The Taxing Impact of State Taxes

It’s one of life’s certainties: Athletes need to make sure they have an ITIN and pay taxes on income earned on the road. What is an ITIN? It is an individual taxpayer identification number and everybody must have one when they are an American citizen unless they are eligible for social security.

For each of his first seven NBA seasons, Dwyane Wade has worked in Florida, where there’s no state income tax.

Yet, each April, he undoubtedly pays a small army of accountants to file hundreds of pages of tax returns and sends out checks all over the country covering taxes on income he earned on the road.

April 15 — tax day — is quite possibly the most stressful day for professional athletes, now that 20 of the 22 states(1) with NBA franchises, and several cities and other municipalities(2) within those states, have laws that require visiting athletes to pay state income tax for each game they play there.

This so called “jock tax” is an income tax levied against visitors to a city or state who earn money in that jurisdiction. Since the state cannot typically afford to track the thousands of individuals who do business on an itinerant basis, the ones targeted are typically the very wealthy and the very high profile, namely professional athletes. Not only are the working schedules of professional athletes public, so are their salaries. The state can compute and collect the amount with very little investment of time and effort.

The states take the total salary paid to the visiting professional athlete, allocate a portion of it to the time spent within its state, and then send a tax bill for a prorated portion of the athlete’s total annual salary.

There is no consensus method between states for calculating the allocation of salary. A few use the “games played” method, which divides the total number of games in the season by the number played in the state. Most, however, utilize a “duty days” method, which divides the player’s total number of work days during the season by the number of days spent playing in the state.

Even for states which utilize the “duty day” method, there is no consensus on what constitutes a duty day. Some jurisdictions treat practices and organized team activities as a working day. Some count travel days while others only count travel days if a game is played on that day. Most jurisdictions that use the duty day method, however, include all practice days, game days, and travel days from the beginning of the team’s official preseason training through the last game in which the team competes, including any postseason play, as well as off-season days in which the athlete has a contractual obligation to perform services, such as camps, instructional leagues, all-star games, team imposed training activities, and promotional events.

NBA training camps officially begin 29 days prior to the start of the regular season. The regular season lasts 170 days. Players are typically provided approximately 16 days off during the season. Therefore, duty days can equal about 183 days or so for any given year(3). If a player’s annual salary is $5 million, he can be said to earn $27,322 per duty day. Therefore, each city and state with a jock tax that uses this duty day calculation methodology will consider his salary to be $27,322 times the number of duty days spent in that jurisdiction.

All the individual state tax collectors have left to do is multiply their prorated salary calculation by the state’s applicable tax rate in order to calculate the non-resident player’s tax obligation, with some using the help of someone like this tax accountant nyc to help with their taxes.

For the player, calculating his non-resident tax obligations is substantially more complex.

Not only do they need to file jock tax returns in as many as 20 different states and a several cities, each imposing its own definition of a player’s income and duty days, they also need to deal with potential double taxation issues. Although dealing with taxes is not something that people enjoy, it has to be done. If you have brushed it to the side and are now finding it difficult to manage, you may be in need of tax debt relief to get this all sorted.

States that impose a personal income tax require that the tax be paid on all income earned by residents of that state, independent of where it was actually earned, as well as by non-residents who perform itinerant work in that state. This leads to a double taxation. Players are required to pay taxes to two states for the same game: their state of residence and, when different, the state where the game was played.

To avoid this unduly onerous tax charge, most states allow for tax credits to be applied to the tax returns of their resident athletes for taxes paid to other states, but only up to the amount the home state would have collected. If the out-of-state tax is higher, the player receives no credit for the incremental out-of-state taxes paid. If the out-of-state tax is lower, then the home state generally tops it off by levying a tax for the difference. Certain states do not allow a home state tax credit for certain other states. In this situation, a “reverse tax credit” is taken on the non-home state, determined in the same manner as the home state tax credit.

As with all state tax matters, each state handles its version of the jock tax differently. Three major exceptions deserve comment.

