Earlier this year, Federal Reserve Chairman Ben Bernanke stated, “Under current law, on January 1, 2013, there’s going to be a massive fiscal cliff of large spending cuts and tax increases.”
The tax increases include cancelling the Bush era tax cuts of 2001 and 2003 which would increase the individual tax rate for those in the highest tax bracket from 35% to 39.5% and eliminate the payroll tax holiday, which would increase the payroll tax withholding from 4.2% to 6.2%.
What does this mean to professional athletes?
For those who earn more than $110,100, the elimination of the payroll tax withholding would only reduce their take home income by $2,202. So let’s focus on the 4.5% increase in income tax rates for those earning $388,381, which represents the highest tax bracket in the 2012 IRS tax Code.
In general, the tax increase at the highest level means professional athletes will owe more taxes in 2013, but exactly how much more depends on the athlete’s income level.
Starting at the league minimum for the four leagues, salaries range from the National Football League’s (NFL) base salary for rookies of $405,000 to the National Hockey League’s (NHL) base of $525,000 for the 2012 season.
League Minimum Salaries LeagueSalary2013 Tax2012 Tax% IncreaseAdditional TaxMLB$490,000$154,626$144,9356.69%$9,692NHL$525,000$168,451$157,1857.17%$11,267NFL$405,000$121,051$115,1855.09%$5,866NBA$490,180$154,697$144,9986.69%$9,700
As the chart above shows, these athletes will see their tax liability increase between five and seven percent. Those at the league minimum in the NHL will pay an additional $11,267 in federal tax as their marginal rate increases to 32.1%. Those who earn the league minimum in the NFL will see their marginal tax rate increase to 29.9% for an additional $5,867 in federal taxes.
The burden would be much greater for those earning the league averages. Last year average salaries ranged from $1,900,000 for the NFL to $5,150,000 for the National Basketball Association (NBA).
League Average SalariesLeagueSalary2013 Tax2012 Tax% IncreaseAdditional TaxMLB$3,213,479$1,230,400$1,098,15212.04%$132,248NHL$2,400,000$909,076$813,43511.76%$95,642NFL$1,900,000$711,576$638,43511.46%$73,142NBA$5,150,000$1,995,326$1,775,93512.35%$219,392
Athletes earning the league average in the four professional leagues will see their average tax burden increase by 11.46% (NFL) to 12.35% (NBA). NBA players who earn the highest of the four league averages will pay an additional $219,392 or 12.35% in taxes in 2013, while those in Major League Baseball (MLB) will pay an additional $132,248 or 12.04%.
Athletes at the highest level will be the most affected by the potential expiration of the Bush era tax cuts. Alex Rodriguez’s $29,000,000 salary in 2013 is the highest in the four leagues and he can expect his 2013 marginal tax rate to be 39.37%, which means his federal tax liability will be $11,416,076 or 12.77% higher than 2012.
Is there any way around the fiscal cliff?
Year-end financial planning is always critical and this year even more so. Think about shifting income into 2012 rather than 2013, for example, by restructuring signing bonuses and endorsement income with lump sum payments from the beginning of 2013 to the end of 2012. If you restructured a lump sum payment of $100,000 from January to the end of December, you could save $4,691 if you earn the league average in the NBA. If the lump sum payment were $1 million, you could save $43,031.
Josh Hamilton who just signed with the L.A. Angels of Anaheim reportedly accelerated a $10 million signing bonus to 2012, which could save him approximately $486,000 in taxes. Another option is to delay paying for business related expenses until next year. In general a deduction of $1 will save you the equivalent of your tax rate. So if tax rates increase in 2013, your deductions will save you more.
Remember: business expenses such as agent fees, conditioning costs and equipment are all deductible. If you earn the league average in basketball, you could save up to $4,260 on a $100,000 expense by delaying the deduction.
Another year end strategy is to maneuver year end capital gains and losses. With the long term capital gains rate going up in 2013, you can benefit by taking capital gains in 2012 and holding off capital losses for 2013.
A higher tax on the highest tax bracket is probably inevitable, but with proper tax planning strategies you can lessen or at least plan for this additional tax burden.
For a customized income tax projection to determine your 2013 tax liability, please contact me at email@example.com or 585-705-3405.
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