Max Scherzer’s new seven year $210 million contract is a good example of how proper tax planning in a negotiation can increase its’ overall net (after tax) value.
Much has been made of the resident and non-resident tax liability that professional athletes face in the multiple states and cities in which they preform services. Often referred to as the “Jock Tax” this liability is unique to each professional team and is determined by each team’s home and away schedule as well as the state of residency of the athlete.
In salary negotiations there are several ways to structure a contract which enables a client to receive the greatest after tax value or “net value”. In Max Scherzer’s recent contract with the Washington Nationals, there are two ways in which proper tax strategy enables his deal to exceed the net value of Clayton Kershaw’s $215 million contract signed just last year.
State Residency
First, The Home Rule Act prohibits the District of Columbia from imposing a commuter tax on non-residents. Should Scherzer establish his residency in one of the six states with no income tax, he will only need to pay income tax on games played in jurisdictions that impose a tax on non-residents. By establishing residency in one of the six states with no income tax as opposed to being a resident of the District of Columbia which would make him liable for resident tax, Scherzer increases his net value by nearly $10 million.
Status
Income
Federal
State and City
Net Income
Pct. Retained
Non-Resident
$15,000,000
$6,229,299
$333,561
$8,437,140
56.25%
Resident
$15,000,000
$5,878,150
$1,395,952
$7,725,898
51.51%
Even should Scherzer establish residency just outside the District of Columbia in Virginia his state tax rate would be 5.75% which is considerably lower than the District of Columbia’s 8.95%
Signing Bonus
The second area that provides an opportunity to increase the overall net value of Scherzer’s contract is the large signing bonus. A true signing bonus is only taxable to the resident state and doesn’t need to be allocated to other states and therefore will not be taxed in those states. Should Scherzer establish residency in one of the six states with no income tax, he can escape state tax completely on the signing bonus.
Since $50 million of Max Scherzer’s $210 million contract is a signing bonus, how he structured the wording in his contract and where he establishes his residence will potentially save him from having to pay state tax on 45% of his entire income.
Total Net Value
$105 million of Scherzer’s contract will be differed over seven years therefore making his contract in essence $15 million in signing bonus and salary spread out over the next 14 year. In order to gain an accurate picture of the net value of Scherzer’s deal the after tax value needs to be converted back into today’s dollars.
In financial terms a dollar today is worth more than a dollar received tomorrow, because of the ability to invest that dollar. Over the last 14 years the S&P has in my own calculations had an average return on investment of 5.56% while the consumer price index has increased by 2.41% over that same time period. By Using a discount rate of 3.985% which is the average of the two indexes, Scherzer’s contract’s present value after tax is $90,122,396.05
Year
Scherzer Contract
Signing Bonus
Net Value
Present Value
1
$10,000,000
$5,000,000
$8,480,139
$8,155,156
2
$15,000,000
$8,448,151
$7,813,044
3
$15,000,000
$8,448,151
$7,513,626
4
$15,000,000
$8,757,749
$7,490,481
5
$15,000,000
$8,757,749
$7,203,425
6
$15,000,000
$8,757,749
$6,927,369
7
$15,000,000
$8,448,151
$6,426,386
8
$15,000,000
$8,448,151
$6,180,108
9
$15,000,000
$8,448,151
$5,943,269
10
$15,000,000
$8,448,151
$5,715,506
11
$15,000,000
$8,448,151
$5,496,472
12
$15,000,000
$8,448,151
$5,285,832
13
$15,000,000
$8,448,151
$5,083,263
14
$15,000,000
$8,448,151
$4,888,458
$210,000,000
$119,234,896
$90,122,396
Clayton Kershaw’s Contract
There are similarities in Clayton Kershaw’s contract and that of Scherzer with the big exception that Kershaw signed with the Los Angeles Dodgers and performs services in the state of California. With Kershaw’s recent purchase of a house in Studio City the state of California will likely consider him a resident of the state and tax him accordingly.
The fact that Kershaw has purchased a residence in the state of California makes it more difficult to escape taxation as a resident
Using the same method and discount rate as used previously to figure Scherzer’s present value of his contract we can determine that Kershaw’s present value after tax is $88,838,923.98
Year
Kershaw Contract
Signing Bonus
Net Value
Present Value
1
$4,000,000
$2,571,429
$3,327,308
$3,199,796
2
$30,000,000
$2,571,429
$15,943,314
$14,744,743
3
$32,000,000
$2,571,429
$16,922,289
$15,050,365
4
$33,000,000
$2,571,429
$17,411,776
$14,892,249
5
$33,000,000
$2,571,429
$17,411,776
$14,321,536
6
$32,000,000
$2,571,429
$16,922,289
$13,385,511
7
$33,000,000
$2,571,429
$17,411,566
$13,244,727
$215,000,000
$105,350,318
$88,838,924
Although Kershaw receives a greater amount of money over a shorter period of time the net value of the contract can’t overcome California’s tax liability in spite of receiving nearly 100% tax credits for taxes paid to other states.
Conclusion
As the evaluation of Scherzer’s contract demonstrates, although contracts are often judged by the gross value written on the contract it’s important to understand how proper tax strategy can lower the tax liability of an athlete and therefore increasing the actual net value from the contract.
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.
©2015, Alan Pogroszewski. All Rights Reserved.