Bonuses and taxation

DMZ · January 5, 2005 at 1:25 pm · Filed Under Mariners 

You may notice from the handy M’s contract chart that the team paid a ton of money to Beltre and Sexson this year that more or less with their 2005 salaries equals what they’re paid in other years. Why do this, you ask? The answer conveniently is clearly explained in an ESPN article today:

For the rest of the American public, signing bonuses count as wages earned, with both the employer and employee having to pay taxes under FICA (the Federal Insurance Contribution Act). But in 1958, baseball players — the exclusion for other athletes later became understood — were exempt from FICA taxes on their signing bonuses because it was determined that no service was technically rendered for the player’s bonus.

But in November, the U.S. Treasury Department modified the loophole so that FICA taxes had to be paid on signing bonuses signed after Jan. 11.

The article’s about how different taxation schemes affect the actual value of contracts. It’s wrong in one important respect: players in all states pay income taxes when they play in states with income taxes, and in many states, they pay double tax from their state of residence. Sammy Sosa attempted to sue Illinois over this, but Illinois cowardly weaseled out of the suit (which was entirely reasonable: Sosa said “how come you’re taxing me on income I made in another state and was taxed for there?” and Illinois’ response was “Uhhhhhhhh… you’ll have to take that up with that other state.”)

So there’s kind of a… an automatic tax burden for every player that can be made substantially worse if they live in the wrong state, or if they play for a team in a state with particularly aggressive residency requirements (81 days a year? taxable!).

This is one oft-overlooked advantage that Washington (and Texas, and others), with our regressive sales taxes, have in attracting free agents: there’s no additional tax burden on free agents.

Comments

34 Responses to “Bonuses and taxation”

  1. Jim Thomsen on January 5th, 2005 1:50 pm

    To add a bit of detail to DMZ’s prescient observation: Just nine of the 50 states have no income tax — Washington, Alaska, Florida, Nevada, New Hampshire, South Dakota, Texas, Tennessee and Wyoming.

    Taken to its logical extreme, this means that if free agents use this rationale as a primary consideration in their search for a new home, the Mariners may only have to worry about competing offers from the Marlins, the Devil Rays, the Rangers and the Astros.

    Obviously, it’ll never be that easy … but wouldn’t it be a hell of an interesting world if it was?

  2. DMZ on January 5th, 2005 1:56 pm

    As a sort of interesting side point, I’m really shocked that this problem hasn’t been reformed. Double taxation is obviously, grossly unfair to anyone who has to earn an income working in many states, but it’s particularly enforced and so disproportionally hard on people who are rich and well-connected (CEOs, people who earn their money doing public speaking, successful musicians and comedians, and so on) because it’s easy for local tax agents to look up who played at Key Arena and then send them a demand letter. And because it hurts the players (and doesn’t help teams), franchises in locations affected by this should be applying pressure to (at least) get an exemption passed, if not reform the whole process. But it hasn’t happened and as far as I know, hasn’t really been attempted.

  3. Alex Sasser on January 5th, 2005 2:07 pm

    While I think that double taxation may be a hardship, I’m not sure the policy behind it is unsound. After all, baseball players (and others who work in one state while living in another) do take advantage of the benefits of the state, from transportation (freeways, airports, etc.), protection from the police force and fire departments of the state, to residing in the state while away from their home (whether it be in an apartment or even a hotel). I would respectfully submit that this is a somewhat rational reason for states to justify taxing those who live and access resources available in a state for more than a few days or weeks of a year.

  4. ajp on January 5th, 2005 2:09 pm

    Washington taxes aren’t regressive.

  5. DMZ on January 5th, 2005 2:15 pm

    There’s no policy behind it, though. There’s no way that, say, California can justify a policy that taxes the income of residents made outside their state and the income of people who pass through California and make money while they’re there.

    If the philosophy is that the income tax is for goods and services the taxee uses while in the state, then residents shouldn’t pay tax on money they earn while in Texas.

    If the philosophy is that the income tax is for the intangible benefits that residents enjoy, including the larger things like education that benefit the state but not visitors, than you can’t tax non-residents.

    Or even if you want to make the argument that even in Texas, California residents enjoy California police protection, etc, or the reverse argument that visitors benefit, however briefly, from the larger goods provided by the state, you can’t argue that they’re consuming a full share in those circumstances, and should be taxed during that time at the full rate.

  6. DMZ on January 5th, 2005 2:18 pm

    As for sales taxes not being regressive: look, it’s certainly not progressive, increasing as you go up the scale, and sales taxes consume a larger proportionate chunk of income the lower you go on the income-o-meter, so I’m calling it regressive. You can skip the word if you think it’s loaded. At least we don’t have a sales tax that goes after food purchases (shudder).