First, there are two states, one province, and one foreign city in which NBA games are played that have no jock taxes at all: Florida, Texas, Washington, D.C. and Toronto. There are no taxes imposed by these jurisdictions on non-residents. Speaking of taxes, residential tax in particular – Malta’s tax system is similar in sorts, but also very different, you can read here if it’s something that interests you or could affect you, https://maltaguides.co/tax/rates/.

Second is the case of Tennessee. Although Tennessee does not have a state income tax on earnings, in 2009 it enacted a “professional privilege tax” on professional basketball players (NBA) and hockey players (NHL). The tax on each player is $2,500 per game for up to 3 games ($7,500 per year) for both residents and non-residents. This may not seem like a big deal to multi-million dollar athletes, but it can be quite punitive for players on smaller contracts. This past season, visiting minimum salary players paid nearly as much in taxes to the state of Tennessee for each game played against the Grizzlies as they earned in salary for the day of the game. After incorporating federal income taxes, they essentially had to pay to play. But here’s where it gets really strange. The tax isn’t even given to the state. Instead, it goes to the operators of the arena in which the teams play. In the case of the Grizzlies, that’s the owner. And if that’s not strange enough, while NBA and NHL players are required to pay this tax, NFL players are exempted.

Third is the case of Illinois. Illinois is the only state with a jock tax that forgives such taxes on athletes who come from states with no jock tax. It also provides state income tax credits to its resident athletes for jock taxes they pay out of state, but only if these athletes are not employed by an Illinois-based team. The state is not so forgiving to athletes who are employed by Illinois-based teams. Resident athletes do not receive credit for jock taxes paid out of state and non-resident athletes are required to allocate 100% of their income to Illinois for tax purposes, in each case if they play for an Illinois-based team. In both cases, this often requires them to pay a double taxation on their road games. (Illinois has a reciprocal agreement with border states Iowa, Kentucky, Michigan and Wisconsin. Illinois residents aren’t subject to jock taxes in these states so double taxation is avoided, as it is for states that don’t charge a jock tax at all).

For a professional athlete, jock tax considerations are just one part of a much broader issue: minimizing state (and federal) income tax obligations.

Proper tax planning for athletes starts with establishing a state of residency. The athlete’s state of residency forms the baseline for all state and jock taxes he pays.

For most of us, establishing a state of residency is rather obvious. We live and work and have our homes and families and spend most of our time all in the same state. But for athletes, who spend a great deal of the year on the road, and can therefore manipulate residency rules to their benefit, things aren’t as clear.

An athlete’s state of residence is not necessarily the same as the state of the team for which he plays. Players who don’t play in tax beneficial states often attempt to minimize their onerous tax consequences by establishing residency in tax favorable states different from those in which their teams are located. However, it’s neither an easy nor a completely effective proposition.

Establishing residency is a complicated endeavor which is based on the location of real property, how much time is spent in a given state (more than 183 days per year is a general guideline), the location of family, business ties to a state, and many other factors. This can be a confusing and subjective test, creating a potential playground of sorts for state tax auditors. Given the time commitments to the state in which a player’s home team resides, it is often very difficult, and sometimes impossible, to avoid establishing residency in that state. And if such individuals are not careful, they could possibly wind up establishing residency in multiple jurisdictions — both the state of domicile and a state of statutory residency — which could subject the individual to tax on his entire income by both states.

Even if residency were to be established in a tax preferred state different from the state in which a player plays his home games, since the vast majority of his duty days will be spent in the state where his team is located, most of his basketball income would be allocated to that state anyway.

But residency issues can affect more than just a player’s basketball salary. Many players attempt to establish residency in alternate, tax preferred domiciles in order to shelter their non-basketball-playing income. This can create huge tax savings for players with large signing bonuses, endorsement deals, personal appearance fees, dividends and interest income.

Establishing residency in a player’s team state and, by extension, choosing to play for a team located in a tax preferred state, makes these complex residency issues much easier and much less controversial. That, in turn, provides tax-advantaged states a competitive advantage when competing for the services of a potential free agent.

