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Professional sports athletes face challenges on and off the field, especially when it comes to finances and potential tax liability. Whether playing at home or on-the-road, athletes need to consider how a state is going to tax their income. In this article, OFS's Sean Packard discusses what's involved in state income tax planning for professional athletes.
By Sean Packard
For more than eight years Sean Packard has been the Tax Director at OFS, a full-service financial services company for professional athletes, where he focuses on all aspects of tax planning and preparation for over 200 clients
The most involved part of tax planning for a professional athlete is at the state level. From the time an athlete enters his sport's draft until he retires, he and his tax professional will navigate state tax rules and regulations on domicile, residency and non-resident taxation.
When a top prospect is entering a draft, he and his tax professional must look at where his family lives, which teams have shown strong interest in him and where he has ties (high school, college, extended family he is close with) to determine where he could legitimately establish domicile. Once he is drafted—and before he receives his signing bonus—they should determine where it would be most beneficial to establish domicile and whether it is economically and logistically feasible to do so.
Signing bonuses are taxed only in an athlete's state of residence under most circumstances if the bonus meets three criteria: 1) it is paid separately from normal payroll, 2) it is not contingent upon the athlete performing future duties for the team and 3) it is non-refundable. In every sport it is possible to claim residency in a state other than the one in which a player's team is located during his first year, mainly because it is easy for a player to avoid spending 183 days in that state that year if he plans accordingly.
As an athlete becomes more established, state domicile and statutory residency rules become even more important. A legitimate domicile can sometimes be difficult to determine. An athlete will sometimes establish a home in his hometown while also having a home in his team's town. If both homes are available year-round, states will look to other factors to determine domicile, including place of employment, where the athlete's cars are registered, where his most personal possessions are located, where he votes, etc.
Oftentimes, the athlete will rent a place in his team's city for the duration of the season, will return home during the offseason and will find a new place at the start of the next season. In this situation, domicile is easier to determine, but tax residency can be more difficult, depending on the states' rules and regulations.
Some states will treat a person as a resident if he spends 183 days there. Others look more closely to a person's true domicile rather than time spent. For example, California takes a holistic approach to determining a person's residency. Time spent in the state is a factor rather than the factor. California also looks at other dynamics such as where a person's doctor(s) is located.
A person can only have one domicile at any given time. In order to abandon domicile in one state, he must establish domicile elsewhere. Player movement via trades and free agency forces the athlete to confront these rules.
If a player signs to play for a team in Texas after having spent most of his career in California, where his family owns a home, it would be highly advantageous from a tax perspective to move his family to Texas. But even if they move, domicile may remain in California if he keeps his home and bank accounts there, goes back there during the offseason and maintains ties to the local community. Although most of the player and his family's time is spent in Texas, domicile in California has not been truly abandoned.
It is possible to be a domiciliary resident of one state while being a statutory resident of another. Using the example above, let us assume the player signs in New York instead of Texas and has no intention of establishing domicile in New York. Under New York law, the athlete is considered a statutory resident by spending any part of 183 days in New York. In this situation, the tax professional must determine where to take state tax credits and where to apply reciprocity agreements—if any exist.
At the most basic level, a tax professional must understand each state's non-resident athlete laws, as most states have rules and regulations directly addressing non-resident athlete income. Most states subscribe to the duty day method whereby the state's taxable income is determined by multiplying the athlete's income by the ratio of days spent working in the state divided by the total duty days worked during the year.
Most states recognize total duty days beginning with the first date players report to their team's training camp. Arizona begins the total duty day count with the team's first game—otherwise Major League Baseball would have to relocate Spring Training for half of the league. Pennsylvania and Michigan use the games played method for non-football sports but duty days for football. Pennsylvania taxes preseason games/days whereas Michigan does not.
Understanding state income rules is important because teams rarely allocate income properly. In some cases, this results in teams allocating too much income to a state. In other cases, teams allocate too little to states that are aggressive in coming after players who report too little. In many cases teams do not report income to or withhold in New York, but New York is highly aggressive in pursuing athletes who do not report or properly allocate income to the state.
When teams do not allocate income properly, the tax professional must recalculate income and attach a statement to the athlete's return explaining their position. When income is adjusted down states will usually send a notice to the athlete to which the tax professional must respond. Sometimes states will require a statement from the athlete's team confirming the income reported on his return.
In most cases, team payroll departments are reluctant to admit to state authorities that their income calculations are less than perfect. They report income on a bi-weekly, semi-monthly or monthly basis based on the player's salary during that period. It is nearly impossible for them to get it 100% right all the time.
When teams are reluctant to admit their mistakes it is incumbent upon the tax professional to obtain a letter that states the basic facts of the athlete's situation so that the tax professional can take that information and produce an income calculation according to the state's laws and regulations that the state will accept. In some cases, this saves the athlete hundreds of dollars. In others it will save him thousands.
Finally, the tax professional working with athletes must understand how tax credits are calculated in the various states in which their clients live. In most states credits for taxes paid to other states are calculated on the taxpayer's home state return. However, some states reverse this rule. For example, a basketball player who resides in California will play games in Arizona, Oregon and Indiana and will report income in each state accordingly. Instead of taking credits for taxes paid in these states on his California return, the athlete will take credits for California taxes paid on each of the other three state returns.
There are other considerations an athlete and his advisor could face. High-end baseball players are now negotiating deferred compensation into their contracts. When done properly, this income can escape state taxation if a player retires to a no-tax state, no matter where the team who pays him is located. Another issue is contract buyouts. Most states exclude buyout payments from taxation, though teams will inevitably withhold. If a player is paid a $2 million buyout from a California team but lives in Florida, understanding this rule could save him well over $200,000.
Professional athletes face many unique state income tax situations that are unseen in other professions. Therefore it is important that an athlete work with a tax professional who is experienced in the nuances of state income tax reporting for professional athletes.
Copyright © 2017 Tax Management Inc. All Rights Reserved.
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