Understanding the Jock Tax and How to Plan for It

March 14, 2022

By James A. Jacaruso, Jr.

My favorite coach, the legendary John Wooden, used to preach, “failing to prepare is preparing to fail.” Coach Wooden had a commonsense approach to basketball and life that athletes should follow, especially when tax planning.

Although states had been targeting athletes for decades, the so-called Jock Tax picked up steam in 1991 when California issued tax bills to Michael Jordan and his teammates on income earned while performing in the state for the NBA Finals. Illinois quickly instituted its own tax on visiting players whose teams played in a state imposing tax on Illinois athletes. Many states and municipalities quickly followed suit. 

Athletes are not the only ones impacted by this as the tax is levied on any visiting individual conducting business in a state or city. Technically, this tax applies to team employees that travel with the team and any non-athlete that travels and conducts business on the road. Athletes are easy targets for taxing jurisdictions because their salaries and schedules are public knowledge and easy to track.

Determining Domicile

The first thing I always emphasize to athletes is that it’s not how much they make, but how much they keep. This discussion focuses on their spending since what they keep is what they do not spend. The second most important thing is where they reside now (their domicile), where they should consider residing during their career, which state they will live when their athletic careers are over and understanding the impacts their residency decision will have on how much they keep.

To understand the impact of state taxes, athletes must understand the difference between a domicile and a statutory resident designation. In general, one’s domicile is their primary residence; where their heart is, where they keep things near and dear to them and where they return when away temporarily. An athlete’s tax home is where his team plays its home games.

States will look to five primary factors to determine a taxpayer’s domicile:

  1. Home – If an athlete only owns one home, domicile is generally easy to establish. Establishing domicile is more difficult when the athlete owns multiple homes, especially when he owns a property in his tax home.
  2. Time – Since an athlete may be away from his domicile for an entire season, where he spends his time before and after the season can be a critical factor.
  3. Active Business Involvement – Again, since an athlete will spend most of his season in his tax home, this may not be a major factor unless the athlete engages in business in his tax home before and/or after the season.
  4. Personal Items – This is commonly known as the teddy bear test and ultimately asks at which residence does the athlete keep his/her sentimental items.
  5. Family – Where does the athlete’s immediate family, usually meant to include spouse and minor children, reside? The children’s school location is an important decision of where to live and is often linked to the quality of the schools.

Impacts of State Income Tax

It is advantageous for an athlete to live in a state that does not impose an income tax. Currently, nine states do not have an income tax, including Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Also, the District of Columbia does not impose tax on non-residents.

Many states use the duty days method which allocates income based on the ratio of duty days an athlete is present in a state to the total number of contractual duty days. Duty days are counted from the first day a player is contractually obligated to report to pre-season training and ends on the last day of the season. For most, their season ends on the last day of the regular season and for some, the day their team is either eliminated from the post-season or wins the league championship.

For example, an MLB player who is a Florida resident with either the Miami Marlins or Tampa Bay Rays will spend fewer duty days in states that impose an income tax which will result in less tax. Conversely, the highest paid players with any of the five California baseball teams will spend almost half their duty days in California and be subject to the highest state tax in the country, 13.3%, which includes the 1% Mental Health Services Tax. Similarly, New York based athletes will pay a 10.9% state tax.

When Robinson Cano chose to leave the New York Yankees and sign his $240 million, 10-year contract with the Seattle Mariners, almost 50% of his income was not subject to state tax. If he had signed the same contract with the New York Yankees, he would have paid 8.82% on almost 50% of his salary. Though he would have initially received a federal tax deduction for the additional state tax, provided he was not subject to the alternative minimum tax, the Tax Cuts and Jobs Act limited the state and local tax deduction, including real estate taxes to $10,000 (for taxpayers filing jointly). As a current member of the New York Mets, he will pay a 10.90% state income tax on income allocated to games played in New York and receive minimal, if any, federal tax benefits.

Some athletes have their careers shortened by injuries limiting their earning potential. Imagine this scenario, a New York resident athlete signs a $30 million contract over three years and decides to stay in New York, but suffers a career ending injury. By remaining as a New York resident, they would pay approximately $900,000 per year in state tax compared to zero if they had established domicile in a no-tax state.

Athletes that live in a state that imposes a tax will not pay double tax on their income since they will receive a credit for taxes paid to other states against their resident income tax. There is also the statutory resident trap for those players that live in a non-tax state, but maintain a permanent place of abode where they play their home games (tax home) and spend at least 183 days in their tax home. Like residents in a tax state, statutory residents are taxed on all income, including portfolio income and other income such as appearance fees earned in other states. Although they will receive a credit for taxes paid to other states, portfolio income is not allocable to a state and will be double taxed. Statutory residents may also be subject to an onerous city tax that may not be claimed as a credit against their resident state income tax. New York City’s top rate is almost 4% and that can sting.

The Importance of Planning

Planning considerations when entering a contract must consider the state tax impact on signing and performance bonuses (which are treated differently for state income tax purposes), service contracts, and licensing with sporting goods companies. Due diligence should also be taken when scheduling appearances and attending autograph shows.

For both the athlete at the top of their sport and those that do not make BIG money, tax planning is no longer an offseason checklist item. They need a tax advisor that is well-versed in income allocation, statutory resident issues, and understands the resident state tax credit rules to minimize the tax hit. By choosing the right tax professional, the athlete will have a financial quarterback that can work with their agent and financial advisor to minimize taxes.

About James A. Jacaruso Jr.

James A. Jacaruso Jr. is a Personal Wealth Advisors Group Director with more than 25 years of tax compliance and planning experience focusing on personal and fiduciary income taxation, gift taxation and wealth transfer planning.