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CALIFORNIA’S JOCK TAX

Feb.24,2016

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 ¹ 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 winnings².

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.³ 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 ⁴ 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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Footnotes:

Unreported Foreign Income or Bank Accounts?

Feb.21,2016

Received a threatening letter from a foreign bank threatening to report you to IRS?

Read on the Web that you are going to prison for failing to file and report your foreign income and bank accounts?

Own property overseas or received a large foreign gift or inheritance in recent years?

Don’t panic, you’ve come to the right place. A substantial portion of my tax practice involves U.S. taxpayers just like you and there is a lot of false information on the Web to alarm and traumatize you.

Please Note: This is a highly specialized area of tax law and there are many so-called tax practitioners who use scare tactics, but are largely clueless as to how this area of tax law actually works.

In contrast, since 2003, I’ve represented hundreds of clients in similar situations. I’ve battled IRS for 35+ years. I understand how they think and will react to your situation if they find out about you. Don’t worry, I can fix your problem and keep you out of jail.

If one or more of these apply to you, contact me immediately:

Ownership of or signature authority over, one or more foreign bank or financial accounts1 worth $10,000 or more at any time during the year;
Foreign accounts, deferred compensation or ownership in foreign entities (stock, securities, family business ownership) exceeding $100,000 for joint filers ($50,000 for single filers) determined at the end of the year;
Receipt of foreign gifts or inheritances of $100,000 or more in total during any year in which you were a U.S. citizen or long-term resident, subsequent to 1995; or
Regardless of the value, ownership of 10% or more in a foreign corporation or partnership;
Unreported interest, dividend, rents or royalties or other earnings and profits from foreign accounts, investments, assets or real property;
Beneficiary of a foreign trust or estate.

[1. Note: Account is broadly defined and includes insurance, retirement accounts, on-line accounts, gaming accounts and precious metal accounts.]

Summary of the Law on Gifts From a Non-U.S. Taxpayer

Dec.11,2015

A transfer of real property or tangible personal property by a nonresident alien is subject to gift tax only if it is situated in the U.S. Internal Revenue Code Section §2511(a); Regs. §25.2511-3(a). Section 2511 (a) reads as follows:

…, the tax imposed by section 2501 shall apply … whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible; but in the case of a nonresident not a citizen of the United States, shall apply to a transfer only if the property is situated within the United States. (emphasis added)

IRC Regulation 25.2511-3 reads as follows:

(a) In general. Section… 2511 contain[s] rules relating to the taxation of transfers of property by gift by a donor who is a nonresident not a citizen of the United States. … these rules are:

(1) The gift tax applies only to the transfer of real property and tangible personal property situated in the U.S. at the time of the transfer if …—

(i) The gift was made on or after January 1, 1967, by a nonresident not a citizen of the United States…(emphasis added)

Thus, under IRC Sec. 2511(a), gift tax does not apply to transfers of intangible property by a nonresident alien. Examples of intangible property include stock, bonds, debt obligations, and bank deposits. For instance, the transfer of Treasury Bills not subject to gift tax, see PLR 8210055 which held as follows:

In general, section 2501 does not tax the transfer of intangible property by a person who is neither a citizen nor a resident of the United States. Section 25.2511 – 3(b) of the Gift Tax Regulations defines the term “intangible property” as “a property right issued by or enforceable against a resident of the United States or a domestic corporation (public or private), irrespective of where the written evidence of the property is physically located at the time of the transfer.”

Debt obligations such as bank deposits or obligations of which the United States is the primary obligor are considered to be intangible property. See section 25.2511 – 3(b)(4) of the regulations. Accordingly, a transfer of ownership by B to A of these Treasury Bills will not be subject to a gift tax pursuant to section 2511 of the Code. The transfer by B to A of $20,000 by a check to be drawn on a foreign bank and payable by a United States bank will not be subject to a gift tax as such property is situated outside the United States.

Generally, tangible personal property is property the value of which is dependent upon the property’s physical form ( such as a block of gold or a diamond ring). Texas Instruments Inc. v. U.S., 551 F.2d 599 (5th Cir. 1977). See Regs. §25.2511-3(b). In determining whether property is tangible or intangible property, courts have defined “intangible property” as property the value of which is attributable to the property’s intangible elements rather than to the property’s tangible form. See Ronnen v. Comr., 90 T.C. 74 (1988).

Consequently, monetary gifts in the form of a check or wire transfer by a non-resident alien to a U.S. taxpayer are not subject to gift tax. The recipient of a foreign gift does not pay tax on the gift, but may have a reporting requirement (Form 3520) if the total value of all gifts or inheritances received exceed certain threshold amounts (generally $100,000 or more received from one or more individuals during a calendar year).

The concept of “domicile” controls whether an individual is a U.S. person or non-resident alien for gift and estate tax purposes. A non-resident alien (not domiciled in the U.S.) is subject to gifts taxes only on U.S. real property and tangible property located in the U.S.. However, the U.S. estate of a non-resident alien (the individual dies) is comprised of U.S. real property and both tangible and intangible properly located in the U.S. (this includes securities issued by a U.S. company).

A green card holder is usually considered to be domiciled in the U.S. as a permanent resident, but a student or an individual in the U.S. on a work visa is generally not considered to be domiciled here for gift and estate tax purposes, even though the individual may be a resident for U.S. income purposes.

The gift and estate tax exemption equates to only $60,000, so a non-resident alien who dies owning $1.0 million of stock in a U.S. company (or a U.S. residence), has a taxable estate of $940,000 ($1.0 million – $60,000 exemption = $940,000). Thus, many non-resident aliens purchase U.S.-based assets through a foreign corporation to avoid estate taxes.

Domicile is a complicated concept, but in general terms, means the place where one intends to live on a permanent basis. Thus, in general, a non-resident alien in the U.S. for a limited time (F-1, L-1, H1 B visas) would not be domiciled here, but an individual applying for green card would, because a green card means the person want to immigrate to the U.S. , i.e. he/she want to live here permanently. A non-U.S. citizen who is domiciled in the U.S. is subject to gift and estate taxes on gift-type transfers of their world-wide assets, but they have a unified estate and gift tax exemption of $5,350,000 currently – the exemption is indexed for inflation.

In summary, a non-resident alien is not subject to gift taxes, except on tangible property located in the U.S. and U.S. real estate, but is subject to estate taxes on intangible property located in the U.S., including U.S. securities (subject to an exemption worth $60,000). A non-U.S. citizen domiciled in the U.S. is subject to both gift and estate taxes on their world-wide assets, but has a unified gift and estate exemption currently worth $5,350,000 in 2015 (the amount is indexed for inflation).