Whether you are a seasoned veteran or a rookie navigating tax season for the first time, it can prove to be an extremely stressful time of year for all professional athletes. In addition to facing the same tax requirements as others, professional athletes have several additional layers of complexity.
First, filing requirements can be confusing as professional athletes’ income is earned in multiple jurisdictions. Where an athlete is required to file a tax return and in which state (and even country) they file as a resident are among many of the issues they face. In addition, many athletes have significant expenses in training and advisor fees. Changes in the tax code have impacted a taxpayer’s ability to deduct business related expenses. However, that does not mean athletes should stop tracking these expenses as they can provide a dollar for dollar reduction in endorsement income and can still lower taxable income in certain states. Large amounts in these types of expenses are a red flag to the Internal Revenue Service (IRS) and state agencies which could cause these returns to be pulled and examined. Finally, take into consideration that high income individuals are examined by federal and state tax jurisdictions at a higher percentage than others and the unique issues that professional athletes face are now even further compounded.
Often, athletes have international and state tax complications because they are not residents of the state or even the country in which their home team is based. To add to this complexity, different international jurisdictions have different filing requirements. For example, the U.S. requires both citizens and residents to file, while countries such as Canada only require residents. Therefore, cross border tax consequences can be determined by not only your physical location but your citizenship and residency.
In North America, we face two specific international tax issues. First, there are athletes who play in an international league such as the NBA, NHL and MLB and play for a team based in a country in which they are not a resident or citizen. In the situation in which you are employed outside your home, playing predominantly in another country, you potentially face filing requirements for two jurisdictions and double taxation. Understanding tax treaties and how each jurisdiction defines residency provides the opportunity to successfully navigate the two tax structures. In many situations with proper tax planning strategies, you can alleviate not only potential double taxation but minimize your overall tax liability.
The second international tax issue that professional athletes face relates to playing overseas. Although agents often refer to this income as tax free, be forewarned: even if you earn your money outside of North America, you still have to report all income earned. 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 tax return. Therefore, if you played in Europe or Asia, or any country outside of the U.S. or Canada for that matter, you’ll need to claim your full income. The good news is that you’ll be able to deduct the portion of your income that went towards paying taxes in the country you played in and in many cases, especially when playing in Europe, this deduction will offset your federal tax obligation.
While all athletes incur federal tax liability on their earnings, their exposure to state and local taxes will be dictated by their team’s home and road schedule. For example, in this upcoming season, an athlete who plays in the National Basketball Association (NBA) will potentially be taxed in up to 28 different states and cities. Those playing in Major League Baseball (MLB) will be exposed to 21 different jurisdictions and a National Hockey League (NHL) player will potentially play in 23 US jurisdictions and possibly five additional Canadian provinces.
High profile legality challenges to Cleveland and Tennessee’s nonresident tax (commonly referred to as a jock tax) have brought to light the unique burden that athletes face as they typically earn income in multiple jurisdictions. Twenty of the 24 states that are home to a professional sports team in the four major leagues currently enforce nonresident state tax laws. In addition to individual state taxes, many cities also tax both resident and nonresidents, therefore causing an additional tax burden and compliance for professional athletes.
The pandemic has created havoc on most league schedules over the past two years. Games were postponed, moved, or even cancelled, while ‘bubbling’ in a central location became the strategy leagues deployed to safely finish their seasons.
The ever-changing league schedules, along with players frequently being placed in COVID-19 protocols, has added another layer of complexity for professional athletes. Keeping additional records and organizing paystubs have become critical for professional athletes. First, any athlete that did not travel on a road trip due to COVID-19 (or injury) should keep records of when they did not join their team on the road. Adding to the record keeping required, any athlete that spent time on a taxi/practice squad, in the minor leagues, or played on a try-out contract, received different rates of pay. The combination of missing road games or earning a different rate of pay while traveling would reduce the amount of salary earned in that state and the amount of tax owed.
While income earned in multiple jurisdictions can add to the complexity of an individual athlete’s tax return, athletes have the opportunity, with an advisor’s assistance to successfully minimize their potential tax burden with proactive tax planning strategies.
The Internal Revenue Code gives little guidance regarding specific tax deductible business expenses for various professions. It is critical to understand what expenses are “ordinary” and “necessary” (as defined by U.S. tax law) in carrying out the business of professional sports so as to provide the proper guidance on deductible business expenses. Professional athletes have substantial business related expenses, however, the change in the tax code starting in 2018 has eliminated a taxpayer’s ability to take business deductions against their employment income. This does not mean athletes should stop tracking these expenses as they still can be used at the federal level to offset endorsement income and in some instances signing bonuses. Additionally, these expenses can still be taken as deductions at the state level. Athletes should be most concerned with providing their agent fees, union dues, and conditioning expenses as those most commonly the most substantial and impactful at the state level.
Unlike other taxpayers, expenses for professional athletes are often large enough to raise a red flag to the IRS or state agencies causing these returns to be pulled and examined. Once audited, athletes are called upon to substantiate the amount and purpose of their expenses. In a profession, which a majority of their time is occupied by training, practicing or traveling, maintaining adequate records in order to meet the standard of the IRS can be difficult and although the expense may fulfill the ordinary and necessary component of the law, they may still be disallowed if the records kept do not adequately substantiate the expense.
All taxpayers are required to comply with federal and state tax requirements. What makes the situation unique for professional athletes is not only the complexity but the likelihood of having their return audited by the Internal Revenue Service (IRS) and state agencies. Higher incomes attract greater scrutiny. In 2020, IRS statistics revealed that 2.5% of all individuals who earn between $1 million and $5 million had their tax returns pulled and examined with that number jumping to 5.1% for those who earned between $5 and $10 million and 8.6% for those earning over $10 million. With the average salary in all four U.S. major professional sports leagues above $2 million, it makes this population more susceptible to further examination of their tax returns. Because an athlete’s location and salary is highly publicized during the season, state agencies can easily determine an individual’s filing requirement and earnings in their state. A failure to properly follow the state’s tax laws can result in scrutiny from the state.
Professional athletes have the same obligation to file and pay taxes as anyone else, however, their situation has additional layers of complexity and compliance issues that others in the general public don’t. Further, for many athletes, the tax season parallels their regular playing season or opening of spring training where their focus is anywhere but on taxes. Because of the complexity and compounded layers of compliance specific to professional athletes, seeking out the help of a qualified advisor and tax planning specialist becomes essential to the process. These professionals provide effective strategies that can not only aide in navigating through these land mines but potentially place athletes in a favorable tax position to lower their burden while complying with their filing requirements.
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.