Income Tax Considerations: A look at Toronto Blue Jay Jose Reyes

Reyes will pay income tax to Canada and Ontario and is allowed a credit against New York income tax.
It is not uncommon for athletes to properly establish residency in states with low individual income tax rates.
If Reyes remained with the Marlins he would save $800,000 in combined net federal and New York State income tax.

For more information on income tax considerations, contact our tax services team who is proactive in tax analysis and tax planning.

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How Much Does it Cost To Be a Toronto Blue Jay? Income Tax Considerations

Contact: Timothy Speiss

November 15, 2012

By:  Evan R. Waxman, Tim Speiss, Yosef Willig and Brent Lipschultz

Recently, the Miami Marlins traded, among others, former New York Met Jose Reyes to the Toronto Blue Jays. As part of our ongoing look at the ramifications of domicile and residence on the taxation and financial planning of professional athletes, models and entertainers, the tax professionals of EisnerAmper LLP have assembled this article on the effect of the trade on the tax treatment of Mr. Reyes and his income.

If Jose Reyes became a Florida resident in 2013 and remained with the Marlins, he would have saved nearly $8 million dollars in total income tax.
   
In December 2011, Jose Reyes was awarded a guaranteed $106 million six-year contract by the Florida Marlins, which on November 14, 2012 requires annual payments of $10 million in 2013; $16 million in 2014; $22 million in 2015, 2016 and 2017; and $4 million in 2018. These contract terms were assumed by the Toronto Blue Jays.

Based on the 2013 Blue Jays spring training and regular season schedule, the Blue Jays home games represent only 42% (rounded, 81 home games divided by 193 total spring training and regular season games played) of total 2013 games played. Therefore, as games played in Canada represent less than 183 days and assuming Reyes spends no additional days in Canada in 2013, Reyes will be treated as a Canadian non-resident for 2013 Canadian individual income tax purposes. However, as Canada imposes an individual income tax on non-residents based on Canadian work days, a Canadian income tax would be applied against Reyes’ 2013 Canadian source income of $4.2 million (rounded; multiplying 42% times Reyes’ 2013 salary amount of $10 million).

The 2013 $4.2 million Canadian source income will result in a 2013 Canadian income tax of $2.1 million (rounded, a Canadian combined federal and Ontario Province tax rate of 49.53%).

Assume Reyes is a U.S. and New York State resident taxpayer, as he purchased a home in New York in February 2007 that presently remains unsold according to Nassau County, New York property tax records. In 2013 Reyes is required to pay U.S. and New York resident individual income tax of $4.68 million ($3.8 million federal tax rounded, and $880,000 New York income tax rounded); a 2013 federal income tax rate of 39.6% is assumed based on the scheduled expiration in 2012 of the current 35% top income tax rate. However, Reyes is paying $2.1 million in income tax to Canada and Ontario and is allowed a credit against 2013 U.S. federal and New York income tax. Accordingly, after applying the Canadian and Ontario tax paid as a credit, the 2013 U.S. federal income tax is $2.2 million and the New York State income tax is $515,000 ($2.715 million federal and New York tax).

Based on the above, Reyes ends up paying an additional $134,000 in 2013 Canadian Provincial income tax due to playing for the Blue Jays.  Alternatively, if in 2013 Reyes remained with the Marlins and became a Florida resident, he would save $800,000 in combined net federal and New York State income tax and the additional $134,000 Canadian provincial income tax savings.

If all the above facts remain the same over the remaining term of the 2011 Marlins contract (with no tax equalization provisions), and Reyes became a Florida resident and remained with the Marlins, he would have saved nearly $8 million dollars in total income tax.

Following is content from the earlier EisnerAmper article “Lin-come Tax: State and Local Income Tax Considerations.” 
 
Athletes Residing in States with No Income Tax and Earning Income in Other States  

It is not uncommon for athletes to properly establish and maintain residency in states with low individual income tax rates or with no income tax at all, in order to minimize their overall tax liabilities. Florida and Texas are good examples of states that do not levy individual income taxes, and that have professional sports teams, including the Houston Rockets, Miami Marlins, and others. Beyond Florida and Texas, the states that do not levy an income tax include Alaska, Nevada, South Dakota, Washington, Wyoming, New Hampshire (limited tax on dividends and interest), and Tennessee (limited tax on dividends and interest).

In contrast, New York and California are among the highest taxing jurisdictions in the United States. The 2012 New York state individual income tax rate is 8.82% (for taxable incomes in excess of $2 million). For New York City residents an additional tax rate of up to 3.82% applies, for a combined state and city rate in excess of 12%. New York State and City residents may not even benefit from the payment of federal, state, and city taxes due to the federal AMT, which disallows these payments as deductions against federal taxable income.

While it is often the decision by athletes to maintain a domicile in jurisdictions imposing no or low income tax rates, it should not be overlooked that these athletes will be exposed to state and local income taxes in jurisdictions that impose an income tax, and in which games are played or where team practices are held; these factors are most usually out of the athletes’ control and change on a yearly basis.

