William Nylander’s recent signing provides a multitude of lessons in the valuation of a linked contract for a restricted free agents
Minutes prior to the December 1st deadline to sign, restricted free agent William Nylander, agreed to a six-year $45 million contract with the Toronto Maple Leafs. However, there are many facets to this contract which need to be taken into consideration before one can analyze the true value of it.
Proration of Salary
The first issue is the actual amount received in the contract. Although it’s reported as a $45 million-dollar contract and actual cap hit to the team, there are two issues which need to be addressed immediately. The first effects only Nylander as his salary in the first year is prorated. In year one, Nylander is to receive a signing bonus of $2 million and a salary of $10 million. Take into consideration that Nylander missed the first 59 days of the season, so the actual prorated amount of his salary is $6.827 million. Therefore, the actual value of Nylander’s contract is $41,827,957.
The second issue that needs to be taken into consideration, effects all players in the NHL and that is the withholding of escrow payments by the team. Under article 50 of the Collective Bargaining Agreement (CBA), the players and owners share 50% of the Hockey Related Revenue (HRR). Since revenues are used from the previous year and salaries are paid in the current season, an escrow is withheld by the team to ensure that the current year’s league salaries don’t exceed the player’s percentage of the HRR.
The escrow changes each quarter and this year the range in the withholding have been between 11.5% to 13.5%. Once the actual revenue is calculated any adjustments will be released back to the players. However, in previous years the players have never received a full refund for the amount with the actual amount lost exceeding 10% in both the 2013-14 and 2014-15 seasons.
Without knowing the exact escrow withholding and potential refund, it is not known for certain the actual amount of Nylander’s contract. However, it would not be out of the norm to expect that 10% of his entire salary to be withheld and kept by the league. Therefore, Nylander’s total contract should be discounted to $37,645,161.
CONTRACTS IN TERMS OF TRUE VALUE
As noted above, the reported amount of Nylander’s $45 million contract after proration and escrow is closer to $37.645 million. However, the analysis of the true value of the contract still requires taking into consideration two additional items – tax liability and the time value of money.
There are two major factors that effect the tax liability of an athlete. First is the state or province in which they are a resident or in which their team plays and the second is the team’s schedule of road games. Although all hockey players incur either US (37%) or Canadian (33%) federal tax liability on their total earnings, their exposure to provincial, state and local taxes are dictated by the team’s home and away schedule.
Therefore, Nylander as a Leaf, is not only taxed in Ontario at the resident rate of 13.16% (when the 56% surtax on income over $89,131 is taken into consideration that rate jumps to 20.53%) – he is also subject to nonresident tax in each jurisdiction the team plays. During the 2018-2019 season, the Leafs play in 19 different jurisdictions that enforce non-resident state and city taxes (AKA Jock Tax) that range from a low of 1% (St. Louis) to a high of 13.3% (California).
Taking into consideration Nylander’s tax liability the net value after tax on his six-year contract is now valued at $18,020,337.
Time Value of Money
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.
To convert money earned either in the past or in the future into the present value, we used the average increase in the NHL salary cap of 4.73% over the past six years. Using this percentage in the present/future value formula(s), we can convert all dollars into today’s dollars, which either will provide an increase or decrease in the contract’s net value, based on when the money is earned or when the dollars are expected to be received. This will provide an accurate depiction of the true value of that contract.
By taking Nylander’s tax liability into consideration along with the time value of money, his true value is only $16,312,738
Comparable Market of “Linked” Contracts
In order to understand the value of Nylander’s contract, it is best to compare it to other similar deals within the marketplace.
A common practice in the NHL is to link a long-term contract which combines a player’s restricted free agent years with their unrestricted years. Since 2015, William Nylander marks the seventh, six-year contract that bridges this gap or links the two categories of free agency, which have opposable degrees of leverage. Although Nylander’s contract on the surface appears to be the largest of this marketplace, the chart below indicates Nylander’s contract actually has the second lowest ‘true value’ with only Jonathan Drouin’s contract with the Canadiens having less value.
The following chart reflects the true value of each of the comparable player’s contract: where the “net value” is the player’s salary minus escrow and after-tax income while the “true value” reflects that amount in today’s dollars.
Chart I – True Value of Contracts
Although Nylander’s total salary, after proration is $5.828 million, more than both Saad and Forsberg, when you take into consideration the tax consequences (Forsberg in Nashville and Saad in Chicago) Nylander’s contracts actual value is over a million less than both. In fact, in Forsberg’s situation, playing in Tennessee, a state with no tax, his value is $2.33 million greater than Nylander.
Two forces cause the true value of both Forsberg and Saad’s contracts to exceed Nylander. First, both players contracts preceded Nylander, with Saad’s signed in 2015 and Forsberg’s in 2016. Therefore, both players (Saad’s $16 million and Forsberg’s $12 million) had earned a percentage of their income prior to Nylander’s recent signing. Second, Nylander’s salary, as a resident of Ontario playing in Toronto, is exposed to a much greater tax liability than both Forsberg or Saad.
A ‘linked contract’ that combines a player’s restricted and unrestricted free agent years in the NHL is becoming much more common for talented young players coming off their entry level contract. Although high profile players such as Connor McDavid, Jack Eichel and Leon Draisaitl have grabbed the headlines, Nylander’s recent signing shows a strong market underneath the superstars who are also signing linked deals. Understanding this market is important and understanding the true value of these contracts provides agents a much greater understanding.
Overall, it’s 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 example above, a team or agent can systematically adjust their contract proposal depending on the market forces involved in the actual case.
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.