The federal government does, however, provide a small measure of relief for athletes (and all taxpayers) who choose to establish residency in less advantageous states. Those who choose to itemize deductions on their personal income tax returns (on Form 1040, Schedule A) can deduct city and state taxes paid.

So what does it all mean?

If a player’s tax bill factors into his free agency decision, the Miami Heat has a clear advantage.

There are three states in which NBA games are played with no state income taxes: Florida, Tennessee and Texas. Players who play for the Miami Heat, Orlando Magic, Houston Rockets, Dallas Mavericks, San Antonio Spurs and Memphis Grizzlies, assuming they establish residency in that state, would need not pay any state income taxes for any of their home games played per calendar year (though Grizzlies’ players would need to pay $7,500 in privilege taxes, as noted above). They also don’t need to pay state income taxes for any of their road games played against the Miami Heat, Orlando Magic, Houston Rockets, Dallas Mavericks, San Antonio Spurs, Memphis Grizzlies, Washington Wizards, Toronto Raptors or Chicago Bulls (though they would be required to pay $2,500 in privilege taxes for every road game played against the Grizzlies, as noted above). For all other road games, they need to pay jock taxes at the individual tax rates for the states in which they play.

In other words, a player who chooses to play for the Heat would pay no income states on his salary to the state of Florida, and owe jock taxes to various other states and municipalities on a bit more than 1/3 of his total games (at the various tax rates imposed by those jurisdictions). At a hypothetical $20 million salary(4), that would likely equate to a bit more than half a million dollars. In addition, any signing bonus and all endorsement deals would be free of any state taxes.

Players who play for the Chicago Bulls, assuming they establish residency in Illinois, would need to pay Illinois state taxes on all home and road games. They would also need to pay jock taxes for all of their road games not played against the Miami Heat, Orlando Magic, Houston Rockets, Dallas Mavericks, San Antonio Spurs, Washington Wizards, Toronto Raptors, Detroit Pistons or Milwaukee Bucks.

In other words, an Illinois resident who chooses to play for the Bulls would pay a 3% income tax on his entire salary to the state of Illinois, and would owe jock taxes to various other states and municipalities on a bit less than 1/3 of his total games (at the various tax rates imposed by those jurisdictions). At an assumed $20 million salary, that would likely equate to a net amount approaching a million dollars after accounting for federal tax deductions (more than 1.5x what he would pay if he were to establish residency in South Florida and play for the Heat). In addition, any signing bonus and all endorsement deals he signs would be taxed by the state at a rate of 3% (less applicable federal tax deductions).

Players who establish residency in other states would need to pay state taxes on all of their home and road games per calendar year, at a rate which is equal to the greater of the rate imposed by the individual state in which they play and their home states(1).

In other words, a New York City resident who chooses to play for the Knicks would pay a 12.85% income tax rate on his entire salary to the city and state of New York. At an assumed $20 million salary, that would likely equate to a net city and state tax amount approaching $2 million after accounting for federal tax deductions (more than 3x what he would pay if he were to establish residency in South Florida and play for the Heat). In addition, any signing bonus and all endorsement deals he signs would be taxed by the city and state at a cumulative rate of 12.85% (less applicable federal tax deductions).

If the player instead chose to be an L.A. resident and play for the Clippers, he would pay a 10.55% income tax rate on his entire salary to the state of California. He would also owe a net state tax amount approaching $2 million (though slightly less than if he chose New York) after account for federal tax deductions. In addition, any signing bonus and all endorsement deals he signs would be taxed by the city and state at a cumulative rate of 10.55% (less applicable federal tax deductions).

The relative tax savings of living in Miami and playing for the Heat therefore depends upon the alternative to which it is being compared. For a maximum salary player, the relative tax savings of choosing to play for the Heat versus choosing to play for the Bulls on an equivalent salary would surely be several hundred thousand dollars per year and upward of $1 million versus choosing to play for the Knicks, Nets or Clippers. When incorporating potential endorsement contracts, the relative tax savings could easily run into the millions of dollars!

