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The New Moneyball (Article Summary)

Professional sports teams in high-tax states need to adjust to a new economic reality under the Tax Cut and Jobs Act of 2017.

This past fall, an article by Alan Pogroszewski, Kari Smoker and Keith Donnelly, published in the NYS Society of CPAs online publication, The Tax Stringer, addressed the impact the Tax Cut and Jobs Act of 2017 has had on professional athletes and teams based in high tax states.  Below is a synopsis of their article The New Moneyball:

Introduction

In 2003, Michael Lewis’ book, Moneyball: The Art of Winning an Unfair Game, outlined the economic disadvantages the small-market Oakland A’s faced competing against the New York Yankees and other large-market teams. Lewis’ book also examined the A’s strategy of exploiting market inefficiencies in the valuation of Major League Baseball players to not only compete, but succeed, within the parameters of large-market and small-market teams. Such is the business of sports.

Today, however, a new economic reality is hitting the Oakland A’s, along with every other team based out of New York, California, and to a lesser extent Minnesota. Teams based in these high individual income tax states find themselves, after enactment of the Tax Cuts and Jobs Act (TCJA), at an even greater disadvantage competing for talent in a national labor pool. Higher state taxes mean players take home lower net pay, and the TCJA’s new limitation of the federal income tax deduction for state and local taxes (IRC § 164(b)(6)) compounds the effect. By limiting a player’s ability to deduct their state and local income taxes, the new law erodes any savings they otherwise realize because of the reduction in federal income tax rates (IRC Code § 1 (j)) In contrast, players signing with teams in no-tax states are less affected by any limitation in their ability to deduct state and local income taxes. Therefore, they realize a net savings under the TCJA because of the reduction in federal tax rates.

The Economic Reality

To illustrate the effect of the TCJA, consider a hypothetical NHL player who earns an average salary of $2,697,017 in 2017–before enactment of the TCJA—and in 2018–after enactment of the TCJA. (As of 8/1/2019, there were 748 players under NHL contract, for a total of $2,017,483,250, in 2019. These number are subject to change as contract negotiations continue.) For simplicity’s sake, assume that he is single, plays in all home and away games as determined by his team’s 2017 and 2018 game schedules, and is a resident of the country, state, and city in which his team is located. Applying the corresponding federal, state, and city tax rates for 2017 and 2018, as well as the appropriate apportionment factors to determine the player’s nonresident taxes, it is evident that the player’s 2017 and 2018 after-tax net salary amounts, as shown in Table I, vary depending on the city and state in which his team is based.

TABLE I

2017 & 2018 After-Tax Net Values of Average $2,697,017 NHL Salary

The differences in the after-tax net salary for 2017 and 2018 illustrate the corresponding effects of the TCJA on professional athletes who play in high-, low-, and no-tax states. As Table I indicates, players for the New York Rangers, located in New York City, are hurt the most, with an NHL player who earns an average league salary of $2,697,017 netting $44,614.82 less in 2018–after the TCJA took effect—than in 2017. (Although the highest marginal rate for New York is lower than California’s, the lower tax brackets in New York impose more tax than California’s do.) Also negatively impacted are players for the New York Islanders, as well as those for California-based teams. In contrast, players in no-tax states—Florida, Nevada, Tennessee, and Texas—are subject to the lowest potential jock taxes, and they net the greatest savings under the TCJA. The net difference in salary from 2017 to 2018 for the New York Ranger player (a decrease of $44,614.82) versus the Nashville Predator player (an increase of $54,494.54) represents an extensive widening of the gap in after-tax net salaries—to the tune of $99,109–effectuated by the TCJA.

The fact that there are winners and losers illustrate not only the cumulative effects of jock taxes and the TCJA but also the competitive disparity it creates between teams.  When competing for talent in a national labor pool, the disadvantages for teams in high-tax states are readily apparent. Artemi Panarin’s recently signed contract with the New York Rangers demonstrate the real disparity between teams at opposite ends of the state tax spectrum. The result is staggering.

Artemi Panarin’s seven-year $81,500,000 contract with the New York Rangers is depicted in Table II below.  His after-tax net salary amounts also vary widely depending on whether the tax laws in effect in 2017–before the TCJA took effect—or those in 2018–after the TCJA took effect—are used to compute his annual taxes.  The results also vary widely depending on whether he signed with the New York Rangers or, instead, with the Predators in Nashville, Tennessee, where there is no state income tax.

TABLE II

After-Tax Net Value of Artemi Panarin $81,500,000 NHL Contract

Again, the TCJA effectuates significant after-tax disparities.   The after-tax net salary with the New York Rangers decreases by $1,067,405 when applying the tax laws in effect in 2018 after the TCJA took effect, while increasing by $1,983,033 with the Nashville Predators. The gap in after-tax net salaries thus widens by over $3 million in 2018, after enactment of the TCJA, to over $9 million total.  To bridge this gap, the New York Rangers would need to increase Artemi Panarin’s gross annual salary by a premium of over $19 million. Conversely, the Nashville Predators could offer a discounted gross salary of only $65,848,997.55 to match the New York Rangers’ after-tax net salary dollar-for-dollar.

Conclusion

To ensure their market power, leagues have limited not only the number of teams within their league but also the number of teams within each market. Historically, this created a competitive disparity between large-market and small-market teams as they fought for talent from a national labor pool. But now a new set of circumstances is causing teams–this time, those in large markets like New York City and Los Angeles—to operate at a competitive disadvantage. First, high state taxes, in combination with recent changes in federal tax law enacted under the TCJA, put these large-market teams at an increased disadvantage. In addition, while large-market teams like the Los Angeles Clippers and the New York Rangers may have the financial ability to pay a premium that allows them to compete with teams in in no-tax states, they are unfortunately thwarted by their league’s salary cap policies. These salary caps ultimately limit a large-market team’s options, forcing them to operate at a competitive disadvantage.

On the flip side, league salary caps and state and federal tax law present a golden opportunity for small-market teams in low- and no-tax states to compete against traditional large-market teams in high-tax states. This could explain how the NHL’s Nashville Predators, Tampa Bay Lightning, and Vegas Knights—all small-market teams— have risen in the ranks, competing in three of the last five Stanley Cup Finals. In any case, the appropriate response to changes in the tax law should be the reliance on professional guidance from a tax accountant who specializes in these areas of tax law. Teams and athletes alike must carefully navigate the unique tax issues facing the sports industry today in order to maintain a competitive advantage.

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