By Christopher Deubert, Senior Writer
On January 16, 2024, the IRS announced its “Sports Industry Losses” campaign, which is intended to scrutinize the reported tax losses of pass-through entities operating professional sports teams. The campaign is part of the IRS’ efforts to increase enforcement and collections through its Large Business and International Division, in accordance with provisions of the 2023 Inflation Reduction Act. While the campaign may be good news for the American Treasury, it is likely troubling for owners of clubs in Major League Soccer (MLS), the United Soccer League (USL) and National Women’s Soccer League (NWSL).
Soccer’s Net Losses
While American soccer has made steady progress in recent years on many fronts, it is still generally not a profitable business operation on a day-to-day basis. Some post-Messi estimates show that a few MLS clubs are profitable, but that historically has not been the case. For most of the league’s history, essentially all MLS clubs lost several millions of dollars per year and the league office relied on multi-million-dollar capital calls from its clubs to operate each year or large expansion fees (which has caused some to call the league a Ponzi scheme). MLS club revenues generally range between $25 and $100 million. About a third of the league’s clubs are below the $47 million revenue threshold to qualify as a small business with the U.S. Small Business Administration. By comparison, most NFL clubs net profits of $100 to $200 million annually on revenues of between $500 million and $1 billion per year. Even all NHL clubs are profitable on estimated revenues of $150 to $280 million.
The situation is generally only worse in other leagues. The USL operates multiple leagues below the MLS and which follow a model akin to that of minor league baseball teams – constructing new multipurpose facilities as part of redevelopment projects in small and medium-sized cities. The strategy has generally been successful and resulted in a growth in the number of professional soccer teams operating in the United States. Nevertheless, the clubs themselves still generally have limited ticket sale, sponsorship, or broadcast revenue and thus operate at a loss.
The NWSL is the same. While the league has stabilized recently after a series of scandals, and is in a growth mode that has attracted prominent investors and new clubs, team revenues generally do not exceed operating costs.
The Benefits of Ownership
In light of these less-than-ideal financial realities, American soccer clubs are generally reliant on wealthy owners who see two principal benefits from their ownership: (1) short-term tax losses; and (2) long-term growth in enterprise value.
The first benefit is that which is likely to attract the attention of the IRS. Many of the individuals who own American soccer clubs or a portion thereof likely do not mind – and may even prefer – losing millions of dollars every year on their clubs because the losses likely offsets taxable gains from profitable businesses elsewhere. For example, several MLS clubs are owned by individuals who also own NFL clubs: Arthur Blank owns Atlanta United of MLS and the Atlanta Falcons of the NFL; David Tepper owns Charlotte FC of MLS and the Carolina Panthers of the NFL; Kroenke Sports & Entertainment owns the Colorado Rapids of MLS and the Los Angeles Rams of the NFL; Jimmy Haslam owns the Columbus Crew of MLS and the Cleveland Browns of the NFL; the Hunt family owns FC Dallas of MLS and the Kansas City Chiefs of the NFL; Robert Kraft owns the New England Revolution of MLS and the New England Patriots of the NFL; and the Wilf family owns Orlando City SC of MLS and the Minnesota Vikings of the NFL. The losses from the MLS clubs would pass through to these individuals and then when combined with the owners’ gains from their NFL clubs, ultimately reduce their taxable income generally.
The clubs are able to operate at a loss by tapping the resources of their owners or, more commonly, borrowing from large financial firms, such as Goldman Sachs. The banks are willing to provide this funding due to the often-exponential growth in franchise valuations, particularly when new stadiums are involved. Sports franchises are a rare property and thus when available for sale, they have regularly commanded a premium price far above prior valuations or that which would seem rationally connected to the club’s revenues. This is true no more so than with American soccer franchises.
In the meantime, the clubs’ debt service is just another expense which increases the clubs’ losses and reduces the owners’ taxable income. The principal can ultimately be refinanced by another willing lender or repaid in full at the time of a sale.
The Potential Ramifications
The IRS campaign seems likely to interrogate this business model. Generally, the IRS (and the public) may find it untoward that wealthy owners of prominent professional sports teams are paying little or no income tax. Specifically, the IRS will seemingly evaluate the way in which revenue is being accounted for and the types of deductions being taken, such as depreciation related to a stadium.
Obviously, the IRS is empowered to initiate problematic and costly legal proceedings against professional sports organizations and their owners if it finds that any of the accounting or tax practices were not appropriate. Additionally, such scrutiny may have a chilling effect on ownership and investment interest in these leagues. The long-term consequences of the IRS’ initiative remain to be seen but it seems likely that there are at least some nervous people out there in the ranks of American soccer club owners.
Deubert is Senior Counsel at Constangy, Brooks, Smith & Prophete LLP.