  7. Jim Thomsen on January 5th, 2005 2:27 pm

    I saw this firsthand a lot in the mid-nineties, when I took a time-out from my career and worked with my dad, who did income taxes for Americans weho worked overseas. He and I would go to Papua New Guinea or Indonesia or the United Arab Emirates, at some engineering or mining site out in the mountains or desert, and help these guys troubleshoot their tax issues. For the most part, more often than not, they got triple-dipped: They had to not only pay income taxes to their host country, but to the United States (unless they spent more than 330 days abroad during the tax year) and to their home state if it was one of the illustrious 41.

    It makes you wonder if a lot of foreign-born ballplayers have to pay a chunk of tax to the Dominican Republic or Venezuela or Japan if they maintain residences there and are at least part-year residents — in addition to Uncle Sam and the New York Tax Revenue Board or wherever it is they play.

    I think it would be EXTREMELY interesting to look at a professional athlete’s tax return.

  8. Ralph Malph on January 5th, 2005 2:39 pm

    Aren’t FICA taxes capped at $87,000 of income — well below the major league minimum? Meaning that FICA can’t be a factor in the signing bonus issue?

  9. Brad on January 5th, 2005 2:41 pm

    This may be going into a bit too much detail concerning state and local taxation, but the threat of double taxation of income at the state level actually is not that great. It’s not trivial, but it does not happen often.

    The state of residence has the authority to tax the income of a state resident in full, wherever earned, on the theory that this is the jurisdiction in which the individual gets to enjoy all of her income. The state in which services are performed has the authority to tax that income earned in that state (so-called “source-based” jurisdiction). This state has provided the economic environment and market which the indivdual has used to earn the income in question.

    Clearly, this combination COULD often lead to multiple taxation of the same income, but it usually does not. The reason is that every state that taxes personal income affords a credit to residents for taxes paid to other states on income earned in those other states. These credits generally ensure that the income is only taxed once.

    Granted, states can adopt inconsistent defnitions of residency, and they can come up with different ways of determining where income is earned. (For instance, one state might treat 1/162 of a player’s salary as earned in that state for each game played there, while another might factor spring training into the denominator, or even leave the denominator at 365.) And these differences can lead to the same increments of income being taxed bt two states.

    But this is rare. Scott Radinsky actually challenged the Illinois scheme (which ensnared Sosa as well) and he prevailed. It is not that it does not happen, but it is really an exception and not the rule.

  10. Jim on January 5th, 2005 2:41 pm

    The ESPN article is almost Pocket-Lintesque in its irrelevance to reality. Must have been a slow day in Bristol. Income taxes take over a third of these bonuses – do you really think anyone even notices the extra 1.45 percent for medicare? If you want to give me $20M and take away $290k, I’m game.
    The last paragraph at least shed some interesting light on the Yankee situation. Not that that will stop George….
    More interesting is DMZ’s point about income earned in certain states. The reality is, the revenooers go after the big bucks (which leads to athletes, entertainers, high-paid speakers, etc). I spend several days “working” in other states as a normal course of my job. It would be possible for, say, California to audit my travel reports, figure out how many days/hours I worked in, California, and attempt to collect taxes. But the effort wouldn’t justify the few bucks, and in the extreme it would bring interstate commerce to a grinding halt. Don’t most states have partial-year residency considerations in their tax codes? If a player on the Cubs spends his off-season in California, isn’t he basically in CA 5 months and IL 7(simplifying – he’s reported for duty with the Cubs who are headquartered in Illinois – they may send him to Florida or Arizona for a month, then on various road trips, but he’s fundamentally employed in Illinois for 7 months (since post-season appearances by the Cubs are so rare….)
    Seriously – a few players have grumbled about playing in Canada because of the higher taxes and possibly double-taxation with the US, but when has this ever even been a factor for any professional athlete? Sammy Sosa didn’t wake up one day, log onto TurboTax, and figure out that he’s been getting taken – his accountant’s flunky thought he had a good idea, and his attorney’s flunky went along….

  11. DMZ on January 5th, 2005 2:46 pm

    Aren’t FICA taxes capped at $87,000 of income – well below the major league minimum? Meaning that FICA can’t be a factor in the signing bonus issue?

    FICA is, but that may not be what they want to say — Medicare contributions are not capped, so that’s a big hit they don’t mention.

  12. DMZ on January 5th, 2005 2:48 pm

    We’re about at the limit of my knowledge on double-taxation specifics, so at this point I’m going to say “it exists and it sucks” and leave the realllly detailed arguments about credits versus methodology of calculation to more familiar minds.

  13. David J Corcoran on January 5th, 2005 3:02 pm

    So why would any player sign to play in California? The whole cost of living is ridiculously high.

