Taxation of Professional Athletes
By Stephen Roettger – Senior Tax Accountant
May 2, 2012
One of the more unique tax situations around is the taxation of professional athletes. Most states tax nonresident professional athletes for services performed in that state. Thus, athletes will be required to file and pay taxes in many states and cities. There is significant planning that an athlete can do to minimize state taxes.
The state in which an athlete lives can have a big impact on his or her overall tax situation due to the fact State tax rates vary. Some states have no income tax (Florida, Nevada, Texas, and Washington among others) and there are others that do not tax non-resident athletes (Tennessee, the District of Columbia).
Just imagine the difference between the tax savings someone like LeBron James incurred when choosing to play in Miami (no state income tax) rather than somewhere like New York which is on the high end of state income tax rates.
What is a Professional Athlete's Tax Home?
Generally, a team athlete’s tax home is wherever his club home is located. A team player (baseball, football, hockey, etc.) can only deduct certain expenses away from his tax home. Such expenses would be deductible as miscellaneous itemized deductions and would be subject to the alternative minimum tax and the itemized deduction phase-out. Travel and living expenses in the tax home city are nondeductible personal expenses.
There are numerous cases where players tried to claim that the assignment was temporary, and thus the expenses were deductible. The leading case was the Maury Wills case. Generally the tax court has consistently held that the tax home is the team’s home, even where a player was often traded and his contract was short term.
However, a player, who for a short time, is called up to the majors to replace an injured player may qualify as temporary. In the Horton case, a hockey player was allowed to deduct expenses as it was determined his stay was temporary.
An athlete or performer, such as a golfer, or tennis player, whose accomplishments do not take place in conjunction with a team is considered away from his tax home in a series of professional assignments, provided that that the taxpayer can establish that he has a permanent residence involving a duplication of living expenses. Such an athlete would be able to deduct his away from home living and travel expenses.
The athlete would be able to file a business return (schedule C or corporate return) and deduct the business expenses directly against his gross income from the activity including away from home travel and living expenses.
However, if the bulk of the activity is at one location, for example, a jockey who works primarily at one track, the away from home expenses would not be deductible.
How States Allocate Income
Income that gets apportioned is total compensation paid to the individual for services rendered for the team.
Income generally not subject to apportionment often includes severance pay, termination pay, strike benefits, contract buy out payments, relocation payments, and other payments not related to the performance of services.
There are two main methods by which states allocate income to team athletes, the duty day method, and the games played method.
Duty Days Method
The duty days method allocates income using a ratio of the days an athlete is present in the jurisdiction to the total number of days (including preseason, post season and regular season games, and required training such as spring training, etc.) that the athlete is required to work.
This method includes all days from the beginning of the team’s official pre-season training through the last game in which the team competes. It also includes all days in which the individual is required to perform services but which fall outside the above period, such as instructional leagues, “All-Star” and “Pro Bowl” games, or promotional events.
Travel days are included in the total days if the day includes a game, required practice, meeting or other service. These days are apportioned to the state in which the game, practice or service is conducted. Travel days involving no game, practice or service are not considered duty days spent in a jurisdiction. However, these travel days are included in the total number of duty days.
The Games Played Method
Under the games played method, compensation to the player is apportioned based on the ratio of games played in the jurisdiction to the total games played.
Under both methods, pre-season, post-season and regular season games are included. However, the games played formula fails to reflect that athletes are paid for activities in addition to game performance. For instance a baseball player that has spring training in Florida would not get credit for the days in a state that does not have an income tax.
These methods apply to active team members, team members on the disabled list, and other persons required traveling with and performing services on behalf of the team (including coaches, managers, and trainers.)
Based on our experience, many teams inaccurately allocate income to states often resulting in excessive taxes. It is important that advisors to team athletes recalculate the state income allocations. This often results in significant state tax refunds.
Initial Signing Bonuses
The initial signing bonus for a professional baseball player is paid for an agreement not to negotiate with other teams. It is not contingent on the player actually performing services and is not refundable.
Under this type of signing bonus a player has significant planning opportunities. If the player lives in a low tax state he has the opportunity to receive it before changing residence and thus can avoid state taxation on the bonus. Similarly if a player lives in a high tax state, if he establishes residence in a low tax state, before he receives the bonus, he can reduce taxes on the bonus. The bonus generally would not be taxed in the state of the professional team, unless the player becomes a residence of the state prior to receiving the bonus.
A signing bonus for a professional football player is contingent on the performance of future services for the team and can be forfeited and is thus taxable in the state of the player’s team.
In an effort to reduce the compliance burden, some states have agreed to not tax each other's non-residents. These “reciprocal agreements” make filing a tax return in the non-home state unnecessary in most cases. If a reciprocal agreement applies, a return should be filed only for a refund of income taxes withheld or paid.
Rules for Pennsylvania
If a player plays in Pennsylvania and is a resident of Indiana, Maryland, New Jersey, Ohio, Virginia, or West Virginia he does not have to pay Pennsylvania income taxes on the wages.
Pennsylvania apportions differently for football and baseball. For football, Pennsylvania uses a duty day formula. For all other sports it uses a games played formula. This results in a higher tax for non-resident athletes that play in Pennsylvania.
As most teams withhold for their players on a duty days calculation, the non-football players usually have too little withholding and end up owing taxes and penalties to Pennsylvania.
Expenses of Professional Athletes
The tax code allows a deduction for ordinary and necessary expenses paid or incurred in the carrying on of a trade or business. Services performed by an athlete as an employee of a team are considered a trade or business. In order for employee expenses to be deductible, they must be ordinary and necessary to the performance of the employee's duties. Deductible employee expenses include:
- Agent fees
- Conditioning expense
- Clubhouse Dues
- Union Dues, licenses and subscriptions
- Entertainment expenses
- Legal and accounting fees
- Local transportation and related expenses (not including commuting to and from your club's stadium)
- Out-of-town traveling expense (including meals and lodging)
- Suppliers and materials
- Training expenses
At Alpern Rosenthal we have experience with the special tax needs of the professional athlete. We also have a comprehensive State and Local Tax practice to not only help professional athletes with their complicated state tax reporting requirements but we can assist all those who have multistate taxation issues. We are able to provide these taxpayers with expertise that can reduce their overall state tax liability.
For more information, contact your Alpern Rosenthal representative.