The professional sports landscape is defined by four seasons: the preseason, regular season, postseason and, most lucratively for some, the offseason. But there’s one season that’s often overlooked: tax season.
For athletes, tax season is continuous. Athletes are assessed taxes in almost every state in which they play and practice. But athletes usually don’t view themselves as playing in the “tax season. Do you really think Tom Brady sits down every April to crunch the numbers on his own? The tax code is extremely complicated and cannot be learned overnight. Most athletes have accountants and financial advisors to help them through the complex contracts and compensation arrangements.
Legendary UCLA basketball coach John Wooden famously said, “failing to prepare is preparing to fail.” The same can be said for tax season each year. Sometimes athletes and coaches need to make unpopular decisions to win. So if you’re a Lions fan upset at Ndamukong Suh for leaving Detroit, read on. For everyone else, these tax code nuances may help you come to terms with why your favorite player decides to test the free agent waters. And they may just make you think differently about your own tax situation.
You pay where you play
Individual states have been targeting athletes for decades, but this practice was brought to the surface in 1991 when California taxed Chicago Bulls players who played against the Los Angeles Lakers in the NBA Finals. In a move dubbed “Michael Jordan’s Revenge,” Illinois imposed a similar tax that affected visiting players from states who levied a tax on Illinois athletes. Many states soon followed suit, charging players as soon as they stepped off the plane. From the perspective of states, this practice made a lot of sense. Professional athletes are high-profile, high-salaried and easy to track. What better way to collect tax revenue than from rich athletes who play for teams that taxpayers don’t like?
This practice is now termed the “jock tax,” which stipulates that anyone who earns income outside of their home state is potentially subject to additional state and local taxes. California, for instance, collected more than $229 million in income taxes from professional athletes in 2013, up $13 million from 2012. Even though the jock tax applies to many groups, it hits athletes the hardest. States more aggressively enforce the jock tax against athletes because their salaries are well known. In fact, most states impose this tax to “duty days,” not just game days. In other words, for every day an athlete spends on the road during the season—for games, practice or any other meetings that take place—he is subject to taxes. Even athletes that live in no-tax states—Washington, Texas, Tennessee and Florida, for example—still have to pay the “jock tax.”
California Tax Revenue from Professional Athletes in 2013
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It's the net, not the gross
Adding to the complexity of tax implications in sports contracts is that the overall number usually makes the news headlines isn’t actually what that athletes pull in. The gross number, always the larger number, doesn’t account for taxes. Take Ndamukong Suh’s six-year, $114 million contract. On paper, it might look the same in Michigan or Florida. But each state taxes at a different rate, so the net salary varies from team to team. Along those lines, the $114 million after taxes in Florida—a state without an income tax—is actually millions of dollars more than the net wages of this same contract in Michigan, which taxes income at 4.25% plus local taxes. As a result, teams in states with extra income tax need to offer a significantly higher gross salary for the net wages to even out. Suh is reportedly guaranteed $60 million by the Dolphins. For the Lions to have matched that figure after tax, they would have had to pony up nearly $5 million more. If the Oakland Raiders wanted to make a bid, their offer would have needed to be more than $10 million than the Dolphins’ because California’s state tax is 13.3%, the highest in the nation. Players need to be aware before making any major purchases that a large portion of that contract is going to Uncle Sam at the end of the year.
Where you live matters
Many major sports teams—especially in the NFL—play in states that closely border other states. The Washington Redskins play in Maryland, but practice in Virginia. Both the New York Giants and New York Jets play their home games in New Jersey. Those two states tax at different rates. Many Philadelphia Eagles players can stay reasonably close to Lincoln Financial Field by living in south New Jersey suburbs. Pennsylvania and New Jersey do have a reciprocal agreement where employees who live in one state and work in the other are only subject to withholding in one of the states. But not all states have such provisions.
Players have started to take note of the state tax issue. Pitcher Clayton Kershaw wears Dodger blue but saves a lot of green by living in Texas, a no-tax state. The Dallas-area native stands to save $6.5 million throughout his seven-year contract by living at home during the offseason. Mariners Infielder Robinson Cano has the best of both worlds. His current contract with Seattle nets him $42 million more than the Yankees’ (his former team) best offer because Washington is a no-tax state, and he plays about 70% of his games in no-tax states, thanks to division rivals Texas and Houston. Taxes aren’t the only factor to consider when deciding where to play, but they better be near the top of the list.
Players can deduct fines
While team and league fines may make a dent in athletes’ wallets, they won’t get dinged twice on tax day. Considered unreimbursed work expenses, fines instituted by an employer are tax deductible. This includes Marshawn Lynch’s hefty $100,000 “personal conduct” fine—assessed because Lynch refused to speak with the media—and Ndamukong Suh’s $70,000 penalty for his hit on Packers quarterback Aaron Rodgers. Wages lost because of suspensions, for which players totaled a staggering $23.2 million in 2014, are not tax deductible.
Another big deduction: training expenses
Training expenses such as yoga, nutritionists, gym memberships or the like are deductible as business expenses. Same goes for equipment expenses, union dues and other management fees.
One caveat: business expenses—fines, conditioning, management fees, etc.—are deductible only if they total more than 2% of the player’s adjusted gross income (AGI). This is known to some as the “Two-Percent Haircut.”
Now more than ever, it’s critical for athletes to know that filing taxes isn’t as simple as writing the government a check. There’s too much nuance and complexity involved. Leaving tax planning as an offseason checklist item could result in more work and missed opportunities for deductions. The modern athlete needs a modern accountant, a financial quarterback that knows the tax playbook inside and out. To remain compliant and mitigate costs, athletes need a partner who can take a holistic look at their financial situation throughout the year. Only then can they truly use the tools at their disposal to win tax season.
Robert Raiola is the Sports & Entertainment Senior Group Manager at O’Connor Davies, LLP in New Jersey. A certified public accountant, Raiola is a nationally recognized expert on sports tax and sports business matters. He represents a number of professional athletes in tax and related matters.