With the large fines being imposed by the National football League this past month as well as the talk of possible suspensions in the future for head-to-head tackles, I decided to review the tax implications for both fines and suspension to learn which scenario has the best tax consequence for athletes.
This article will address two questions from an income tax stand point. First, how are fines and suspensions treated by the Internal Revenue Service [IRS]? Second, is there any advantage to one as opposed to the other?
Business related expenses for athletes are deductible under the Internal Revenue Code [IRC] §162 which states that deductions are allowed for all “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” The IRS further expands on ordinary and necessary in publication 334 chapter 8 as ‘ordinary’ being “common and accepted” while ‘necessary’ as being “helpful and appropriate.” It is also important to note that “an expense does not have to be indispensable to be considered necessary.” For athletes and all individuals, business related expenses are claimed under job and other miscellaneous expense on an individual’s Schedule A and are subject to a 2% limitation.
The question that needs to be answered is: are league fines paid by a professional athlete a deductable business expense? IRC §162 (f) specifically addresses fines and penalties, but states only that any “fines paid to the government for violation of any law are not deductible.” In the case of a professional athlete who is paid to perform violent acts that sometimes border on being illegal under the rules of the league they play (whether hockey or football) and are thus punishable by the league, it could and should be argued that these fines are indeed both ordinary and necessary in the performance of their services.
In a November 2010 Forbes article, it was noted that Lamar Odom of the Los Angeles Lakers and the National Basketball Association has sued the IRS for their disallowance of $12,000 in league fines. Although the federal tax court has yet to specifically address athletes, it has addressed the issue in general in Rothner v. Commissioner (1996). In that case, David Rothner, a floor broker for the Chicago Mercantile Exchange, was fined $75,000 for rule violations by the exchange. On September 26, 1996, the court ruled in favor of allowing Mr. Rothner’s deductions and stated: “Fine payments pursuant to exchange disciplinary procedures were common and frequent in taxpayers’ businesses where securities and commodities exchanges imposed numerous similar fines on exchange members, and payment was necessary.”
A league suspension of a game, on the other hand, would be treated as a loss of wages and therefore not an expense. The athlete would be able to claim a lower taxable income but would not be able to claim a deduction for that lost income.
This now leads us to the question: what is the true cost of a suspension or a fine? To determine an answer, I will use a professional athlete who plays in New York and earns $1,000,000. For the purpose of figuring deductions, let’s assume the individual is single, pays state tax on his New York income, and has miscellaneous business expenses of $50,000. For the length of the suspension, I used one football game or approximately five hockey games and for the fine I used the equivalent amount, which would be $62,500. So there is no financial difference between the fine and the suspension.
The end result: financially speaking, a suspension is more tax beneficial to the athlete. In general, the loss of after-tax wages for one NFL game or five NHL games is only $35,600. In comparison, the equivalent fine of $62,500 will cost the athlete $38,867.
Even though the fine is deductible and so lowers the athlete’s taxable income, it does not offset the fact that the fine is paid with after-tax dollars and therefore the athlete ends up paying $3,000+ more in the end. You could argue that the gain made by being suspended is not lost in other ways. But when you crunch the numbers, you can say that with everything being equal, from a tax standpoint anyway, it’s more beneficial for an athlete to be suspended than fined.
To answer our original questions then: fines and suspensions are treated differently by the IRS and fines are more costly to the athlete when viewed strictly from an income tax perspective.
For more information on available income tax deductions or key tax issues regarding international and or state income tax issues for professional athletes, please contact me at 585-705-3405.
ALAN POGROSZEWSKI is an Assistant Professor of Sports Studies at St. John Fisher College and the President of his own tax consulting business whose clientele include professional athletes performing services on three separate continents. Prior to accepting his position at St. John Fisher College, Mr. Pogroszewski was the Vice President of Business Operations for Sports Consulting Group, a firm that specializes in the representation of professional hockey players. Mr. Pogroszewski received his M.B.A. from Rochester Institute of Technology in 1996 and his M.S. in Taxation from St. John Fisher in 2003