Although Athletes receive credits for taxes paid overseas, they should understand that foreign income isn’t tax free and they still need to file in the US as well
First of all: There’s no such thing as ‘tax free.’ However, the way your income is reported and distributed may make it appear to be without tax. Here’s an example: In Canada and the United States, contracts and income are reported in gross dollars, while in Europe and Asia a player’s salary is reported in net dollars. So a contract in North America for $500,000 is not what ends up in your pocket after federal, state, social security, and Medicare taxes are deducted. But in Europe and Asia, a contract for $500,000 is what you receive after your team has paid all taxes, pensions, and even agent fees.
Impact on Players Moving from North America to Europe or Asia
Be forewarned: even if you earn your money outside of North America, you still have to report your income. Although the U.S.’s personal income tax system is based on citizenship and Canada’s policy is based on residency, both countries require you to report all worldwide income on your income tax return.
The bad news: if you played in Europe or Asia, you’ll need to claim your full income. The good news: the United States and Canada allow taxpayers to take a credit for foreign taxes paid, even if the team paid them on your behalf. Since most European countries have higher federal income tax rates than the United States and Canada, the credit will offset most, if not all, of your federal tax liability in the United States or Canada.
However, if you’re a North American athlete, your tax liability on foreign income will most likely be at the provincial and state level. If you’re from Canada (except Quebec), you report your provincial taxes with your federal return–and the two tax rates combined can be nearly 50%. Because of the combination of federal and provincial tax, it is possible that you will end up owing additional taxes.
Concerns for American athletes who play in other countries
If you live in the U.S., you should be concerned about four things:
Your resident state income tax liability. Unlike on your federal tax return, you can’t take a foreign tax credit on your state tax return (with a few limited exceptions). And with some state income tax rates being as high as 13%, you could be left with a substantial tax liability.
There are situation that can cause your foreign tax credit to be limited. Many athletes earn income from many different sources throughout the year. It is important to note that income from other sources, such as investments or earning from a U.S. based team for half of the year, could limit the foreign tax credit you are allowed to take.
The U.S. government may attempt to subject your foreign income to a 15.3% self employment tax because your foreign employer does not withhold US Social Security and Medicare taxes. With the proper reporting of foreign wages, this should not become an issue. The United States has Totalization Agreements with 24 foreign countries. If you work in one of these countries, you may avoid U.S. self employment tax if you establish an exemption under the country’s system. To do so, you’ll need your foreign employer to request a certificate of coverage from the government in your team’s region.
The U.S. requires all individuals who file a United States tax return to disclose any financial interests they have in foreign financial institutions. For example, you play in Germany and have a checking account with a German bank. The U.S. requires you to file paperwork that shows how much money you have in the bank. This is strictly a required disclosure and will not impact your tax liability.
Limiting your tax liability
Here are a few things you can do to limit your potential tax liability:
If you’re Canadian, try to establish residency in your team’s country. The Canadian system is based on residency, so if you live in a different country, you don’t have to claim your world-wide income in Canada. The country has rules on who is and is not a resident of Canada, so be sure you understand the criteria to be sure to avoid having to report foreign income on your Canadian income tax return.
If you’re a U.S. citizen, you’re not as lucky. In the U.S., taxation is based on citizenship rather than residency, so establishing residency in a foreign land creates potential issues of double taxation. But in most cases—except for those exceptions discussed above—the foreign tax credit will eliminate your foreign tax liability and filing a return is nothing more than documenting your income and subtracting the foreign tax credit from the potential tax.
Consider establishing your residency in one of the nine states (Florida, Tennessee, Washington, Texas, Nevada, New Hampshire, Alaska, South Dakota, & Wyoming) in America that don’t tax income. It is critical to know that properly establishing residency can be complicated and consultation with our tax specialists would be recommended to learn the steps you should take.
Live overseas full-time. Many athletes will live abroad while their season is on-going and come back to the U.S. at the conclusion of their seasons. If you remain abroad for 330 days each year, you can take advantage of a special income exclusion. Although this option does not make sense for everyone, it can generate savings for individuals whose foreign tax credit is insufficient to cover their U.S. liability.
Navigating international tax laws can be incredibly complex and complicated. If you do not take the necessary steps when playing overseas, you could end up having a higher income tax liability. If you are in need of assistance in navigating international tax laws, we would be happy to assist you.
ALAN POGROSZEWSKI is President of AFP Consulting LLC, which specializes in the consulting and preparation of professional athlete’s international, federal and state taxes. Mr. Pogroszewski is also the creator of the Jock Tax Index (JTI) which was presented at the 2015 MIT Annual Sloan Sports Analytics Conference and has also been featured on “Off the Charts” by Scarlet Fu on Bloomberg Television’s Market Crashers. The JTI was used in determining the calculation in the above article as it measures how much a team’s location dictates the tax burden on an athlete because of the jurisdiction’s income tax policies and allows individuals to compare the net take-home income after tax liabilities and credits of any contract proposal between competing offers from different tax jurisdictions.