Typically, an athlete’s earnings are taxed based on duty-days (game days), or an apportionment (or allocation) formula, calculated based upon where games are played, where team meetings are held, and where practice sessions occur. Not all states compute the state income allocation on the same basis; certain states exclude practice sessions and allocate state sourcing strictly based on games played. Illinois, for example, computes duty-days by including the days starting upon arrival (for Sunday NFL games, typically the preceding Thursday) and through the day of departure (which could be the day after the game).

To illustrate, assume that a professional basketball player (athlete) with the Houston Rockets establishes domicile in Texas, which does not impose an individual income tax; as a result, the athlete will pay no Texas income tax attributable to games played, team meetings and practice sessions held in Texas. However, based on the Houston Rocket’s 2012/2103 regular season schedule, the athlete will be required to pay state income tax attributable to games played in states that impose an individual income tax. Accordingly, as approximately 37% of the Rockets’ regular season games will be played in states that impose an income tax, and assuming the athlete’s first year salary is $5 million, $1.850 million of his salary will be allocated to and taxable in states that impose an individual income tax. In addition, Cleveland will impose a local city tax on the athlete when he plays the Cavaliers in Cleveland, for a combined state and city Ohio tax rate of 8%.

Tax Credits: Athletes Residing and Playing in States with an Income Tax 

Athletes residing in states that impose an income tax generally will obtain an income tax credit (subject to certain limitations) for taxes paid to other states. For example, if the basketball player had remained a New York State resident and had decided to play for the Golden State Warriors, the athlete would be subject to a 2012 top individual New York State tax rate of 8.82%. However, the athlete would also be subject to California individual income tax (California has a 2012 top individual state rate of 10.553%) attributable to games played, team meetings and practice sessions in California. In this example, the athlete would be paying a significant amount of income tax to the State of California (in addition to taxes paid to New York state as a resident) because 57% of his salary would be allocated to California based on games played in California for the 2012/2013 regular season. Considering practice sessions and team meetings held in the state, an even higher California allocation percentage could result. However, the athlete generally should be entitled to claim a tax credit (subject to certain adjustments and possible limitations) against his New York tax liability for the California income tax paid, but limited to the New York tax paid on the California sourced compensation (i.e., the New York tax rate of 8.82%). Since California imposes one of the highest income tax rates in the United States, it would make sense that if the athlete’s compensation structure and amounts and other facts were the same, to attain total income tax minimization it could be more beneficial for the athlete to be a Knicks player than a Warrior’s player, since New York has a lower tax rate compared to California.  

Athletes Must Also Consider the Tax Bite from Other Sources of Income   

There are additional factors that athletes consider when selecting to play for a certain team, in order to circumvent a potentially enormous tax bite associated with “Jock Taxes” – so named for the tax on income levied by certain states against non-resident athletes that play a professional sport in a city or state and earn compensation in that jurisdiction.

There are additional factors that athletes consider when selecting to play for a certain team, in order to circumvent a potentially enormous tax bite associated with “Jock Taxes” – so named for the tax on income levied by certain states against non-resident athletes that play a professional sport in a city or state and earn compensation in that jurisdiction.

There are numerous types of compensation income streams that athletes receive, and that are subject to state taxation, therefore proper tax planning should be considered to minimize the related state income tax. These streams include players’ current salary and signing bonuses; compensation contract deferrals from current or prior years and payable at a later date or upon an event; licensing, branding and endorsement fees; personal appearance fees; awards or prizes paid in cash or property constructively received, non-cash benefits received and not excludable from income; taxable reimbursements received such as certain moving and housing allowances; royalties; rental income (may not apply to all athletes); and other income streams.   

Income and Estate Tax Minimization Strategies Athletes Should Consider 

Following are additional planning ideas to consider and analyze, to properly minimize state and local income tax on behalf of an athlete. 

  • Defining and maintaining or changing “tax home” and “tax domicile” – these definitions strive to resolve the identification of where an athlete resides for state income tax purposes.
  • State income sourcing (or/and) apportionment based on duty-days or games played (pre-season, regular season, post-season, and practice sessions). Every state has its own unique rules regarding the sourcing computation of a player’s income.
    • Players will receive a benefit for playing home games in a tax-free state (assuming the athlete has taken the proper steps to establish domicile in such state), but will pay taxes to other jurisdictions (that impose and income tax) for all away games with no offsetting tax credit from their home state.
    • The state of domicile could be different than the state where the home games are played.
  •  De minimis filing exceptions (i.e., Minnesota has a minimum income filing threshold).
  • Tax treaties between states that address the taxation of athletes (the athlete is resident in one state and playing games or rendering other services in the other state).
  • States that assess “Jock Fees” instead of income taxes; whereby an athlete is prevented from obtaining a resident credit on their resident state return (i.e., Tennessee).
  • State credits and limitations on the amount of credit to be applied resulting in double taxation (i.e., Illinois does not honor the credit for taxes paid by athletes to other jurisdictions).

