January 6, 2011
Checking the Numbers
The Jock Tax
When the Cliff Lee saga reached its apex last month, a new type of article began to sprout up across the web. Instead of analyzing how Lee projected to perform and comparing his worth to the offers from the Rangers and Yankees, some writers began to calculate which offer would actually prove more favorable given the tax rates of the cities and states involved. Based on the tax codes of different jurisdictions it stood to reason that Lee might actually be able to take home more net compensation in an offer that, on the surface, looked to pay less in salary than another. I found this type of analysis intriguing since, by day, I am an accountant for a mid-sized firm in the Philadelphia suburbs. Naturally, articles that marry my two careers are right up my alley, but given the general confusion that arose from many of these pieces, I felt it prudent to do some research of my own and provide a primer of sorts on what is known as the “jock tax,” as well as some key components of how players are taxed.
For starters, what is the jock tax? To answer, we must take a trip back to 1991, when Michael Jordan and his Chicago Bulls beat the Lakers for the NBA championship. When it became known how much money Jordan stood to receive just from winning the title alone, the state of California decided it made sense to tax his earnings. After all, he earned that money while playing in California, and even though he wasn’t a resident of that state, the Franchise Tax Board felt that his non-resident income earned should be taxable to their benefit. Soon thereafter, Jordan received a tax bill from California. In retaliatory fashion, the Illinois Department of Revenue began sending tax bills to athletes from California who played in Illinois, a tax that became known as “Michael Jordan’s Revenge.” Suffice to say, it was not long before many other states and even local jurisdictions got in on the act.
The Jock Tax was given its name based on the principle that states tend to tax non-resident athletes earning income in their territory. Technically, the tax on non-resident income applies to everyone working out of state, but athletes tend to make more money and their salaries and schedules are out in the open for everyone to see. It isn’t the most difficult thing in the world to determine how much tax Chase Utley owes from road games if we know when he is there, how long he was there, his salary, and the tax rates of the states and cities involved. As I will explain below, the actual process can be tricky given the lack of a uniform code across the state and local jurisdictions, but the major pieces of information fueling the calculation are readily available.
Essentially, an athlete is liable for taxes in two primary states: his home team state, and his state of residency. Someone on the Diamondbacks who meets residency criteria in Georgia would be liable for state taxes in both Arizona and Georgia. Some states, like Texas, Florida, and Washington, do not levy a personal income tax, which is one of the main reasons athletes tend to flock to those cities. When the athlete travels to play a team on the road he is liable for taxes on income earned while in those states. The tax is based on a pro-rated portion of the player’s salary, which can be arrived at through the games played method or through what are known as duty days. The two methods produce different results. What makes the situation rather wonky is that duty days are not uniformly defined.
As an example, if a baseball season has 220 duty days, and a player making $10 million spends four duty days—say a travel day and a three game series—in a state with a 6.85 percent tax rate, then his taxable income for that state would be (4/220)*$10,000,000, or $181,818. His tax liability would be $181,818 * 6.85 percent, or $12,454. Given how much athletes make, this should illustrate just how much money governments can earn from taxing non-residents. Under the games played method, the taxable income would be (3/162)*$10,000,000, or $185,185, and the tax incurred would be $12,685.
In this example the discrepancy across the two methods is negligible, but when dealing with football players, who have a season with 200 duty days but way fewer games the differences in the methods can be substantial. Making matters even screwier is how a travel day can actually count as a duty day in both the departing and arriving states, depending on the specific statutes of each state. This obviously results in double taxation. On the positive front, most “home” states offer credits for taxes paid to other states. In Pennsylvania, if I end up paying income tax to Illinois, California, and New York, I get credits for the amounts paid on my Pennsylvania return, reducing the burden of my home state. In theory, this should mean that athletes would not be paying much extra tax, but because states do not follow a uniform rate, it is certainly possible for an athlete to pay a higher amount based on the primary state of his team and the teams he plays on the road.
