State Taxes makes Dwight Howard’s Decision more Taxing
There are several financial dynamics in Dwight Howard’s potential decision where he will play next season. First, there’s the length and the terms of the contract, which are dictated by the Collective Bargaining Agreement (CBA) of the National Basketball Association (NBA) and secondly, there are the unique income tax liabilities for each team and the states in which they reside.
Under the current CBA, the Los Angeles Lakers can afford to offer Dwight Howard a five year maximum salary of $118 million, while the Houston Rockets, Atlanta Hawks and Golden State Warriors can only offer a four year contract worth $94.4 million. Therefore, a contract with the Lakers will gross Howard $23.6 million a year over the next five years, while a contract with the Rockets, Hawks and Warriors will only gross him $21.9 million a year.
In order to have an accurate evaluation of these numbers, the federal and individual state tax liabilities need to be taken into consideration in determining the net value of each team’s offer. Once the net value of each contract is determined, these numbers need to be brought back to today’s dollars and the net present value should be used to make a fair comparison of the different offers.
The Jock Tax Issue:
Professional athlete’s income is taxed in not only their home state, but in all states in which they play. Non-resident taxation is not isolated to only professional athletes however this type of tax is commonly referred to as a jock tax, since athletes make an easy target for states to both enforce and collect on it.
As outlined in my article on the subject: When is your CPA as important as Your ERA? published in the Marquette Sports Law Review – http://scholarship.law.marquette.edu/sportslaw/vol19/iss2/3 – it can be shown that both California and New York have been taxing their nonresident athletes as early as 1968.
Over the past several years California’s increasing tax rate has caused athletes to reconsider their tax liability of signing with a team in the state. Dwight Howard’s recent free agency has once again brought the issue to light. The question is does California’s additional tax liability offset any advantage the Lakers have in being able to offer more than any of their competitors?
No matter where Dwight Howard signs he will have tax liability that will include federal, Medicare, Social Security, both resident and non-resident state along with city.
Last season the Los Angeles Lakers played games in 16 different states as well as the state of California. With an average salary of $23.6 million, Howard’s tax liability would net him 51.19% of this income or $12.08 million per year. In comparison, last season the Rockets played games in 18 different states as well as the state of Texas. Since Texas does not have any state income tax, Howard’s state tax liability would only be his nonresident exposure which would be considerably less than that of the Lakers, Warriors or the Hawks. With an average salary of $21.9 million Howard’s tax liability would net him 58.86% of his income or $12.82 million.
As the chart below shows, even though Howard would receive less gross income by playing in Houston and Atlanta, he would actually net a greater percentage of that income. Over the first four years of the contract Howard would net nearly $3 million ($2,972,418) more by playing in Texas as compared to California.
State and City
Los Angeles Lakers
Golden State Warriors
Since the Lakers can offer Howard a fifth season, we need to take into consideration the value of the additional year. The time value of money indicates that a dollar received in five years has far less value than one received today. Therefore, the net income from all contracts needs to be discounted back to today’s dollars in order to make a fair comparison. Using a discount rate of 5% the chart below shows that the Laker’s five year contract has a present value of $6,830,933.76 more than the maximum offer the Rockets could make and $9,218,060.41 more than the Hawks maximum offer.
Los Angeles Lakers
Golden State Warriors
In analyzing Howard’s contract options, you need to consider the unique tax consequences of each team’s home state while also taking into consideration both the terms and length of the offer. Despite the fact that the Lakers can offer Howard nearly $1.7 million a season more than the Rockets maximum offer, Howard would net nearly $3 million more over the first four seasons of the contract should he accept the Rockets offer.
The interesting issue concerns the fifth year. By the Lakers being able to offer the additional year, Howard would net $9,108,792.46 more over the full term of the contract or $6,830,933.76 in present day dollars.
Therefore, the question that Howard and his representatives need to consider – if they were to take a contract from any of the teams that can only offer four years – what type of contract could Howard receive for the 2017-18 season and beyond? If they believe that Howard will be able to receive greater than the $9.1 million (Rockets) that the Laker’s contract already provides, than they should feel confident in taking that offer.
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 includes professional athletes performing services on three separate continents. Prior to joining St. John Fisher College, Mr. Pogroszewski was the Vice President of Business Operations for Sports Consulting Group, specializing 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