Where will Lightning Strike?

As free agency approaches, the Stamkos watch is on.

INTRODUCTION

With the Los Angeles Kings extending Anze Kopitar’s contract for eight years at an annual average value (AAV) of $10,000,000, the extension places Kopitar equally between Evgeni Malkin of the Pittsburgh Penguins $76 million, eight-year contract and Chicago Blackhawks teammates, Jonathan Toews and Patrick Kane who signed matching eight year, $84 million contracts.

With Kopitar signed and free agency quickly approaching, all eyes now turn to the next high profile NHL sniper scheduled to reach the open market, Tampa Bay Lightning forward Steven Stamkos. The question that will confront Stamkos is not whether he joins the quartet, but where he will sign his next contract.

As a likely unrestricted free agent this summer, Stamkos is able to field offers from any team that has salary cap room and can afford him. Although the future contract’s terms will be reported in gross salary, the true net value of the contract will be determined on the location in which he signs.

CONTRACTS IN TERMS OF TRUE VALUE

While the total salary of a contract is easily obtainable, determining the true value takes considerable analysis. In order to determine the true value, two items need to be taken into consideration – tax liability and the time value of money.

Tax Liability

All athletes incur federal tax liability on their total earnings. Their exposure to state and local taxes will be directly correlated to their team’s home and away schedule. Therefore, Jonathan Toews and Patrick Kane who play in Chicago, will not only be taxed in Illinois, at the resident rate of 3.5% – but also subject to nonresident tax in each jurisdiction the Blackhawks play. During the 2015-2016 season, the Blackhawks will play games in 18 different jurisdictions, exposing Toews and Kane to non-resident state and city taxes ranging from a low of 1% (Pittsburgh) to a high of 13.3% (California).

With Kopitar as a resident of California, and a member of the Los Angeles Kings, his salary is exposed to the highest percentage of tax (50.37%). In comparison, Malkin, a member of the Pittsburgh Penguins and resident of Pennsylvania, is exposed to the lowest percentage of tax (45.46%) while Toews and Kane have identical (45.67%).

Time Value of Money

A basic financial principle states the value of a dollar received today is more valuable than a dollar received tomorrow – because of the ability to invest that dollar. Therefore, time value of money plays a significant role in analyzing the overall value of a long-term contract.

As shown in Chart below, Malkin’s contract is the only one to consist of eight equal payments of the four players shown. The three remaining players will receive a larger portion of their salary in the early years therefore maximizing the contracts present value.

CHART I

Chart 2

Over the past ten years, the S&P 500 has increased at a rate of 7.4% while the consumer price index (CPI) since 2010 has increased by 1.8%. By averaging the two and using 4.6% as a discount rate, we can convert dollars received in the future into today’s dollars to compare the current value of each contract.

ANALYSIS

By taking into consideration each player’s tax liability and the time value of money, the following chart reflects each player’s contract’s true value: where the “net value” is the player’s after-tax income and “true value” reflects that amount in today’s dollars.

CHART II

Chart 3

Although Anze Kopitar’s total salary is $4 million more than Evgeni Malkin’s, and he receives $12 million more over the first four years of the contract – Malkin’s true value exceeds that of Kopitar’s by nearly $4 million.

Two forces cause the true value of Malkin’s contract to exceed Kopitar’s. First, Malkin’s contract precedes Kopitar’s by two years, allowing him to earn $19 million before Kopitar’s new deal begins. Second, because Kopitar is a resident of California, playing in Los Angeles, his salary is exposed to a much greater tax liability than Malkin’s.

ANALYSIS – STEVEN STAMKOS

Where Stamkos signs will have a direct impact on his contract’s net present value and the premium or discount a team may need to offer in order to sign him.

Paying a Premium or Discount

Using the NHL Jock Tax Index (JTI) (Note: Figures are using the 2015 JTI) it is easy to calculate the premium or discount potential suiters would be able to offer Stamkos in order to match the same true value of Toews’s and Kane’s contract with the Blackhawks.

In order for Steven Stamkos to receive the same true value as Kane and Toews, Toronto needs to understand that their jurisdiction’s high tax rates cause them to have to pay a premium. In contrast, Tampa Bay is  able to offer a discount. In order for Stamkos to have the same net take home, Toronto would have to offer a contract that is worth $10,000,000 more. If that is spread out over seven years, Toronto would need to assume an additional cap hit of approximately $1,428,000 per season, the cost of a bottom six forward.

CHART III

Chart 4c

It should also be noted that under the NHL’s Collective Bargaining Agreement (CBA) only the Tampa Bay Lightning would be able to offer an eighth year on the contract. All other teams would only be able to offer seven, unless the Tampa Bay Lightning worked out a prearranged sign and trade with a team.

CONCLUSION

It is important for teams and agents to understand the potential tax consequences that professional athletes face. By quantifying the advantage or disadvantage as shown in the Stamkos example above, a team or agent can systematically adjust their contract proposal depending on the teams in competition for the player’s services.

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.

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