Introduction
Enjoy the Super Bowl? Cheer for your favorite team? California’s Tax Man was also clapping for an entirely different reason: the state made a cool $1.0 million in income taxes off the players, because the Super Bowl was played in Santa Clara, California 11. Of course, California probably made several millions more from the broadcasters, entertainers and media that gathered for the event. How is this possible? Welcome to California’s Jock Tax.
California earns about $239 million from taxing athletes on professional teams when they are present in California during their sports season. Take Peyton Manning for example: because the Super Bowl was played in California, his tax bill roughly doubled, from $60,000 to $130,000, whether or not he won the Super Bowl!
California does not just tax him on his Super Bowl earnings, he is taxed on a proportionate share of his entire $20 million salary!
Apportionment Formula
California taxes the number of “duty days” and athlete spends in California during the entire season, defined as the first official preseason activity to the last game played. Here is the California’s Jock Tax regulation (Section 18662-6 (f)(1):
A “duty day” is defined as “any day services are performed under the contract from the beginning of an official preseason activity until the last game played”. The “duty days” in California are then divided by the total “duty days” to create a ratio. This ratio is then multiplied by the total compensation. This then is deemed to be the California source income.
For Payton Manning, the total duty days was 208 (rounded to 200 to illustrate the tax). Manning was in California three days to play the Oakland Raiders and another three days to play the San Diego Charges, or six duty days in total. 6/200 = 3% X his $20 million salary = $600,000 of taxable income to California. Assuming an effective tax rate of 10%, his California tax is $60,000.
The Super Bowl, however, caused him to spend seven days additional in California, thereby increasing his duty days to 13, resulting in a apportionment formula of 13/200 = 6.5% x $20 million = $1.3 million x 10% tax = $130,000, more than his entire Super Bowl winnings22. Note, under the formula, his $102,000 of winnings raises his California tax only and additional $6,653, because the winnings are added to his salary portion of the calculation..
Manning Visits the Tax Prophet
Manning hears about his California tax bill and makes an appointment with yours truly (aka the Tax Prophet). He says, “This can’t be right, Tax Prophet lower my taxes!” I notice the vagueness of the terms “duty days” and “official preseason activities” and decide to challenge all implicit assumptions in the formula.
The regulations do not mention how to count duty days when an athlete is in more than one state during the day.33. Eliminate days in which the team was in California, but the athlete was not, due to injury or other reason (this does not apply to Manning’s situation). And what happens when duty days extend to a subsequent calendar year? I conclude that:
• Manning was not in California three days when he played the Raiders and Chargers, he was in Denver for most of the first day. Therefore, remove the first day for both regular season games and the first day of Super Bowl under the same theory, thereby reducing the number of California duty days from 13 to 10.
• The total number of duty days can be extended if Manning were required to workout in Denver as part of his contract. The workouts must be mandatory and not voluntary. Assume he worked out an additional 60 days in Denver as mandated in his contract, thereby increasing the total duty days to 260. His apportionment formula becomes 10/260 = 3.86% and his California taxes drop about 40% to $77,200.
• But let’s not stop there. Manning plans on retiring after the Super Bowl so he will not be paid a salary in 2016. So even if he had seven Super Bowl duty days, they occurred in 2016 not 2015, when he earned his $20 million salary. Manning has a claim that he owes California nothing in 2016 and the apportionment formula contains only the four days he played in California in 2015. Reducing the total duty days by the days in 2016 (37), the formula for 2015 would be 4/233 or 1.72% x $20,000,000 salary = $343,350 x 10% = $34,335, a reduction of $95,665 over the initial calculation of $130,000.
Manning, elated with Tax Prophet’s wizardry, spikes the ball!
The Lesson: Ambiguity creates opportunity. Challenging the basic assumptions, especially then the terms used are vague, can yield huge tax savings.
Why Do Successful Athletes Live In Florida?
I ask Manning why he is resides in Colorado, where he pays income taxes of 4.63%. I explain that his $12 million in endorsement income is fully taxable in Colorado since he lives there, costing him $555,000.
If Manning moved to a non-tax state such as Florida 44. Additionally, Nevada, Texas, Alaska, South Dakota, Wyoming and Washington have no income taxes. he’d be $550,000 richer. That’s why Derek Jeter, Tiger Woods, Serena and Venus Williams and a host of other professional athletes live in Florida; their endorsement income is shielded from state income taxes.
The Rolling Stones and U-2 use the same concept to avoid income taxes on their non-performance income. Their business operations are located in the Netherlands, where the tax on royalty income is extremely low, Entertainers are subject to tax on income earned where physically perform, but they can divert income from their: (i) music royalties and sales; (ii) clothing and product lines; (iii) endorsements; and (iv) other rock star income and sales, to a low-tax jurisdiction.
In fact, Apple, Google, Facebook and a number of U.S. companies pay no tax on their earnings outside the U.S. by using the Netherlands royalty law as part of their international tax strategies (called the Double-Irish Dutch Sandwich). The same is approach applies to athletes and their endorsement income: move to a state with no income tax.
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