What is NIL?
Name, Image, and Likeness (“NIL”) rights are a part of the right of publicity, which is designed to prevent unauthorized commercial use of an individual’s identity, including their name, likeness, or other recognizable aspects. This right grants individuals exclusive control over the licensing of their identity for commercial purposes and enables individuals to exploit the value from their respective NIL without the dependency of the individual in the commercial arrangement through the transfer of the right of publicity.
NIL rights are an important component of total income for athletes, entertainers, and other public figures. This income can be generated long after the direct activity of the chosen craft of the individual (e.g., an athlete can generate income through NIL rights long after retiring from playing the sport).
Over long careers, celebrities build up a high level of value in their NIL rights which can be used to generate income for life. The ability for NIL rights to generate significant long term income and contribute to building long term wealth makes it important to consider the optimal way to structure. This article provides a strategy that enables celebrities to use NIL income for strategic investments while simultaneously decreasing tax liability.
Contents of this article include:
- NIL Rights Overview
- Purpose of Structure
- Details of Structure
NIL Rights Income
A. Types of Income
Sponsorship/Service Income: Sponsorship and service income are among the most common types of income derived from NIL deals. Under these agreements, the individual is required to present logos or products at events or through various media channels, for which they receive compensation.
Cash Awards: Cash awards from NIL income likely need to be reported on Form 1099-NEC, which the individual will receive from the organization they are representing. Such income must be included in the individual’s taxable income. Notably, these earnings differ from W-2 wages, and no income taxes will be withheld upfront. The individual will be subject to both income tax and self-employment tax and will be required to file tax returns. They may also need to make quarterly estimated tax payments with respect to such income.
Royalty Income: If the individual is compensated for the use of their NIL on media, such as video games or merchandise, the compensation will be treated as royalty income. Royalty income is included in the individual’s taxable income. The key difference between royalty income and sponsorship/service income is that the individual does not have any obligation to present the sponsor’s logo or products in the case of royalties.
Non-Cash NIL Benefits: Non-cash benefits received in exchange for the use of NIL can be considered taxable income and should be factored into financial planning. For example, if the individual is compensated with goods or services for autographs, appearing in an advertisement, or promoting on social media, they are required to include such consideration in their gross income.
B. Income Type Considerations for NIL Rights
The different types of income generated by NIL rights results in two types of income for tax purposes: Passive Income and Active Income.
Passive income includes all income from passive activities and generally includes gain from disposition of an interest in a passive activity or property used in a passive activity. There are two kinds of passive activities: (1) trade or business activities in which a taxpayer does not materially participate during the year and (2) rental activities, even if a taxpayer does materially participate in them, unless they are a real estate professional. The unique legal attributes of NIL rights enables the ability exploit the value from respective NIL without the dependency of an individual (e.g., material participation) resulting in passive income.[1] Passive income may only be offset with passive losses. [2]
Active income is defined by the IRS as income earned from services performed by the taxpayer. This includes wages, salaries, commissions, bonuses, and income from businesses in which the taxpayer materially participates. Active income is subject to ordinary income tax rates and may also be liable for self-employment taxes if the activities constitute a trade or business. In the context of NIL rights, active income arises when the individual is actively involved in generating the income. Examples include:
- Personal Services: Income from appearances, performances, or engagements where the individual is physically present and actively participating.
- Endorsements and Sponsorships: Compensation received for promoting products or services, especially when the individual is required to perform activities such as attending events, giving speeches, or creating promotional content.
- Social Media Activities: Earnings from actively managing and producing content for personal social media channels that capitalize on their NIL rights.
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C. Tax Considerations
Understanding the tax landscape is crucial when planning strategies for maximizing income from NIL rights. Below is a summary of key U.S. tax rules that impact income derived from NIL rights, which can help in structuring income in a tax-efficient manner.
Corporate Tax Rate: The flat corporate income tax rate applicable to C-Corporations in the U.S. is 21%.
Graduated Personal Income Tax Rates:
- 10% on income up to $11,000 (Single)/$22,000 (Married).
- 12% on income over $11,000 (Single)/$22,000 (Married) up to $44,725 (Single)/$89,450 (Married).
- 22% on income over $44,725 (Single)/$89,450 (Married) up to $95,375 (Single)/$190,750 (Married).
