Another exciting tax season has come and gone, as many of our attorney readers can look forward to helping pay the refunds distributed to our indebted law student followers. Most Americans have a relatively simple return in that they live and/or work in the same state throughout the year. Such is not the case for professional athletes. Between trades, away games, and multi-state sponsorship deals, the tax return for a professional athlete can prove to be a true nightmare, subjecting them to what is commonly known as the “jock tax.”
Nick Zotos is an associate with Satterlee Stephens Burke & Burke LLP’s New York office. Admitted to practice in New York, Illinois, the District of Columbia, and before the United States Tax Court, Zotos focuses his practice on sports law and business/personal tax planning and has particular experience working with cross-border and expatriation tax issues and representing taxpayers before federal and state audit. Zotos also serves as trustee of the New York Mixed Martial Arts Initiative, a non-profit organization that provides funding for inner city youth and young adults so that they can experience the benefits of MMA training.
1. Does a professional athlete have to pay tax to every state where he/she plays in a particular season? What methods are commonly utilized to calculate these values?
Constitutional principles mandate that in order for a taxpayer to be subject to State income tax, the taxpayer’s income producing activities must have sufficient minimum contacts or “nexus” with that State. The two main bases for State income taxation are: 1) that the taxpayer has established State “residency” (a technical legal term which varies from state to state), or 2) that the income is generated from in-state business or sources. In the case of professional athletes, their income is generated from the performance of personal services, which generally are sourced where the services are performed. Thus any State where an athlete is paid to compete would have a jurisdictional basis to tax the income earned in that State.
The methods used to compute taxable income of non-residents vary from state to state. The basic concept is that income must be apportioned between the States where it was earned. For wage earners, a common method is to apportion income based on working or “duty days”. All days of presence in which the athlete is required to perform services would be included. Days in which the athlete is not compensated or performing services would not. Many States offer credits or have reciprocal agreements in place with other States to help relieve the burden of double taxation.
2. How does the NHL’s substantial presence in Canada affect the tax returns of American citizens who play for U.S. teams?
U.S. residents and citizens are taxed on worldwide income, thus American citizens who play for U.S. teams in Canada must pay U.S. income tax on all income even that earned in Canada. There exist provisions that may apply to alleviate the tax burden of American athletes who compete abroad. One such provision being the foreign earned income exclusion, which allows qualifying citizens and residents living and working outside the U.S. to exclude up to $97,600 (adjusted annually for inflation) from income, plus an allowable exclusion for certain housing expenses. It is important to note that such an election must affirmatively be made on a timely filed return; otherwise the only recourse is to file a special request for IRS relief.
When counseling multi-national athletes in general, it is important to be aware of the existence of international tax treaties which may impact the athletes’ tax positions. Many treaties have clauses that specifically govern the taxation of athletes that compete internationally, the United States – Canada Income Tax Treaty is one such example. There are also issues that arise with dual citizenship, foreign tax credits, and withholding issues to name a few. There are many complex tax and legal issues that arise when dealing multinational clients. American athletes who compete abroad would be well advised to seek competent counsel.
3. Is there any difference in treatment for the type of money earned (salary vs. sponsorship dollars)? Which states gets to claim the tax benefits for each of these?
It goes back to the two main bases for State income taxation: residency and sourcing. A state must have a jurisdictional basis for every single item of income it taxes. If an athlete is a non-resident of a State, the State would have to show there was a nexus between the income and activities within the State. Any sponsorship dollars directly tied to a performance or appearance at a particular event within the State would potentially be subject to taxation by that State. Tax sourcing determinations regarding endorsement deals can be highly fact specific and are routinely a point of contention with local taxing authorities.
4. An athlete’s signing bonus seems to create a potential hurdle because it is income that is could be considered “earned” at signing although it is actually paid out over time. With the burdens of local, state, and federal taxes, is it possible that an athlete with a fresh contract could actually owe more than he/she actually pocketed?
This can largely turn on how the signing bonus is structured. A true signing bonus is not conditional on the athlete playing any games for the team, or performing any subsequent services for the team, is payable separately from the salary and any other compensation and nonrefundable. However this is not always the case. Many signing bonuses are payable over time, tied to performance incentives, or even in some cases subject to claw-back in the event the athlete breaches the contract. As a general rule, individuals do not report and pay tax on income until they actually receive payment. Moreover, if the signing bonus is conditioned upon the future performance of substantial services by the athlete then the signing bonus is not currently taxable.
5. Is there any argument that it is unfair to place tax burdens on foreign players who may never establish citizenship, let alone vote, in this country?
Politics aside, the legal argument for taxing non-residents who earn income in the U.S. is that they have availed themselves to the benefits and protections of U.S. law in order to earn that income, and accordingly that they should pay their share of tax. The economic argument for taxation is that to not tax U.S. source income of non-residents would put U.S. businesses at a competitive disadvantage with foreigners doing business in the U.S.
6. For retired players who reside in a different state than the teams for which they played, what state collects the tax on their pension distributions?
Many States do tax deferred compensation paid to nonresidents who earned the compensation for services previously performed within the State while they were residents. There exists however, a federal restriction which prohibits States from imposing income tax on pension and other qualified retirement plans of an individual who is not a resident of the State.
7. Do professional athletes sometimes sign out of free agency with an eye to the teams located in states such as Texas and Florida with no state income tax? Could that be part of the reason LeBron “took his talents to South Beach” and why some argue that Joe Flacco should have considered doing the same?
Athletes contemplating free agency should absolutely be counseled regarding tax considerations as it can mean the difference of millions of dollars. For example, the greater the athletes share of income that is not directly tied to the performance of personal services such as endorsement, royalty or signing bonuses, the more critical the determination of tax residency becomes. In the case of Joe Flacco, he may have decided that it was in his best overall financial or personal interests to not “take his talents to South Beach.” However as a trusted advisor, my job would be to ensure Mr. Flacco is aware of all tax and legal considerations necessary to make a fully informed decision.
Any tax advice contained in this writing was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. This writing is not intended to be comprehensive or to serve as a substitute for personal tax or legal advice from a qualified advisor.