  14. Shoeless Jose on January 5th, 2005 3:06 pm

    With regard to teams in Canada (I guess we’re down to the Blue Jays and the Raptors, until whatever decade the NHL starts up again or the Exponationals find yet another new home) there’s a tax treaty between the two countries and taxes taken in one country can generally be written off the taxes paid in the other, so aside from higher rates at pro athlete paygrades in Canada it’s a wash. The bigger issue for the team has been that they have to pay their players in american dollar equivalent salaries while collecting gate and local TV revenue in canadian dollars. However, with the recent fall in the greenback against the loonie, this is less of an issue for teams (while bringing Canadian “nearshore” TV and movie production to a virtual standstill for inverse reasons). Which leads to an interesting question: will the Blue Jays now feel richer and make more moves to rebuild?

  15. Evan on January 5th, 2005 3:21 pm

    We all know California has a crippling tax burden. Jurisdictions with pleasant weather often levy excessive taxes as the climate encourages residence as much as the taxes discourage residence.

    That said, I know of a programmer who voluntarily moved from Los Angeles to Edmonton (a very chilly city) to avoid California’s taxes.

    Though, Canada’s federal sales tax DOES apply to some food.

  16. Evan on January 5th, 2005 3:29 pm

    Which means, of course, that Toronto has the greatest problem attracting free agents due to taxes. They have federal income taxes, provincial income taxes, federal sales taxes, and provincial sales taxes.

    Be happy you live in Seattle and not T.O.

  17. Jon on January 5th, 2005 3:42 pm

    Generally speaking, there is no double taxation, due to interstate tax compacts. Players do not pay taxes to two different states on the same income. Players pay income taxes on income earned in a particular state (where the game is played)if that state has an income tax. So players on teams from states with no state income taxes still have to pay state income taxes for games played in states that do have income taxes. Make sense?

  18. David J Corcoran on January 5th, 2005 4:33 pm

    But the Canadians get more with their money. Free health care, for one.

  19. Westfried on January 5th, 2005 4:37 pm

    Brad and Jon have it right. If you live in NJ and work in NY, for instance, you have to pay NY state tax for the portion of time you worked there. But, you then report that tax to NJ, and that counts as a credit on your NJ taxes. If you work in Seattle, then you pay no Washington State income tax, so you have to pay NJ income tax.

    The only “double-taxation” that really exists is state and federal, and even there you get to deduct some of your state tax from your federal income. (Which is why the 9 non-income-tax states pushed for a new deduction based on sales tax – as of 2004, you can deduct either state income tax OR state sales tax from your federal income)

    Theoretically, you could say the people living or working in non-income-tax states are getting double-taxed. For instance, if you live in Florida (as many players do), you do not have an income tax, but you make up for it in a high sales tax. Then, you work in NY, and have to pay NY tax on that portion. But, unlike living in NJ, where you can deduct that NY tax from your state income tax, Florida residents have no income tax from which to deduct. So, you pay the NY income tax, plus the Florida sales-instead-of-income tax. Same if you live in Oregon, and work in Washington – you pay income tax in Oregon, and also sales-instead-of-income tax in Washington.

    Internationally, there is the whole cockamaimy VAT tax, which allows Canadians to not pay sales tax (I think). Or, Americans returnig from abroad can apply to the countries they visited for a refund or somesuch – I’m not very familiar with the international stuff, but it’s there.

    Several conclusions:
    1) it’s complicated, but the system DOES try to be “fair” from a double-jeopardy standpoint.
    2) most mlb’ers have enough money to hire someone to best take advantage of this
    3) most mlb’ers have enough money that a little tax here and there won’t hurt, although the Florida pseudo-double-tax situation is minor enough that manymany players live there expressly for tax purposes.

  20. Matt Staples on January 5th, 2005 4:57 pm

    David, I’m not so sure that they “get more for their money” as much as they simply give more of their money, and (arguably) receive more in return, much of which may not be of any use to that particular person. The government could tax us all 85% and provide free housing for every man, woman, and child in America, and by your definition we would be getting “more for our money.” Those of us who aren’t homeless (or in a very crappy housing situation) would actually be paying a lot more of our money to the government, and we personally would be getting _less_ in return. The only exception to this might be if you considered the “benefit” someone with a house would get by having homeless people placed in a home, and this would be spurious even if not more than overcome by the downgrade in going from a decent house to whatever the government might put you up in (not to mention incentive effects, etc.).

    That turned into a mini-diatribe. I hope you see my point, no matter what one’s feelings are toward taxes, increased government regulation, etc.

