Individual Tax Insights: Audits Are Another Off-Field Headache for Athletes and Their Advisors

In addition to facing so-called "jock taxes in multiple states [160 Daily Tax Report H-1, 8/19/14], professional athletes face another challenge: audits. Changes to federal returns often require corresponding modifications to state returns, which could be a significant compliance hurdle given the number of jurisdictions in which most professional athletes perform. The complexity of this task increases even more when accounting for the different rules states use to attribute athletes' income to their jurisdiction.

At the federal level, the IRS audits individuals with high adjusted gross income (AGI) more frequently than average taxpayers. According to the 2013 IRS Data Book, less than one percent of all returns are subject to audit. But that number increases to nine percent for returns with AGI between $1 million and $5 million, nearly 16 percent for AGI between $5 million and $10 million, and over 24 percent for returns with AGI over $10 million.

Sean Packard, the Tax Director at OFS, a company specializing in wealth management for athletes and celebrities, told Bloomberg BNA that audits tend to come in cycles. It appears to be "game on" for the IRS at the moment, and Packard has one theory why: it's all about the deductions.

"Athletes make a lot of money," Packard said, "but they also take deductions that most people don't qualify for." For example, certain miscellaneous itemized deductions and unreimbursed expenses must exceed two percent of a person's AGI before they are deductible. Packard noted that "an athlete who pays three to five percent of his salary in agent fees will easily surpass that threshold, in addition to training expenses, investment fees, tax preparation fees, etc."

The limitation on itemized deductions under I.R.C. § 68 may reduce those deductions up to 80 percent for high-income individuals; however, for tax years 2010-2012, this IRC provision was not in effect. "The IRS may want to take a look at those itemized deductions now to maximize their collection efforts before the statute of limitations has run," Packard said. The larger the deduction, the greater the tax revenue if disallowed. 

Any changes at the federal level could trickle down to the states. Many states require taxpayers to file amended returns when there has been a change to the federal return, which is very significant for athletes who have to file in a dozen or more states. 

Although many professional athletes receive some assistance from their teams with respect to taxes, even this situation can lead to audits. For example, some states count preseason days when allocating income, and some don't. And even though teams generally provide players with Form W-2s for each state, failure to properly account for preseason days could lead to incorrect information on the W-2. "Even if the number on the tax return is correct, reporting a different amount on a tax return than the amount listed on the W-2 is a surefire way to get a letter from the state requesting more information," warned Packard. 

It's all fun and games, until the audit letter arrives.

*Continue the discussion on Bloomberg BNA's State Tax Group on LinkedIn: What's your worst audit nightmare? 

For more information about audits and multistate taxation of athletes, check out Bloomberg BNA's Individual Income Tax Navigator by signing up for a free trial of the Bloomberg BNA Premier State Tax Library today. 

By: William Olver 

Follow BBNA on Twitter at: @BBNATax.