Introduction
Under the United States Constitution each state has the freedom to invoke their own tax policy separate from the federal government. With professional athletes playing in multiple states, the definition of state residency may potentially cause them to face resident tax issues in multiple states. State or city residents are required to pay tax on their worldwide income despite where it was earned, while non-residents are only required to pay tax on income earned while in that jurisdiction. Therefore, navigating residency issues for an athlete who earns income in multiple jurisdictions – while potentially having more than one residency is critical to limit their tax exposure. Proper tax planning strategies if put in place early can limit one’s exposure to state taxation and put that athlete into the best-case scenario maximizing the net value of their contract.
Although the definition of state resident may vary amongst the states, there are generally two criteria which will cause residency: physical presence and domicile. Residency through physical presence tends to mean that you are in that state or city more often than you’re not, using 183 days as a determination of factor in determining residency. Since athletes may exceed 183 days in the state or city in which they play – this may cause them to become a resident of that jurisdiction by default. Domicile on the other hand, is where you maintain a permanent residence and when you are away (no matter how long) you intend to return. In other words, domicile is your “home”. Once domicile is established it remains intact until it is either relinquished or another domicile is established elsewhere.
What happens if you play in one city but maintain an offseason home in yet another one?
Since athletes generally play in a different state then they are originally from, and play in multiple jurisdictions throughout a season, it is important to determine residency before the fact rather than trying to determine it when you file your tax returns, or worse, years later in a state tax audit.
How domicile affects your net income
Although a player may not meet the physical presence test, they can still be considered a resident should they maintain domicile within a state.
Take the following scenario: A professional hockey player is born and raised in Minnesota. Each off-season, they return to a summer cottage they own in the state, their automobile is registered in Minnesota and they have a Minnesota driver’s license. Under these set of facts, this player could be considered a resident of Minnesota even if they do not spend over 183 days in the state. How this impacts their net income depends on their specific circumstances and if proper tax planning strategies have been taken.
To help illustrate the importance of residency issues we will look at two case studies to show the financial impact establishing residency in one location versus another could have.
Case Study: Los Angeles Kings
In the first scenario we have a Minnesota native who plays for the Los Angeles Kings. Since the Kings play their home games in California and he may or may not reach the necessary 183 days (depending on his schedule and any playoff games) there is no certainty that they will be considered a resident based on physical presence. Regardless, he will still need to pay tax on the income earned in the state. However, if the player keeps his domicile in Minnesota it would prove to be beneficial. As the table below indicates a player who earns $7,500,000 would save nearly $100,000 by not relinquishing their Minnesota domicile and establishing it in California.
Table 1
Case Study: Dallas Stars
In the second scenario we have a Minnesota native who is playing in Texas, a state with no income tax. As in the first case study, the player spends most of the tax year (may or may not be over 183 depending on the number of days in the season and post season) in Texas, however, the question remains whether they should keep their domicile in Minnesota? As you can see below, a player earning $7,500,000 will take home nearly 8.5% more of their wages by taking the steps to relinquishing their domicile in Minnesota and establishing it in Texas!
Table 2
Please note that even though being a resident of Minnesota is not as advantageous in the second scenario, it still is more beneficial to play in Texas and claim domicile in Minnesota as opposed to doing the same and playing in California.
In both scenarios the player will pay the same amount of Minnesota tax on their income, however, in table 1 they will also be subject to California state tax on income earned as a non-resident. Although California tax is a state tax credit on their Minnesota tax return – the fact that California’s tax rate is greater than Minnesota’s causes the credit to be limited. Therefore, the difference between the Minnesota state tax owed in Table 1 is the additional California state tax which exceeds Minnesota’s tax rate for the state tax credit on their Minnesota tax return.
Conclusion
Domicile and residency issues affect more than just the two scenarios we have outlined above, they affect every single individual. Understanding the issues of domicile and addressing them before signing a contract or playing the season is the time to determine your residency as opposed to trying to determine it after the fact. Having a tax accountant who specializes in state tax is important and they should be consulted as you negotiate your contract, because where you play and reside could have a substantial affect on the amount of income you take home.