Taxes, salary caps and sports unions

Key topic

Today’s lesson will focus on three things: taxes, salary caps and collective bargaining agreements in the United States. Specifically, we will focus on the different types of taxes and how they affect sports professionals, the salary caps which exist in most sports and major leagues in the US, and information on the process of collective bargaining agreements. Collective bargaining agreements relate to negotiations between the athletes’ unions and the leagues.

Learning objectives

• Learn what taxes are and how they work
• Discover the different types of taxes and how they apply to sports contracts both locally and abroad
• Understand Salary Caps
• Find out how collective bargaining agreements affect sports employment

Taxes

Tax is a fee charged by a government on a product, income or activity. There are two types of taxes – direct taxes and indirect taxes. If tax is levied directly on the income or wealth of a person, then it is a direct tax. For example, the income-tax which is usually expressed as a percentage of overall income. If a tax is levied on the price of a good or service, then it is called an indirect tax. For example, the sales tax, or import tax, such as a 10% tax on all imported cars. In the case of indirect taxes, the person paying the tax, passes on the incidence to another person. For example, a car-importing corporation pays a 10% tax on a car that was imported and subsequently sold. The amount was essentially paid by the customer.

The reason for the levy of taxes is that they constitute the basic source of revenue of the government. Revenue so raised, is utilized for meeting the expenses of the government like defense, provision of education, health-care, infrastructure facilities like roads, dams etc.

Types of taxes

After income taxes, transaction taxes usually affect taxpayers more than any other type of tax. In a lot of countries, transaction taxes are even worse on people’s incomes than income taxes. Following are some of the most common types of taxes:

Employment Taxes: They are imposed by governments, and they include Social Security taxes whose proceeds finance retirement and medical costs. Usually, a percentage rate is withheld from the employee’s salary and the employer matches the contributions. Self- employed people pay both the employee and the employer portions.

Sales Taxes: As previously mentioned, sales taxes are charged when a customer pays for a good or service. The business collects the amount from the customer and forwards the funds to the government. In the US, each state – in some cases even cities/ countries – can implement its own sales taxes, meaning they vary depending on location.

Death Taxes: Levied by governments on a person’s estate upon death. This is intended to prevent vast accumulations of wealth. These taxes are imposed on the deceased whereas inheritance taxes are imposed on the recipient. The tax base is usually the fair market value (FMV) of the property owned by the deceased at death, minus allowable deductions (e.g., funeral costs, administration expenses, other taxes, philanthropic contributions, liabilities of deceased, etc).

Gift Taxes: Imposed on the transfer of property during the owner’s lifetime. Some governments impose gift taxes. The base of the tax is usually the FMV of the property transferred, at the day of gifting.

Property Taxes: They are levied on property owned by an individual or a legal entity. The most common example is the tax you have to pay on a piece of real estate (house/ flat etc). This tax is an ad valorem type of tax which translates to, at value taxes. These taxes are usually imposed by local governments in the US and form an important source of revenue for state authorities.

Taxes on Privileges and Rights: Examples of these taxes are Custom Duties which are taxes on the right to move goods across national borders and franchise and occupational taxes.

These are basically taxes on the privilege of practicing a specific profession or doing business in a state/ local jurisdiction.

Income Taxes: They are levied by governments. They are generally imposed on corporations, individuals, estates, and trusts. Most jurisdictions use a pay-as-you-go system for collecting taxes. The most common tax formula for all taxable entities is rather similar across jurisdictions. Income is usually included in the tax base, whereas deductions must be specifically provided for in the law. Also, tax rates are progressive, meaning that the more money you earn, the higher rate you will be taxed on, and they differ for individuals and corporations. Apart from progressive, taxes can be either proportional (same percentage no matter how much you make) or regressive (the more you make the less you pay).

Income Taxation of Business Vehicles

Proprietorships – This is a simple type of business and is not considered a separate entity from the individual. Profits are reported and taxed on the taxpayer’s personal return using the individual’s personal tax rates.

Corporations – Corporations are separate legal entities and separate taxable entities as well. Corporations are required to file tax returns and pay tax at corporate rates.

Partnerships – A partnership is not a separate taxable entity and therefore it is not subject to taxation, despite the fact that it is required to file a return. The financial results of the partnership flow through to its different partners and they are included and taxed on their personal tax returns using their personal tax rates.