Further, proper preparation of a typical athlete’s income tax return will include some, or all, of the following considerations:

  • Analyzing an athlete’s contract terms and all applicable provisions to determine the proper federal, state, local and international income tax treatment.
  • Assisting the athlete in establishing state residency in the desired jurisdiction (state and city).
  • Preparing a “duty-day” schedule, properly allocating “duty-days” to each state and local jurisdiction in which the athlete performs services.
  • Determining all jurisdictions in which an athlete’s tax return is required to be filed, taking into account reciprocal agreements, de minimis filing requirements, and non-taxing jurisdictions (states and cities).
  • Properly treating bonus income and income deferrals, to determine if specific allocation is applicable. In New Jersey, an athlete’s signing bonus is not included in compensation of a non-resident if the bonus is not conditional on the athlete playing any games for the team, performing subsequent services for the team, or even making the team.
  • Properly reporting other income such as from endorsements and appearances, royalties, and other activities.
  • Determining applicable business deductions (i.e., agent fees, equipment, etc.), including the consideration of employing a “skip-year” strategy, where income and deductions are accelerated or deferred. Scheduling state and local income and real estate tax payments to avoid AMT should be considered.
  • Properly avoiding potential double taxation through calculation of state tax credits and reverse tax credits (double taxation is not unconstitutional).
  • Calculating all federal and state estimated tax payments, properly deferring federal and state estimated payments while avoiding tax underpayment penalties and making certain employee withholding is correctly computed for each jurisdiction, if applicable.
  • Proper taxation and minimizing state and local taxation attributable to retirement income and deferred compensation income.
  • 2012 federal income tax estimated tax payments due and safe harbors (amounts due are generally the lesser of 110% of 2011 tax liability, or 90% of 2012 tax liability).
  • The top 35% 2012 ordinary income tax rate expires at December 31, 2012, as does the current 15% tax rate on qualified dividends and long-term capital gain income; without U.S. tax legislative action, these rate are increasing, effective January 1, 2013, to a top rate of 39.6% for ordinary income and qualified and non-qualified dividend and short term gains, and  20% for long term capital gain income. 
  • Starting in 2013, athletes will pay an additional .9 % percent in Medicare tax on earned income over $200,000 ($250,000 if married).  
  • Additionally, in 2013 there will be a 3.8% Medicare Contribution Tax liability on unearned income (above certain income thresholds). 
  • For international athletes (non-U.S. citizens or green card holders), consider home- and host-country taxation and special treaty provisions specific to athletes and entertainers.
  • Federal and state estate tax planning considerations based on domicile of choice should be considered, especially if the athlete is considering relocating to Florida, a jurisdiction with no estate or inheritance tax. Note the $5.120 million (per individual) unified estate and gift and generation-skipping transfer tax exemption is scheduled to expire on December 31, 2012.
  • Reviewing additional estate planning opportunities and 2012 tax-free gifts utilizing the $13,000 gift tax exclusion (per donee/recipient) or $26,000 for married donors; planning considering non-U.S. citizen spouses; wills in place and beneficiary designations, and separate beneficiary designations for retirement plans and life insurance; trustee(s) for trusts created by wills or for trusts established during lifetime.   

Financial Planning Matters Athletes Should Consider 

Other areas that require an athlete’s attention include the following:

  •  Reviewing investment portfolio performance (pre- and post-tax), the appropriateness of asset allocation models attendant to investment policy statements considering investment goals and objectives, a desired rate of return (appreciation and yield), risk tolerance, and investment horizon.
  • Reviewing risk management exposures and insurance coverages that can mitigate risk, such as life insurance, property and casualty coverages, and other coverages. Additional considerations pertaining to life insurance contemplates the amount needed to fund family needs in the event of a premature death, types of life insurance (term, whole, universal, variable, other), premium payment modes and options, modeling premium payment modes (permanent and term models), and ownership and titling of life insurance for example utilization of a family trust.  
  • Charitable giving and the appropriate use of tax-exempt foundations and charitable trusts and other vehicles, and related record keeping and documentation and tax filings.

This article represents one in a series of articles that EisnerAmper LLP will release regarding income tax planning and considerations related to professional athletes, models and entertainers. EisnerAmper LLP practices contributing to these articles include members of the firm’s Personal Wealth Advisors Practice (Evan R. Waxman, Tim Speiss, Yosef Willig and Brent Lipschultz); State and Local Tax Practice; and Sports, Media and Entertainment Practice.

The information contained in this article should not be relied upon as, nor intends to provide, investment or tax or economic advice unless specifically stated herein. This article does not provide investment or tax or other advisory services unless specifically stated herein. EisnerAmper LLP is a certified public accounting firm and is an independent member of PKF International Limited.

 

EisnerAmper is an independent member of PKF North America.
PKF North America is an independent member of PKF International.