Professional Athletes - Taxing to the Mind, Body and Wallet

A professional athlete seems to have the greatest job on earth.  It comes with wealth, glamour and fame. 

However, it also exposes the athlete to attention that is not wanted. This article will discuss the very “unwanted” attention of the state taxing authorities.

Most people live and work in the same city or town and have a fairly simple tax preparation process. The average person files a federal, state and possibly city return, depending on his or her place of residence. Athletes, on the other hand, practice and play all over the country and in many cases, the world. Many jurisdictions have the authority to tax individuals performing services within their borders. Therefore, athletes may be required to pay taxes to each city, state, and country where they practice or play.

The average athlete may travel to 20 or more different jurisdictions throughout a single season, which can create a tax compliance nightmare. This situation is sometimes called the "jock tax" because the nature of an athlete's profession makes him or her very susceptible to this type of taxation.

Why Athletes are a Tax Target

States see athletes as juicy targets to extract tax revenue particularly during a time of tight budgets. Between the NFL, NBA, MLB, and NHL, there are over 120 professional sports teams whose players each earn an average of between $1 million and $5 million per year depending on the sport. Each time a puck is dropped, touchdown is scored or player suits up for practice, a taxing jurisdiction expects to receive tax on its share of a player's earnings.

Because of the large amount of revenue involved, many states, like California, have specific tax agents who deal exclusively with professional athletes. Since the salaries and schedules of a professional athlete are publically available, it is very easy for a state tax official to track the revenue that may be subject to tax. This makes return accuracy even more important from an audit perspective.

How Taxable Income is Apportioned for Athletes

Not all taxing jurisdictions use the same method for determining how much of a player's income is subject to tax. For athletes that play on a team, many, but not all, states use the "Duty Days" method. A "Duty Day" is effectively a day of service on which a player is required to perform in his or her capacity and can include both game days and practice days. The "Duty Days" approach apportions a player's income based on the number of days that a player performs services in a particular jurisdiction as compared to the total numbers of days on which services are performed. For example, if a baseball player earns a salary of $3 million for a particular season, and spends 15 out of his 200 duty days in the state of Arizona, the player will apportion $225,000, or (15/200 * $3 million) of income to that state. Different jurisdictions may use various definitions as to what constitutes a day of service or they may use another methodology altogether. Another such methodology is the "Games Played" method. This method apportions income to a jurisdiction based on only the number of games played in that particular jurisdiction as compared to the total number of games played in a year.

It is important that a tax advisor be aware of the interplay between the different methodologies. Depending on the methodology used in the various states, income could be double taxed or an opportunity to significantly mitigate tax liability may be available. This will also, of course, be dependent upon the athlete's state or country of residency. Athletes who are not part of a team, such as golfers, are taxed in a particular jurisdiction on the income earned from a tournament or event played in that jurisdiction.

Endorsement income is another source of revenue for many professional athletes. In general, for an endorsement contract that requires a player to perform in a specific event or location, the income is usually sourced to that location. This could include using a specific brand of golf club or wearing a certain brand of clothing at a tournament. If the contract merely uses the player's likeness or image, then the income will likely be sourced to the player's home state. An example of this would be the income from a national advertising campaign for an athlete's support of a particular product or brand.

Tax Withholding and Reciprocal Agreements

Professional sports teams withhold federal, state and city taxes on a player's behalf. Frequently, the tax withholding does not align with the actual liability as computed by a jurisdiction's taxing methodology. It is important for a tax advisor to be aware of this as an athlete may be significantly overpaid or underpaid in several jurisdictions. Therefore, an athlete can be in a situation where he or she is entitled to sizable refunds in some states while owing large balances in others. These timing differences can have a significant impact on an athlete’s cash flow.

A player's withholding can also be incorrect if reciprocal tax agreements exist. These are agreements where taxing jurisdictions agree not to tax each other's nonresidents. Examples of states with reciprocal agreements are Indiana, D.C., Pennsylvania and Ohio.

Athletes can capitalize on the benefits of these agreements by submitting a withholding exemption form to their employer. Failing to do so will not deprive them of the agreement's benefits, but it will cause them to have a significant amount of taxes paid to a jurisdiction to which they legally owe nothing. Again, an athlete can end up with severe cash flow issues if their advisors are not aware that these agreements exist.

It's important to recognize that athlete's activities can be international in nature. The NFL plays at least one game per year in London and the NHL, NBA and MLB all have Canadian franchises. Tax advisors need to be aware of how foreign tax rules and tax treaties can affect an athlete's tax liability. Some tax treaties have provisions that deal specifically with professional athletes. This is a complex area of the tax law and professional guidance should be sought in navigating the web of international tax rules.

Deductibility of Expenses Unique to Athletes

Athletes, in particular, have certain expenses unique to their profession such as agent's fees, clubhouse expenses and certain sports equipment. Team athletes are considered employees and therefore, many of these deductions are considered itemized deductions subject to a 2% of AGI limitation. As allowable itemized deductions were further limited starting in 2013 by the return of the Pease amendment, it is very important to work with a tax adviser to time these payments, particularly large agent's fees, in order to maximize their deductibility. Individual, non-team, athletes are afforded more flexibility with regard to their professional expenses as they are considered self-employed persons.

The unique nature of the professional sports business can make tax compliance a nightmare for many athletes. Not only is the tax burden itself large and wide-reaching, but the added spotlight due to their publicity makes getting it right even more important. Aside from the federal tax filings, there are many nuances of interstate taxation that a tax advisor needs to be aware of such as the "Duty Days" and "Games Played" apportionment methodologies, tax withholding, endorsement income, interstate reciprocal tax agreements and athlete specific expenses. Diligence, planning, and foresight can go a long way in saving an athlete on their tax bill and eliminate the stress associated with short-term cash flow issues. A skilled tax advisor can help the professional athlete navigate this maze and keep the player's focus on doing what they do best, winning.