The Taxing Impact of State Taxes
It’s one of life’s certainties: Athletes need to pay taxes on income earned on the road.
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 checks, to as many as a twenty different states, 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 with NBA franchises 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 states cannot typically afford to track the thousands of individuals who do business on an ongoing 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 calculate the total number of “duty days” in which a visiting athlete performs services to satisfy the terms of his contract as well as the number of those duty days he spends within its state, and then send a tax bill for a prorated portion of the athlete’s total annual salary.
While there is no consensus method between the states for calculating duty days, most states consider duty days to 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.
Training camps officially begin around one month prior to the regular season. The regular season lasts 170 days. The playoffs can last another two months for teams which make it through to the NBA Finals. Players are typically provided approximately 16 days off during the season. Therefore, duty days can extend up to 245 days or so for any given year. If a player’s annual salary is $5 million, he can be said to earn $20,408 per duty day. Therefore, each state, city or municipality with a jock tax that uses this duty day calculation methodology will consider his salary to be $20,408 times the number of duty days spent in that jurisdiction.
A couple of states instead use the “games-played” formula to prorate salaries, whereby income is allocated based on the number of games played within the state compared to total games played.
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.
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 as well as countless cities and other municipalities, each imposing its own definition of a player’s income and duty days, they also need to deal with potential double taxation issues.
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 be 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.
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 more in taxes to the state of Tennessee for each game played against the Grizzlies than they earned in salary for the day of the game. They essentially had to pay to play, and that’s before federal income taxes were contemplated. And since this privilege tax is not an income tax, it is not even eligible for a state tax credit nor is it federally tax deductible.
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 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).
So what does it all mean?
Well, it depends on which team a player plays for and where he establishes residency.
There are three states in which NBA games are played with no state income taxes: Florida, Tennessee and Texas. So, assuming they establish residency, players who play for the Miami Heat, Orlando Magic, Houston Rockets, San Antonio Spurs and Memphis Grizzlies 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, Memphis Grizzlies, San Antonio Spurs, 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 end up paying state taxes on a bit more than 1/3 of his total games.
Players who play for the Chicago Bulls and establish residency in Illinois face an onerous double taxation. They need to pay Illinois state taxes on all home and road games, albeit at the fairly low flat state tax rate of 3%. They also need to pay jock taxes for all of their road games not played against the Miami Heat, Orlando Magic, Houston Rockets, 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 about the same amount in taxes that he would pay if he instead chose to play for the Heat, plus an additional 3% of his total earnings.
All other players need to pay state taxes on all their home and road games per calendar year, at a rate which is equal to the greater of the rate imposed by the individual states in which they play and their home state. In other words, a player who chooses to establish residency in New York and play for the Knicks would pay state taxes on all of his team’s games.
The potential tax benefits of choosing a team in a tax preferred state can get monumentally compounded when accounting for income that isn’t subject to jock taxes, from such sources as endorsements, personal investments, and often signing bonuses. For players with large endorsement streams, the tax savings of playing for a team like the Heat and establishing residency in South Florida, where such outside revenue streams would not be subject to any state income taxes, can quite easily cross into the millions of dollars annually depending upon how such deals are structured.
It is important to note that an athlete’s state of residence is not necessarily the same as his team state. 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, 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 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. 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.
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. However, 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 or endorsement deals. If successful in doing so, the tax benefits produced by playing in a tax preferred state would be negated for these outside income sources, and therefore not impact for which team a player chooses to play.
So what’s the point?
If a player’s tax bill factors into his decision in free agency, the Miami Heat has a clear advantage. For a maximum salary player like Dwyane Wade, choosing to live in South Florida and play for the Heat can produce a relative annual tax savings of several hundred thousand dollars and, in some cases, even more than a million dollars. When including endorsement deals, the relative annual tax savings could quite easily reach into the multi-million dollar range.
The highest tax-paying NBA states (including municipalities) include California, New York, New Jersey, North Carolina, Ohio, Oregon and Washington, D.C. For a player deciding between the Heat and a team in any of these states, the relative tax savings in choosing the Heat would be greatest. Interestingly, this list covers the majority of NBA teams with significant cap space. The other state which houses an NBA team with significant cap space is Illinois. The tax savings for a maximum contract player choosing the Heat over the Bulls could potentially be upwards of half a million dollars per season and well over a million when including outside income sources.
Of course, as with everything tax related, these rules 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 state tax rates or laws, or the changes in the NBA salary cap to come.