On top of that, there are also times where athletes are double-taxed, such as the case involving Sammy Sosa back in 1999—you know, back before he looked like a zombie. Sosa played for the Cubs, but was also considered a resident of the state of Illinois. The Illinois Income Tax Act provided credits for taxes paid to other states for their residents, but not for residents of the state who also played for teams in the state. In other words, because Sosa played for the Cubs and lived in Illinois, he was taxed twice, whereas an Illinois resident playing for the Phillies would only be taxed once. All told, he paid about $65,000 in taxes to various states in 1998 and was then charged $38,000 by Illinois for taxes on the same income. Outraged, Sosa filed to have parts of the Illinois Income Tax Act deemed unconstitutional. Though the court acknowledged that double taxation was taking place, Sosa lost the case.
Because of the jock tax, it is common for baseball players to file upward of 20 state tax returns per year, which can be a boatload of work for those filing and preparing. Because of the sheer multitude of compliance involved it can be an administrative headache if the tiniest of mistakes emerges. Additionally, players are taxed on the tickets they leave at the gate for friends and family, as well as their per diem compensation. With per diems, players are given a specific amount of money each day for food, since the team covers travel expenses, and any amount that is above the tax-exempt amount—which is different for each state—goes on the player’s W-2 form. Not all per diem funds are taxable, just the amounts exceeding the exempt portion.
While the jock tax first surfaced with Michael Jordan back in the early 1990s, and jurisdictions soon caught on, not every team immediately complied. According to a source of mine who formerly served in the accounting department of a major-league team, his team had been in compliance from the time he arrived, but many of the teams they played were not withholding taxes owed to the road team cities. The situation reached a head in 1997, when interleague play began, because now teams were traveling to cities in which they have never played before, with different taxes and rates to take into account. Eventually, the jurisdictions began harassing teams for the taxes owed, which proved bothersome given that so many had a gross receipts tax, where a business incurs tax purely on the revenues earned, regardless of the net profit or loss.
For teams operating with a loss, being taxed on revenues they were not even converting to profit would only exacerbate their financial woes. If teams had to allocate television revenues to every city and state they traveled to, and had to start paying gross receipts tax in every jurisdiction, their tax bill would increase materially. The income tax was not considered too much of a burden because given the short time a team stayed in each road city and the high salaries of the players, losses were often experienced. To avoid the gross receipts tax problem, a compromise was reached with municipalities where teams would withhold the payroll taxes for each state and city, and nothing else.
Further, there is the issue of what criteria determines whether someone is a resident of a specific state, which comes into play when taxing non-salary income. A famous case from a few years ago involved Derek Jeter, where the city of New York was trying to retroactively tax Jeter as if he was a resident of New York from 2001-03, even though the Captain claimed that his primary residence was in Tampa, Florida. Not only would the city be able to collect taxes on his salary if he was found to be a New York resident, but they would also reap the benefits of taxes owed on all of his endorsement income or other non-salary income. Since Florida doesn’t have a state income tax, many athletes will make it their primary residence to shelter their income. In Jeter’s case, the auditors leading the case against him explained that the shortstop owned a multi-million dollar apartment in the Trump World Towers and argued that, if the shortstop of the Yankees is not a resident of New York, who is? Eventually, Jeter settled out of court, but issues like this surface all the time.
In summary, players are liable for taxes to their state of residency and the home state of their employing team, as well as to the states in which they earn income as non-residents, which occurs every time they are on the road. They are taxed for per diems and tickets left at the gate, and though it might seem like the various non-resident income taxes wash out for every player, it is certainly possible given the difference between the duty days or games methods, and the actual rates of the “road cities” for a player to incur more tax than he would in another situation. Determining what Cliff Lee would take home in net pay given the state and city taxes for New York and Philadelphia—Texas does not have a state tax—is certainly an interesting way to attack a hot topic from a different angle, and hopefully this information will help clear up confusion regarding taxation in baseball.