductions afforded to partnerships under the Internal Revenue Code (“Code”) and report significant tax losses. This is one of the many campaigns announced by the IRS and is designed to identify whether deductions taken by sports partnerships are reported in compliance with the Code.

Owning a sports franchise can provide a myriad of tax benefits to majority and minority owners. Much like other partnerships, sports partnerships can take full advantage of, and receive enormous benefits from, the significant depreciation and amortization deductions the Code provides related to their ownership of stadiums and team facilities, fixed assets, player contracts, and media rights, among other similar items. Oftentimes, these deductions result in the sports partnership operating at a loss over the course of a tax year, even though many of these sports franchises generate hundreds of millions of dollars in annual revenue. More notable is the ability of sports partnerships to deduct the vast majority of the sales price for the acquisition of a sports franchise, which continues to break sale price records. These deals, some of which are valued in the billions of dollars, provide the owners with a high ceiling to deduct the cost of the acquisition of a sports franchise over time. To add more fuel to the fire, many of the acquired assets are eligible for bonus depreciation, accelerating the deductions into earlier years.

While tangible assets provide sports partnerships the ability to deduct and offset some of the revenue generated by the franchise, the real gold mine is the ability of the sports partnership to amortize the acquired intangible assets. Player contracts, TV rights, franchise rights, and goodwill can all be amortized by the partnership over a 15-year period. To put the economic benefit of amortization of intangible assets into perspective, the NBA generated $24 billion from its last TV deal. When layering in the value of player contracts, media rights, and other acquired intangibles, the ceiling for sports partnerships to deduct acquisition costs becomes astronomical.

With the ever-increasing value of sports franchises, the IRS is leveling the playing field and investigating whether sports franchises are taking noncompliant losses. However, an increase in sports partnership audits does not necessarily mean an increase in taxes being paid if these sports franchises comply with the provisions of the Code. Nonetheless, the IRS is aiming to ensure that these sports partnerships are properly reporting income, deductions, and losses allowable under the Code. Although the number of sports franchises continues to grow, the targeted pool of taxpayers that the IRS will audit is relatively small and easy for the IRS to identify.

Partners of sports partnerships should begin proactively preparing for potential IRS examinations and begin identifying and substantiating the deductions that are driving losses with respect to tax reporting. Proper and timely documentation and recordkeeping will also play a crucial role when defending a position in an audit. Partners of a sports partnership should consider working with their tax and legal advisors to navigate audit procedures and traps for the unwary in the context of the partnership taxation rules.

If you have any questions related to the information in this alert, please contact, Mike Cumming, Richard Lieberman, Asel Lindsey, Scott Kocienski, Nardeen Dalli, or your Dykema relationship attorney.