This article co-authored by Withers' Michael Rueda, David Lehn and Gregory Pun regarding the impact of the newly enacted tax reform legislation on professional athletes and professional sports in the United States was initially published by Law 360 on January 2, 2018.
While we, like most of the world, have not had the time to fully digest the newly enacted tax reform legislation, signed by President Donald Trump last month, there are certain provisions worth highlighting that will have an impact on professional athletes and professional sports in the United States.
State and local taxes
The Tax Cuts and Jobs Act of 2017 limits deductions on state and local income, sales and property taxes (SALT deductions) up to $10,000 per year. This will particularly impact professional athletes. Previously, the deduction had been unlimited (subject to alternative minimum tax and the Pease limitations). This new limitation may provide certain teams, particularly those in states like Texas and Florida, an advantage in attracting and signing talent. For professional athletes playing for franchises in high-tax states, like New York and California, their salaries will be worth even less in real dollars than the exact same salaries in states without income taxes. Traditionally, teams in high-tax jurisdictions make up the difference for certain players by agreeing to tax gross ups and other arrangements that are designed to help athletes offset the tax impact of playing in a high-tax state.
Given the deduction limitation, the need for these arrangements will become more significant to help teams in high-tax states attract and sign certain priority athletes. Thus, the impact will be felt by both the athlete and the franchises.
In addition, athletes generally are taxed by the state where each match or game is held. As a result, even athletes playing for teams in a nonincome-tax states will to some extent feel the impact of the lost SALT deductions. The income tax athletes pay that is attributable to matches or games played at opposing team locations will no longer be deductible as they were in the past. State reciprocity agreements and potential tax credits, as well as city or other taxes, will also be important factors to consider to determine overall tax exposure. However, it is expected that some of these state agreements and credits may be reviewed as a result of the new law.
The loss of the SALT deductions and its impact on athletes and their salaries will provide athletes, agents and teams with complicated facts and issues to consider and plan for during contract negotiations. It may require teams to spend more money to attract and keep top talent, while players and their agents must prepare to adjust, or negotiate an adjustment for, dealing with any impact from the lost deductions. Athletes and their advisers should have already considered, or been advised to consider, making payments in December of all state income tax due for 2017 and all real estate taxes that may be due for 2017, making payments of real estate taxes assessed in 2017 and payable in 2018.
Unreimbursed employee expenses
Athletes will also lose the ability to deduct unreimbursed employee business expenses. In the past, athletes who are paid as employees were permitted to deduct expenses, such as agent fees, training and gym fees, reasonable travel expenses, or fines issued by their employer. These deductible expenses can be substantial in the aggregate, particularly the agent fees (although there were various limitations that applied prior to 2018).
Agent fees are not deducted from salary payments, but instead paid directly from the athlete to the agent. As a result, losing this deduction may have a noticeable impact on the athlete. Athletes should meet with their advisers soon and plan for this change. For example, athletes were hopefully encouraged to make 2017 agent payments before Jan. 1, 2018. For athletes under guaranteed contracts and with certain deferred bonuses payments due in 2018, athletes and their advisers should consider whether prepayment of the related agent fees would be permissible under league and/or player association rules. Ultimately, there is a tax impact to anticipate and properly plan for.
Tax rate reduction
Most athletes may be able to make up for some of their lost deductions through the reduction of the highest income tax bracket from 39.6 percent to 37 percent. Players playing for teams in no-tax states will likely benefit from the drop in rates given that the lost SALT deductions have less significance to them overall. For athletes not fortunate enough to be living and working in a no-tax state, depending on the athlete, the decrease in the tax rate for highest earners may offset the impact on take home pay from the lost deductions.
Possible benefit for investment income
There may be a benefit in the new tax law for athletes with substantial earnings from certain investments, which are made in "pass-through entities." There will be a 20 percent deduction on "qualified business income" from certain pass-through entities (depending on the nature of the business of such entity). Most service businesses are excluded from receiving the deduction. Many athletes use pass-through entities for the purpose of receiving nonsalary income such as from endorsement arrangements. It appears that this may be one of the "excluded businesses" since it is based on the athlete's reputation. This would eliminate the availability of the deduction for income generated from endorsement arrangements. However, there may be opportunities to take advantage of the deduction for other activities, especially real estate activities, invested in or conducted by the athlete as a pass-through entity. Athletes and their advisers should carefully review their investment structure for both diversification and after-tax return in light of the new tax law.
Tax-exempt municipal bonds
One proposed change received significant attention in the sports world but was ultimately left out of the law. The House bill had eliminated sports teams' access to tax-exempt municipal bonds for building sports stadiums. This proposal was not included in the act. Sports teams will still be able to build and renovate their billion-dollar stadiums with tax-exempt municipal bonds, making it easier for teams like the Oakland Raiders, which is moving to Las Vegas to build its new $1.9 billion domed stadium.
While tax attorneys and accountants are now spending significant time analyzing the new tax law to understand its full impact on taxpayers, what has been determined from an early analysis is that while the law appears to give with one hand, in terms of rate reductions, it takes away with the other hand, through the elimination of certain useful and relied-upon deductions. The important goal for all taxpayers, whether a professional athlete or not, is to determine the implications of the new law in order to anticipate and plan for these significant changes.