Notes:

As with everything tax related, the rules described above are more complicated and detailed than can be covered in just one small post. In addition, these numbers are only estimates and do not account for possible future change in federal or state tax rates or laws, or the changes in the NBA salary cap to come. While the Bush tax cuts remain in effect, the highest federal fax rate has been reduced from 39.6% to 35.0% and the limitations on Schedule A deductions have been suspended; the figures provided in this post reflect these changes (which may or may not last).

There are many other factors involved in calculating a player’s tax bill. For example, pro athletes can generally deduct such things as expenses associated with preseason training which are not reimbursed by the team (including hotel, apartment or home rentals, meals, transportation to the training location, and car rentals) and agent fees (NBA agents charge 2% for players earning the minimum salary, 4% of the amount above 80% of the scale amount for players on rookie-scale contracts, and 4% for all other contracts) on their state and federal tax returns.

While this post concerns state and municipal tax obligations, Canadian tax rules deserve a special mention. The tax rules between the U.S. and Canada differ substantially. The U.S. taxes individuals based on citizenship and residency, while Canada taxes based solely on residency. The highest federal tax rate in the U.S. is 35.0%. Canada’s highest federal tax rate is 29.0%, which when combined with Ontario’s highest provincial tax rate of 17.41%, comes to a much higher combined 46.41% rate. The U.S. also allows several deductions to offset taxable income (such as agent fees and training costs) that Canada does not. This can have a significantly detrimental impact on U.S. citizens who play for the Toronto Raptors, who would be subject to the higher Canadian tax rates. However, the U.S. and Canada have a tax treaty to mitigate some of the cross-border issues. The treaty prevents any double taxation issues for U.S. citizens playing in Canada who are subject to Canadian taxes. It also prevents income from visiting players from being taxable in Canada. And it allows any signing bonuses from a Canadian team to be taxed by Canada at only 15% (the player gets a full credit on his U.S. return, pays the incremental 20% in U.S. taxes, and is therefore not penalized for playing for a Canadian-based team on any signing bonus he receives). It should also be noted, however, that if the highest U.S. marginal tax rate increases back to 39.6% and itemized deduction limitations are restored, it could conceivably wind up being less expensive for a U.S. citizen to play in Toronto versus high-tax U.S. states such as New York and California.

(1) States with NBA franchises that have jock tax provisions (highest marginal tax rate): Arizona (4.54%), California (10.55%), Colorado (4.63%), Georgia (6%), Illinois (3%), Indiana (3.4%), Louisiana (6%), Massachusetts (5.3%), Michigan (4.35%), Minnesota (7.85%), New York (8.97%), North Carolina (7.75%), Ohio (5.93%), Oklahoma (5.5%), Oregon (11%), Pennsylvania (3.07%), Utah (5%), Washington, DC (8.5%) and Wisconsin (7.75%). Tennessee charges $2,500 per game with a $7,500 per year maximum. The figure of 20 states includes Washington, DC, which is technically a district.

(2) Cities with NBA franchises that have jock tax provisions in addition to those of their states (highest marginal tax rate): Cleveland (2%), Detroit (1.25%), New York City (3.876%) and Philadelphia (3.4985%). Marion County in Indiana has jock tax provisions (0.405%) as well.

(3) The playoffs can last another two months for teams which make it through to the NBA Finals. Therefore, duty days can extend up to 245 days or so for any given year. Bear in mind that each NBA season technically spans two calendar, and thus tax, years.

(4) The $20 million figure is a hypothetical amount utilized to show how the tax rules would be applied. In reality, a maximum contract for a player like Dwyane Wade, LeBron James or Chris Bosh would start at $16.6 million no matter where he signs. His home team has an advantage in signing him though. A contract with his home team can be up to six years in length (versus five otherwise) and have raises of up to 10.5% of the first year salary (versus 8.0% otherwise). For a player such as Wade, James or Bosh, this leads to a total contract value of $125.5 million over six years with the home team (a $21 million average) and $96.1 million over five years for all other teams (a $19 million average). However, a player can achieve the larger contract and play for a new team by means of a sign-and-trade transaction (in which he is technically signed by the home team, by then traded to his new team).