Jock tax
In 1991, the Los Angeles Lakers lost the N.B.A. finals to the Chicago Bulls. Following the defeat, California officials decided to demand tax payments from Michael Jordan and his teammates from the income earned while competing in the golden state. Illinois officials responded with their own tax laws that specifically targeted visiting athletes, such as the Lakers. The Illinois response became known as ‘Michael Jordan’s revenge.’

Following the actions of these two states, over a dozen states, including Massachusetts, Pennsylvania, Maryland, Arizona, Ohio, and Colorado have enacted regulations to collect taxes from visiting athletes who earn income there as part of their travel schedule. Some localities, including Cincinnati, Cleveland, Kansas City, Pittsburgh and St. Louis, have taken similar measures. Only a handful of major state have not adopted this bizarre tax (Florida and Texas included).

Professional athletes have to pay both federal and state income taxes, as any other US citizen. Under the “jock tax” they are required to pay income tax in each state they compete. The logic behind this tax is that athletes should pay state income taxes in the state they earn that income. That means that if a professional athlete earns income in various stadiums, in different states, they should pay income tax to each state accordingly. In order to calculate how much income tax an athlete should pay in each case, states have adopted the method known as “duty day” to calculate how much income athletes earn in their state.

This is usually measured as the percentage of duty days spent in the respective state, compared to the total duty days the athlete had that tax year, multiplied by the athlete’s salary. If the athlete is part of a team, then the team usually takes care of this, through a tax withholding from the athlete’s salary which is remitted to the relevant state tax authorities.

Taxes and sports contracts abroad

It is normal for professional athletes, to accept sports contracts to play abroad. When signing a playing contract abroad, you need to understand the types of tax liabilities that may arise from such a contract, both in your home country and the country where you are competing.  A common mistake that many athletes make, is believing that their tax obligations end by paying taxes in the country where they are currently employed. You should take note that you must always comply with both the tax laws of your home country and your country of residence, when employed and earning money abroad.

Your country of citizenship or domicile, is the country where you come from. Your country of residence is the country where you currently live in. In most countries, in order to be considered as a resident you have to live there for a period over 183 days within a calendar year.

There are four different ways through which countries apply taxation in terms of residency/citizenship and these are:

• Taxing both their Citizens and Residents on their Worldwide Income no matter where they live (for example the United States where citizens and green card holders are taxed in the US despite their actual country of residence)
• Taxing their Residents only on their worldwide income (for example the United Kingdom)
• Taxing their Citizen Residents only on their worldwide income and not the foreign residents of their country (in the case of a non-domiciled tax regime)
• Taxing their residents on their local source income but not on their foreign source income (territorial tax system)
• There are also a few countries which have specific regulations providing tax incentive packages to foreign sports players moving into the country. These incentive packages usually differ from the country’s standard tax regulations, like the ‘Beckham’ tax law of 2005 in Spain. The so called ‘Beckham law’, basically allowed foreign employees living in Spain to be taxed at the rate of 24,75% instead of a progressive tax scale ranging from 24% up to 43%.

So, it is quite important that you are aware of the tax treatment of your earnings in both your country of citizenship and country of residence. As a US Citizen, or a US green card       holder, you have to consider that even if you are a resident of another country, you still have to file a tax return in the U.S. and pay any applicable taxes.

It is vital to make sure that you maintain records of the following:

• Official pay slips
• Official Earnings Statement and Tax Declaration/Tax Return
• Copy of your playing contract
• Proof of payment and invoices of any playing related expenses (such as agent fees)

By keeping a record of the above documents, you make it easier for your CPA or tax advisor to prepare your tax return and take advantage of any deductions that will minimize your tax liability.

Salary caps in the United States

Salary caps are a tool utilized by various leagues, mainly in the United States, to promote competitive balance and assure that teams within a league are able to compete with each other. The issue of competitive imbalance is something that leagues have long been trying to resolve and in altering this issue, leagues have introduced various forms of salary caps.

Despite what many people believe, salary caps are not essentially limits on team or player salaries. They set a band for both the upper and lower salary limits to payrolls for each team within a league. They take different forms according to the league, based on the league’s goals, and they can be categorized as soft or hard salary caps depending on how drastic they are. Salary caps are found in nearly all the major leagues in the United States, including the NFL, NBA, NHL and MLS, but not in Major League Baseball.

