IRS Targets Compliance in the Sports Industry

Published: May 22, 2024
By: Miri Forster; Murray Solomon; Cindy M. Levine
Topics: Tax
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The IRS has launched a compliance campaign focused on Sports Industry Partnership Losses. The campaign will focus on identifying partnerships in the sports industry that report significant losses, with the stated goal of ensuring the tax treatment of these losses are in compliance with the law.

IRS Enforcement Campaigns

Using the additional funding provided by the Inflation Reduction Act (“IRA”), the IRS announced its intention to focus on high-end compliance, with increased scrutiny on high-income earners, complex partnerships, and large corporations. In September of 2023, the IRS announced that, as part of this campaign, they would be creating a new pass-through entity unit to focus on complex partnerships and S corporations. The Sports Industry Partnership Losses campaign is just one part of this overarching campaign.

Sports Industry Partnerships

It’s not surprising the IRS is targeting sports industry partnerships with large losses for a compliance campaign. The sports industry has come under heavy public scrutiny recently, with a slew of news articles and media pieces being published that criticize the potential for high-income taxpayers to use sports teams to reduce or eliminate taxes.

The increasingly high value of sports teams limits ownership to the ultra-wealthy – either by individuals or via private equity funds in many sports leagues. While many other depreciable or amortizable assets do in fact decline in value, sport team values only seem to go up. For example, the Angelos family recently sold the Baltimore Orioles baseball team for $1.725 billion, nearly ten times the 1993 purchase price of $173 million.

How Sports Teams Generate Losses

Sports teams, while often profitable, can generate significant taxable losses that flow through to their owners. This is due to specific tax deductions allowed for the purchase of a team, particularly the amortization of intangibles over 15 years. These intangibles include the franchise itself, player contracts, television contracts, season ticket holder lists, and more. Consequently, even with positive cash flow, a newly acquired team can still result in taxable losses due to these deductions.

The ability for individual owners to utilize these losses to offset income from other ventures significantly influences the valuation of sports teams. This tax benefit, along with the prestige and potential profit associated with ownership, has become a major factor in the escalating prices of sports franchises.

BBA Partnership Centralized Audit Regime

Despite operating in a more glamorous industry, sports partnerships are no different from any other partnerships.

Partnerships are pass-through entities, meaning that they do not directly pay federal taxes (though in most states, they may elect to pay taxes at the entity level). Instead, items of income, loss, deduction, etc. “pass-through” the entity to the entity’s partners directly. If the entity has a loss in a year, that loss will flow through to reduce the partner’s taxable income, which will in turn reduce their tax liability.

In 2018, the Bipartisan Budget Act (“BBA”) dramatically changed how the IRS approaches partnership audits. All partners are subject to the centralized partnership audit regime, unless the partnership makes an annual election out of the regime on a timey filed Form 1065. Under the regime, the IRS is permitted to assess and collect tax at the partnership level calculated at the highest applicable tax rate for the year under review. The partnership may elect to push the adjustments out to its partners, whereby the partners account for the adjustments on their return for the year of adjustment (rather than in the earlier year that was examined).

How to Prepare

The best offense is a good defense. Taxpayers should be sure to maintain good records and be prepared to substantiate losses claimed and their basis in the partnership. If a partner’s share of partnership loss exceeds its basis in the partnership, then losses are allowed only to the extent of basis. Any excess loss is carried forward for use when the taxpayer has available basis.

Additionally, the IRS may look closely at passive vs. active losses under IRC Sec. 469. Under this section, taxpayers must “materially participate” in the business to fully deduct their business losses. Taxpayers should maintain contemporaneous documentation to support their material participation in the business. Failure to meet this requirement can limit the amount of losses the taxpayer can deduct on their personal tax return.

The exclusivity of ownership, coupled with media reports of these high-wealth owners using their teams to generate losses or reduce their taxes, makes these partnerships a welcome target to the IRS. Taxpayers who may be impacted should reach out to a trusted tax advisor to make sure they are in full compliance with the law.