Tax Research Problem.

The Case Situation

In 2017, the New England Patriots and Atlanta Falcons battled it out on the field in Superbowl LI. Atlanta led by as much as 28-3, but the Patriots managed an impressive comeback and went on to win in overtime. The game was broadcast on Fox with an estimated 111.3 million viewers worldwide.

The Patriots and the Falcons weren’t the only organizations who competed in the exciting game. Corporate competitors, Nike and Under Armour battled too. The Patriot’s record setting quarterback, Tom Brady, endorses Under Armour. Matt Ryan, quarterback of the Atlanta Falcons, endorses Nike.

A few weeks before the Superbowl, Under Armour announced the release of the Athlete Recovery Sleepwear otherwise known as “Tom Brady’s jammy pants.” Brady even sported his pajama pants at a press conference. Fans went crazy for the jammy pants and tweeted, “If you wear Tom Brady’s pajama pants, you’ll be able to play football like Tom Brady” and “Need a pair of Tom Brady’s magic pajamas.” Losing the game had double meaning for Ryan. Not only did Ryan have to endure a second half collapse on the field, Ryan lost millions in future endorsement revenues contractually tied to winning the game.

Corporate competition between Nike and Under Armour has been brewing for some time, as both companies search for champion athletes or even teams to endorse. Companies use endorsements as a mode of advertising to increase consumer interest in products and/or services. In return for an endorsement, athletes are compensated. The compensation structure and the respective duties of the company and the athlete are written into a contract. Endorsement deals are structured in a variety of ways can range anywhere from more than $100 million to nothing more than free equipment. Arrangements can include base pay (up front followed by additional payments), bonus payouts for major victories or accomplishments, lifetime contracts that extend beyond the playing duties of the athlete, revenue sharing deals (royalties), or even equity stakes in the company. For example, Brady receives Under Armour stock instead of cash. The value of is Under Armour stock is estimated to have grown 800% since 2010.

Endorsement contracts give a company the legal right to use the player name and image. The player name and image can be used in many forms, such as print media, online or television. The contract determines if the athlete is expected to use the company’s products or wear the company’s logo, specify when and how the products must be used or the logo displayed, including the size and placement of the logo. If the athlete will make any personal appearances, the contract specifies the number of appearances, the time commitment required, any geographic restrictions and travel details. As a general rule of thumb, the contract contains the who, what, when, where, why and how of each obligation.

Also included in the contract are causes for termination of the endorsement contract. Athletes can succumb to injuries and ineffectiveness, significantly lowering their value as endorsers. Athletes can also find themselves embroiled in scandals, from “on-field” issues such as the use of performance enhancing drugs, to tabloid material such as drunken melees in strip clubs. Most endorsement deals include termination provisions that can be triggered if the athlete is unable to compete for a significant time for any reason and/or for “bad behavior” which diminishes the endorsement value.

Accounting for endorsement contract costs raises interesting, but often difficult, accounting questions under both GAAP and Federal tax law. Should these costs be immediately expensed on the financial statements and income tax returns or should they be capitalized and amortized over some future benefit period? Are they advertising expenses or do they become products costs only recoverable when the endorsed products are sold?

RESEARCH QUESTIONS

How do endorsement contracts fit into the Internal Revenue Code and Treasury Regulations treatment of expenses? For example, assume Nike, Inc. enters an endorsement contract with NFL star Matt Ryan paying him fifty million dollars in ten million dollar increments in exchange for endorsing its products for a five-year period. What is the proper income tax treatment for this expenditure? What journal entries would be made to reflect the proper income tax treatment over the five-year period of the contract? Prepare a memorandum summarizing your research of the Internal Revenue Code, Treasury Regulations, IRS pronouncements and case law and stating your conclusions.