Undoubtedly, salary caps have had an impact in reducing competitive imbalance between teams but it’s highly arguable as to the extent they’ve achieved that. In certain leagues such as the NBA and the MLS, whose salary caps are filled with exemptions, they have done little to prevent the concentration of talent in a few teams. Considering the trades of the Golden State Warriors, a few years back, and the formation of a super-star team composed of all- star players, it seems that imposing salary caps and then giving lots of exceptions undermines the salary caps themselves and reduces their effectiveness. On the contrary, leagues such as the NFL and the NHL that implement hard salary caps are more effective in preventing teams to buy their way to the top by massively spending on acquiring super- stars.

Salary caps do not have any real effect on the compensation of elite sports professionals since teams can allocate the largest part of their allowable payroll funds towards the acquisition of such players. However, for lower-tier sports professionals these salary caps do have an impact, in the sense that lower-tier players have to share in terms of salary what’s left after the fat salaries of star players!  Another effect of the salary cap is the release of many higher-salaries veteran players to other teams once their production starts to decline from the elite level. Therefore, mature sports professionals playing in the United States, should take this into account during their financial planning process.

In the following table, we present information on the salary caps of various leagues, accompanied by any exemptions that might come with them:

*Please note that the salary caps were adversely affected by the pandemic

Let’s watch a 4-minute video now, which explains the MLS salary cap system.

MLS salary cap explained

Sports employment and collective bargaining agreements

Professional sports in the United States are almost a world by themselves when it comes to labor relations. Professional sports franchises usually have separate owners but the interests of the owners are unified as a league. The collective bargaining process in the US sports industry has commenced as a tool to protect the welfare and rights of professional athlete-employees and currently the three most popular sports in the US, baseball, basketball and American football, are heavily unionized.

Collective bargaining agreements in professional sports are agreements amongst a sports league’s owners and players.  A collective bargaining agreement for a specific league sets forth a set of agreed upon rules regarding the split of league revenues between the teams and the players, the level of salary caps imposed to teams, player transfers restrictions, player safety issues, player drafting provisions, free agency requirements, disciplinary rules, etc.  Collective bargaining agreements play a substantial role in shaping how a specific league operates because they constitute the core authority of a specific league, its players and their agents, its team owners and the league’s management.

During the collective bargaining process, the parties involved are obliged to discuss the mandatory subjects which include the players’ salaries, working conditions and work hours. The mandatory items that are discussed during the collective bargaining process cover the base salaries of players, the number of games they will play per season, whether their contracts are guaranteed by the league, player transfer procedures, their medical coverage, retirement plans, injury and non-injury grievances, club discipline procedures and access to the personal files/data of players.

In addition to the mandatory subjects the parties may also discuss any other subjects which are called ‘permissive subjects’. It should be noted though that either of the parties involved in the collective bargaining process may lawfully refuse to negotiate over permissive  subjects.

The US and the European sports models are entirely different when it comes to labor relations between leagues, clubs and players. Under the US model, the players are owned by the league with contracts that are the result of collective bargaining. In the European sports-model there exists a system of leagues with member clubs which have independent control of themselves and they are the owners of the individual players. In Europe other than a few basic terms, playing contracts and compensation terms are freely negotiated between the individual players and the clubs and there is no particular form or process to be followed.

Action steps – Exercise 1 (10 minutes)

Let’s see what you took away from today’s lesson. Please answer the following multiple- choice questions:

1. Sales Tax is

1. Tax on things you buy or purchase
2. tax on the house you own
3. tax taken out of your paycheck
4. tax that you pay once a year on your income

2. The county charges the Anderson family a tax on the value of the house they own. What kind of tax is this?

1. Income
2. Property
3. Payroll
4. Sales

3. Revenue raised from taxes are used by governments for public goods such as defense and infrastructure.

1. True
2. False

4. There are three types of taxes. Direct, indirect and neutral.

1. True
2. False

5. By keeping a record of certain documents, you make it easier for your CPA/ tax advisor to prepare your tax return and take advantage of any deductions that will minimize your tax liability. Please choose all that apply

1. Official Earnings Statement and Tax Declaration/Tax Return
2. Copy of your sports contract
3. Both (a) and (b)
4. None of the above

Answer sheet

Lesson wrap-up

Today we tried to provide you with the basics of taxes, why they exist, the most important kinds of taxes out there and how they relate to you and any future sports contract you may have. Moreover, we discussed salary caps in the United States and its major leagues, as well as the collective bargaining agreements between athletes and sport associations.

At this point we will wrap up today’s lesson. First, we will go over the learning objectives of this lesson and we want your feedback as to whether they have been achieved and then we will address any questions you may have. Please feel free to ask anything you’d like in relation to today’s lesson and we would love to hear how the concepts we discussed today relate to you and your life!