- 24% on income over $95,375 (Single)/$190,750 (Married) up to $182,100 (Single)/$364,200 (Married).
- 32% on income over $182,100 (Single)/$364,200 (Married) up to $231,250 (Single)/$462,500 (Married).
- 35% on income over $231,250 (Single)/$462,500 (Married) up to $578,125 (Single)/$693,750 (Married).
- 37% on income over $578,125 (Single)/$693,750 (Married).
Interest Rate Deductibility Rules: Interest expense is deductible up to 30% of Adjusted Taxable Income (ATI). The limitation may be subject to changes after 2025 due to the expiration of the Tax Cuts and Jobs Act (TCJA) provisions.
Bonus Depreciation Rules: Qualified property placed in service is eligible for bonus depreciation:
- 2023: 80% bonus depreciation.
- 2024: 60% bonus depreciation.
- 2025: 40% bonus depreciation.
- 2026: 20% bonus depreciation. These percentages decrease annually, and the provision is set to expire after 2026 unless extended by new legislation.
Long-Term Capital Gains Rates:
- 0% on income up to $44,625 (Single)/$89,250 (Married).
- 15% on income between $44,625 and $492,300 (Single)/$89,250 and $553,850 (Married).
- 20% on income over $492,300 (Single)/$553,850 (Married).
Short-Term Capital Gains Rates: Short-term capital gains are taxed as ordinary income based on the individual’s tax bracket, which ranges from 10% to 37%.
Depreciation Recapture Rules:
- For real property (Section 1250): Depreciation recapture is taxed at 25%.
- For personal property (Section 1245): Depreciation recapture is taxed as ordinary income.
Purpose of Structure
The purpose of this structure is to provide tax efficiency in (1) earning income through NIL right deals through the life of the individual and (2) investing in assets for long term wealth growth and security.
The diagram below provides an overview of a potential structure to achieve these goals. [3]
Structure details include:
- LLC Formation: LLC is formed and NIL rights are contributed to LLC (in exchange for equity in LLC) as a tax-free contribution. This provides liability protection and enables all LLC income to pass-through to the owner(s). LLC will earn income through the royalty payments INC will remit. Income earned by LLC will be offset by passive losses and deferred until a sale of an asset. At this point, the sale of the asset will provide for lower capital gains taxes vs if it was considered personal income tax (20 percent vs 37 percent).
- INC Formation: INC is formed as an entity responsible for sourcing and evaluating business opportunities that can exploit NIL rights. INC will silo active income and pay a reduced corporate tax on said income (21 percent vs 37 percent). INC retains a fee for its activities (e.g., 10% of revenue or amount based on transfer pricing study) and remits the remainder as a royalty fee to LLC (e.g., 90% of revenue).
- Licensing Agreement between LLC and INC: An intercompany licensing agreement is put in place between LLC and INC whereby: (1) INC receives a license to sublicense NIL rights with business partners; (2) INC is responsible for material participation in activities and partnering with partners with third parties and sublicenses NIL rights in pursuit of a variety of business endeavors, including speaking appearances, licensing arrangements, and ambassadorships.
- Commercial Business Arrangements: These are the business arrangements with third parties that enable NIL rights exploitation to generate revenue. INC will be responsible for the sublicensing of NIL rights in these arrangements. INC will generate and book revenue from commercial business arrangements and then remit a royalty fee to LLC.
Investments: The taxpayer will use income from the LLC to invest in other investments (likely housed in LLCs) that provide for passive income/losses. In general real estate will enable the ability to capture bonus depreciation benefits that provide the greatest benefit in the year income is earned in the LLC. The passive income/losses will flow to the taxpayer. In the case of passive losses, these will offset the income generated through the NIL rights.
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[1] The IRS determines material participation in reference to seven criteria that can be found here: https://www.irs.gov/publications/p925#en_US_2023_publink1000104582
[2] Passive income/losses results from passive activities that include: (1) trade or business activities with no material participation and (2) rental activities, even with material participation, unless classified as a real estate professional. Accordingly, passive income/losses may be generated through: equipment leasing, rental real estate, limited partnerships, and partnerships/S-Corps/LLC’s in which the taxpayer has no material participation.
[3] This example structure may not be appropriate for all taxpayers and careful consideration should be taken with advisors before any structure is implemented.
