A comprehensive look at both the US and Canadian tax stance on how signing bonuses are taxed and the overall affects these policies have on professional athletes
Introduction
After years of scrutiny, the Canadian Revenue Agency (CRA) has ruled Toronto Maple Leafs’ center John Tavares’ signing bonus from 2018 was salary. In doing so, the CRA has adjusted Tavares’ tax from 2018. The agency has assessed the Maple Leaf’s captain a substantial tax liability that also included penalty and interest. Tavares had appealed the original CRA assessment, stating that the bonus represented an enticement to sign on with the Maple Leafs and therefore should be taxed at a more beneficial tax rate.
The case with John Tavares provides a great opportunity to review the tax policies of the United States (US) and Canada when it comes to signing bonuses. Understanding tax policies is beneficial in tax planning strategies and is important when structuring how compensation is reported in the contract and even more importantly to the government.
This article will review the taxation of signing bonuses not only in Canada, but the US and within its states by:
Determining what is a true signing bonus and how they are taxed
Reviewing the tax policies on signing bonuses for each country and how the policies differ depending on if the player is a resident or non-resident of the country they play.
Why true signing bonuses are rare and why the benefits of receiving them are not tax related
True Signing Bonuses
The United States and Canada have a tax treaty agreement that limits a non-resident’s tax rate on signing bonuses to 15%. To qualify, the bonus must be a true signing bonus. A true signing bonus for an athlete is an enticement to enter into a contract to perform services for a professional team. Since no services are required to be performed, the benefit in receiving a signing bonus is that it’s not considered compensation for services and does not need to be allocated. Therefore, a true signing bonus is nonrefundable and is taxed solely in your home country and home state/province at the applicable rate.
US Resident - US Based Team
In 2016, Steven Stamkos signed a $68 million contract with the Tampa Bay Lightning of which $60 million was reported as a signing bonus and to be received throughout the term of his contract. The tax benefit of a true signing bonus in the US is that it’s allocated only to their state of residence. Therefore, a player whose residence is in a low or no tax state will only be taxed on that compensation in that state (in addition to the unavoidable federal tax). By structuring the contract with such a substantial signing bonus the goal was to keep this compensation from being allocated into every state the Lightning play. Since Florida has no state income tax, Stamkos could successfully escape taxation at the US state level on the majority of his contract’s earnings if the contract was structured in this manner.
Unfortunately, the most likely result in this situation is that California and their substantial case law would disagree with how the signing bonus was structured, reclassify it as salary, and allocate it into their state and tax it.
US Non-Resident - US Based team
Under the US/Canada tax treaty, a non-resident of the US who receives a non-refundable signing bonus from a US based team is only taxed at 15%. Under the treaty, that player would then be taxed at their Canadian tax rate on the full amount and receive a foreign tax credit for the taxes paid in the US. If the bonus is refundable, the bonus is considered compensation and allocated into the US and taxed at the player’s marginal tax rate at both the federal and state level using the duty day allocation formula.
Canadian Non-Resident - Canadian Based Team
In 2018, John Tavares signed a seven-year, $77,000,000 contract with the Toronto Maple Leafs, of which $6,110,000 was reported as salary and the remaining $70,890,000 as a signing bonus to be received throughout the term of the deal.
As a non-resident of Canada, Tavares would be taxed only 15% on his signing bonus, claiming the full bonus in his resident country and reporting the tax as a foreign tax credit. By moving money into a signing bonus and claiming non-residency, a player playing in Toronto can significantly limit their tax liability, escaping Canada’s and Ontario’s high tax rates while lowering his total tax by claiming residency in the United States.
For the bonus to be taxed at the favorable tax rate in Canada, the bonus must meet two criteria under the US-Canada tax treaty; first, the player needs to be a resident of the US and second, the bonus “is an inducement to sign into an agreement” performing services as a professional athlete.
In the instance of Tavares, the CRA ruled that the income did not fit the description of an inducement to sign,citing...“if at any time during any League Year, [Tavares] breached the Contract, voluntarily retired, withheld his services (including a refusal to report, practice, or play), or left the Toronto Maple Leafs… the Appellant would only be entitled to retain a pro rata portion of the ‘signing bonus’…”.
Non-Tax Related Benefits of a Signing Bonus
In nearly all instances, signing bonuses will be recategorized as compensation and allocated into all jurisdictions in which services are performed. Although the tax benefits of a signing bonus are negligible there are still non-tax related benefits.
First, a signing bonus provides a larger percentage of the compensation up front. The general principle that the value of a dollar received today is more valuable than a dollar received tomorrow, because of the ability to invest that dollar, plays a significant role in analyzing the overall value of a long-term contract.
Second, a signing bonus is still required to be paid even if the NHL were to experience a work stoppage. If in the future the NHL locked out the players, the team would not be required to pay their salaries, however they would still be required to pay the signing bonus.
Conclusion
With the CRA ruling that John Tavares’ signing bonus resembled compensation as opposed to an enticement to sign, it aligns closely to the US’ and its states, particularly California’s interpretation. In doing so, it has limited the tax benefits of non-residents of Canada in avoiding costly double taxation. However, with proper tax planning strategies there are still many tax strategies available to non-resident athletes to keep them from the overpayment of tax.
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