  21. Evan on January 5th, 2005 5:29 pm

    This almost certainly isn’t the place to discuss this, but Canada’s healthcare system is pretty clearly the least efficient and comprehensive of all universal systems offered in OECD countries. Here’s a published study of exactly that:

    http://www.fraserinstitute.ca/shared/readmore.asp?sNav=pb&id=658

  22. Jordan on January 5th, 2005 5:41 pm

    Double taxation unfair?
    How about single taxation?

  23. Shrike on January 5th, 2005 5:50 pm

    A Fraser Institute study. Urk. Not that they don’t have some cogent points, but . . . urk.

  24. John in L.A. on January 5th, 2005 5:51 pm

    #3 – By that logic you should be taxed by every state that you vacation in.

    #4 – A sales tax is inherently regressive. it’s not a value judgement, it’s a defintion.

    #21 – You’re right. It doesn’t seem like the right place. I just hope no one takes that link seriously.

  25. Evan on January 5th, 2005 6:00 pm

    I’d dispute that all sales taxes are regressive. Sales taxes on necessary goods or services are regressive, but a sales tax applied only to items people can reasonably choose not to buy at all would be flat.

  26. Matt Staples on January 5th, 2005 7:15 pm

    #24 — it appears you didn’t read the “for more than a few days or few weeks per year” qualifier in #3’s comment. Otherwise, I agree with your comments as pertinent to #3.

    As for your dismissal of the analysis of the Canadian health care system, this would be the place to discuss its merits just as much as this would be the place to discuss all sorts of off-topic things. If, on the other hand, you simply don’t agree with the viewpoints espoused in the study, you may as well say so (which you may have done; I can’t tell). People will take seriously that which they desire to, and I doubt your hopes have much to do with it, at least as expressed in your comment above.

  27. G-Man on January 5th, 2005 10:45 pm

    I think some athletes may look at the tax issue, but others are more enamored with the gross contract amount. It’s more about respect or ego than what they end up with. Those guys who make eight-figure salaries can squeak by with the net of taxes.

    I do suppose that the likes of Scott Boras use the tax issue to leverage a few more bucks out of teams in high-tax locales.

  28. paul mocker on January 6th, 2005 8:47 am

    DMZ
    You pointed out in #2 that double taxation is unfair, “particularly enforced” and disproportionate. Do you have evidence that local tax agents are auditing athletes disproportionately in comparison to others?

  29. DMZ on January 6th, 2005 10:10 am

    I don’t have a study handy, but I know that it’s true: as noted up-thread, it’s easy and lucrative for states to look up team schedules and tax players that way. Tracking someone like me, who may travel to those states but doesn’t make that much money while I’m there, isn’t a good use of enforcement dollars.

    So wait, I’ll do a quick study.
    Everyone I know who travels a ton and doesn’t make much money: not taxed in other states
    Every baseball player: taxed in other states

    Take that for what you will. That’s not a representative sample of people who travel, of course, and so on and so forth.

  30. paul mocker on January 6th, 2005 4:05 pm

    Since it isn’t a representative sample and the IRS and state taxation audit numbers are difficult if not impossible to access, I am skeptical of your claims that athletes are unfairly targeted.

  31. DMZ on January 6th, 2005 4:27 pm

    I don’t know what else you want from me, really. When Portland was going to build their stadium, their funding mechanism relied on taxing the income of the players and of visiting players. I, and nobody else I know, gets taxed when they work on business that assigns them to Portland. Now if you want to argue that Oregon suddenly would have taxed every Seattle person who went down to work with Intel for a week if they’d built a stadium, that’s fine, but the fact remains — players all get taxed income when they play in income tax sites. People in normal industries do not.

    I don’t have access to state taxation data from California, so I can’t prove that they taxed Pujols when he was in town, but they did. They didn’t tax me when I worked in San Jose for a week.

  32. Evan on January 6th, 2005 5:23 pm

    The province of Alberta imposed a tax like this that only applied to visiting NHL players (so those AAA players on the Edmonton Trappers were okay). Such taxes do exist.

  33. Kevin on January 7th, 2005 3:27 pm

    I’m late to this thread but have a contribution…I travel extensively as a consultant and taxation issues are currently a small concern. There are only a few states (most notably MA and CA)which aggressively pursue out-of-state wage earners who pass through their borders while working. My firm pays a small amount of taxes in these states, and as an owner I receive a small w-2 (or equivalent) from a few extra states each year, like one from MA for a couple hundred bucks. Sure we’d rather have the money than send it to fund art work for the big dig, but our bigger concern is the administative burden of tracking dozens of consultants across a hundred projects and forty-one states.

  34. paul mocker on January 10th, 2005 6:58 pm

    I simply want you to back up your assertion that athletes are disproportionately audited.

    I admire your mind, among other things, but you didn’t use it when you said “it exists and it sucks.” Jon and Westfried have provided ample evidence that there is no double taxation.