The following article is a guest contribution from Tim Johnson, Jason Price and Mitchell Adams of JLK Rosenberger, a full-service accounting, tax and business advisory firm.
For us tax pros, the saying goes “it’s not what you make, it’s what you keep”. That phrase takes on a new meaning with the Tax Cuts and Jobs Act legislation (TCJA) being the biggest tax reset in the last 30 years. Here at JLK Rosenberger, we deal with a number of professional athletes who will be greatly affected by these sweeping changes.
Tax Rates: There are more favorable income brackets and a drop in the top tax rate of 2.6%. This can result in a significant tax drop especially for those with substantial income.
AMT: The Alternative Minimum Tax (AMT) is like that minor league call-up that only those-in-the-know saw coming. It is sneaky and under the radar. It will have a much smaller impact now. The drop in the top tax bracket is a good thing that will temper some of the items that are non-deductible below. This is because state taxes, agent fees, and player-type expenses were non-deductible for AMT purposes. Additionally, there was a 2% floor to overcome before any player-type expenses were deductible, and then an overall limitation on deductions often further limited those deductions. So, in this case, we have to “run the numbers” to see if the lack of deductibility is indeed as bad as it initially sounds.
Agent Fees Not Deductible: Agents are big advocates for their clients, and that advocacy does not come free. So, when it comes to taxes, pro athlete agent fees are a big deal. For example, in the NFL contract fees range up to 3%, and in MLB they are generally 4 or 5% of the draft bonus and 3% of the contract once they make it to the show. These contract agent fees are no longer deductible. However, fees paid for marketing work would generally still be deductible as a business expense. For pro athletes with substantial off-the-field income, agents may want to think about how they are charging for contract versus marketing services in light of this big change.
State Taxes Capped: Individuals are now capped at $10,000 of state income and property taxes. Once they go above that amount, they get no benefit on their Federal Tax return. Athletes are taxed where they live and perform. It is possible that the impact on free agency could be big because teams in high-tax states will have to offer that much more to match the take-home pay of a team in a low tax state.
Player Expenses Not Deductible: Just as agent fees are no longer deductible, neither are other player-type expenses such as training fees, gear purchases, therapy, union dues, and team and league fines. Expenses related to generating marketing income will continue to be deductible.
New Bonus Withholding: With tax brackets dropping, so has the rate of withholding on supplemental wages, which is IRS language for bonuses. It used to be 25%, which for many big bonuses was not enough withholding. Now it will be 22%. A lot of athletes have salaries already in the 37% bracket, so the bonus will be taxed at that higher rate, which means withholding on certain bonuses will fall short of what will ultimately be owed. It’s not that this is money the athlete wouldn’t owe otherwise, but it’s a problem that has existed and it’s likely that a greater number of athletes will be subject to this issue now. We call it the “Bonus Trap” and needs to be looked at for all bonuses, but especially those under $1-Million. It often affects rookies but can be fixed right when they get drafted.
The key factor is taxable income, not necessarily tax rate. With limited deductions, it’s tough to lower taxable income. Although there is a higher standard deduction now, many pro athletes will probably not even itemize going forward because they no longer have the types of expenses qualifying for deductions. That is, unless they own a home or donate a lot to charity. And even with home ownership, they will be limited to the amount of mortgage interest they can deduct depending on the value of the home they bought. Now no one is likely crying for pro athletes when it comes to money, but as one can plainly see, they may be hit hard by the new tax law.
Many Questions Still Remain
Will states conform to the new Federal tax law? Maybe some states will allow the agent fee deduction, which might make it more palatable to live there. There are many other topics that may impact pro athletes not addressed in this article. Proper tax planning is a year-round process accounting for all the athlete’s sources of income, including income generated off the field. It’s a comprehensive process requiring knowledge of tax rules and regulations, but also the nuances specific to professional athletes. If you have questions or need assistance with pro athlete tax concerns, JLK Rosenberger has the experience to help. For additional information, find @CPA4Athletes (Tim Johnson), @UIU_Price95 (Jason Price), or @themitchadams (Mitchell Adams) on twitter, call us at 949-860-9892, or go to http://jlkrosenberger.com/industries/professional-athletes/.