Signing bonuses are common, but how they are taxed is often misunderstood.
There are many factors that need to be taken into consideration when a signing bonus is part of a player’s contract. The two factors that this article examines are:
What are the federal tax implications and withholding requirements for a signing bonus?
What are the state tax implications of a signing bonus, and can you simply allocate it to a state with no tax to escape taxation?
Federal Tax Implications
The IRS regulations provide that the name by which the remuneration is designated is immaterial. Salaries, fees, and bonuses, for example, are all wages, if paid as compensation for employment.[i]
In 2004 the IRS specifically address professional athlete’s signing bonuses and in Revenue Ruling 2004-109, stated that such bonuses are subject to Federal, Social Security and Medicare tax withholdings. Therefore, any bonus received by a player after January 2005, needs to be reported on a W-2 with all required withholdings.
In 2018, the Tax Cut and Jobs Act lowered withholding on signing or playoff bonuses under $1,000,000 to 22%. The result is that for those athletes or coaches who receive a playoff bonus or several signing bonus payments throughout the year, and they are less than $1,000,000 in gross value, their withholding will be significantly lower than their overall federal tax rate. The result is generally a significant balance of tax due. For those athletes or coaches who have significant wages and whose tax rate is at 37% these balances due can be a big surprise to them.
State Tax Implications
Signing bonuses that are not tied to any services performed and are non-refundable will be fully allocated to the athlete’s state of residency. Therefore, an athlete who is a resident of a state with no tax can completely escape taxation at the state level.
Unfortunately, NHL player contracts stipulate that signing bonuses are refundable should a player choose not to perform services and retire or hold out. Thus, NHL bonuses are tied to services and are allocated to all states in which they play throughout the year in which the bonus was received. The same holds true for playoff bonuses. A resident of Texas who has no state tax to allocate will be forced to allocate a portion of their signing or playoff bonus to California and their potential 13.3% tax rate, if games and days were spent in the state.
There are still benefits in receiving a signing bonus, such as guaranteed income in case of a lockout or in the case of an NFL player being released. In addition, a bonus can expediate payment of wages, earlier in the contract, increasing the current value of that money. However, bonuses also bring pitfalls that athletes and their advisors should be aware of. In addition, advisors should seek a trusted tax professional for advice on proactive tax planning strategies that can help to alleviate some of the tax burden.
[i] IRC Sections 31.3121(a)-1(c), 31.3306(b)-1(c), and 31.3401(a)-1(a)(2).