Over the weekend, I read a copy of a presentation on the recent spike in the IRS examination of professional athlete tax returns, made by Mitchell Halpern at this year’s Sports Financial Advisors Association annual conference.  Halpern is a lawyer who works at O’Connor & Drew, P.C. and specializes in taxation of professional athletes.  He wrote the chapter on State and Local Taxation of Professional Athletes in Gary Uberstine’s Law of Professional and Amateur Sports and is a board member fo the Sports Financial Advisors Association.

Halpern’s presentation focused on the process regarding various deductions typically claimed by athletes.  In November, Lamar Odom sued the IRS after it said that he could not deduct taxes on his $12,000 in fines from the NBA and $178,000 spent working out to get in playing shape.  As Halpern explained in his presentation, the lawsuit existed only because the IRS selected Odom’s 2007 income tax return for what was most likely a correspondence examination, where a taxpayer is asked to provide specific documentation for certain items on their tax return.  Recently, the IRS has focused on examining returns that include “un-reimbursed business expenses” of professional athletes.  In particular, the IRS is focusing on claimed deductions for agent fees.

Usually the biggest item in question, in terms of dollar amount, is the agent fees paid by the athlete during the year.  This should not be too difficult to document by obtaining an invoice from the agent and either cancelled checks showing payment of the invoiced fees or a receipt from the agent showing the amount has been paid.  Properly documenting agent fees will generally substantially reduce any amounts of additional taxes assessed by the IRS.

I have spoken with one CPA that has a sizable practice working with professional athletes that believes it is the deduction claimed for agent fees…that is triggering the examinations.

Halpern has been involved with 8 correspondence examinations; he has received 6 “no change” reports from the IRS and the other 2 are still in the IRS pipeline.

When the IRS is interested in an athlete’s tax return, it usually sends a letter which indicates that Schedule A – Itemized Deductions and Unreimbursed Business Expenses are being examined.  The athlete has 30 days to respond, but may ask for an extension within that window.  If the athlete does not respond at all, the IRS will issue an examination report disallowing deductions for the items it is examining and showing a proposed tax due.  The athlete generally has 30 days from the date of the issuance of this examination report to disagree with the proposed changes and provide support for his allegations.

Failure to respond to the examination report within the time frame allowed will generally result in the issuance of a Notice of Deficiency; the IRS will assess the taxes it believes are owed, and the athlete will have 90 days to either pay the tax or file a petition with the U.S. Tax Court.

Keys for athletes = (1) responding to IRS requests on time and (2) keeping documentation to support each claim.  I will add a (3), which is having an experienced tax professional to aid the athlete in this process.

Agent Fees Often Raise A Red Flag To The IRS from Sports Agent Blog - Sports Business, Sports Law, Sports Negotiations, NCAA Rules

Monday’s post about Cliff Lee’s taxes created quite an interesting discussion in the comments section.  Off of the site, I had a good conversation with Robert Raiola, a CPA at Van Duyne, Behrens & Co., P.A. Raiola helps many athletes with their taxes and provided great insight to Darren Rovell of CNBC in his piece on Cliff Lee and taxes from November 4, 2010.  Here are some figures that Lee might have considered when weighing the options of going to play for the Yankees, Rangers, or Phillies:

*State taxes based on top individual income tax rate in Pennsylvania (3.07%), New York (8.97%), and Texas (0.00% – tax listed based on “jock tax”).

I also spoke to Chris Dingman of The Dingman Group to find out where Lee might be looking to move now that he is a member of the Phillies.  Dingman’s Philadelphia clients (MLBers & NHLers) have typically been attracted to Haddonfield, New Jersey. Players also like Rose Tree/Media area in Delaware County, PA.  Both places have great schools with easy access to the stadium.  Single players generally like to live in South Philly near the stadium.

Raiola says the tax play is for Lee to get a place outside the city limits of Philadelphia, since Philly has its own separate city tax rate of 3.9285% for residents (3.4985% for non-residents – Lee would only have to pay this tax on half his income – half his games are played in Philly).  New Jersey has a top individual income tax rate of 8.97%, which is a gross income tax rate (no write-offs).  Lee could live there, but still attempt to remain domiciled in Arkansas as a resident, which has a slightly lower tax rate.

This is why you make guys like Raiola and Dingman a part of your team; your clients will come to you to ask about tax and relocation questions.  It is better to become familiar with the experts in those areas so that you are well prepared to give your clients options immediately.

Did Taxes Have A Role In Cliff Lee’s Decision? from Sports Agent Blog - Sports Business, Sports Law, Sports Negotiations, NCAA Rules

Ken Bolson of the New York Times does a good job of briefly highlighting the tax implications of Lee’s decision; however, I am a little confused by the very last sentence of his piece, where he writes,

He could also do what a lot of star players do: Ask the Yankees to pay his local taxes.

Interesting, because I have never heard of a professional baseball team agreeing to pay any of its players’ taxes.  A few accountants who deal with professional athletes’ taxes tell me that no team will ever pay the local taxes for an athlete.  A team may pay a player more money based on an understanding that the player acknowledges the tax consequences of his decision, but that is not a direct payment of taxes.  So where does Bolson get this idea from?

Cliff Lee Thinking About Texas Taxes from Sports Agent Blog - Sports Business, Sports Law, Sports Negotiations, NCAA Rules

You have just signed a contract, and are ready to embark on or continue your career as a professional hockey player. But then it blindsides you like an open-ice body check – the realization that you must share part of your earnings with the Canadian government, the U.S. government, or both. The questions then become: in which country must you pay income tax, and how much will you pay?

The answers can be surprisingly complex. Let’s examine situations in which you would have to file a Canadian personal income tax return.

There are two scenarios in which a professional hockey player is subject to Canadian tax.

• If he is a resident of Canada, he pays Canadian tax on his worldwide income, no matter where he plays.
• If he is NOT a Canadian resident, he will pay Canadian tax if he plays on a Canadian-based team. In this scenario, only the games he actually plays in Canada will be subject to Canadian income tax.

As such, the main factor in determining how much Canadian income tax a player must pay is his residency status.

Figuring out where a player resides seems like it should be a simple concept – but in fact, it’s not always straightforward. Someone’s residency status can only be determined on a case-by-case basis, and takes into consideration several factors (or residential ties).

The primary residential ties in determining if someone is a tax resident of Canada are: the location of his home and where his spouse and/or dependents reside.

In addition, there are many secondary ties that apply, which a player can examine to assist in his residency determination:

• personal property (cars, clothing, furniture)
• social ties (gym, golf and religious memberships)
• economic ties (bank accounts, RRSP, credit cards, broker accounts)
• hospitalization coverage (health insurance plans)
• origin of driver’s license, vehicle registration or passports
• seasonal dwellings or memberships in Canadian organizations

No one secondary tie will bind someone to Canada, but these ties must be considered in determining his residency status. The more secondary ties to Canada a player has, the more likely he is to be considered a Canadian resident.

It often happens that a player will be considered both a resident of Canada and a resident of another country. For such cases, Canada holds tax treaties with many countries – including the United States and most European countries – that include tie-breaker rules. Most modern treaties review first and foremost the location of a person’s permanent residence, followed by his social and economic ties. If none of these factors points to one country over another, habitual abode and citizenship are taken into account.

The amount of income tax you pay can vary greatly depending on the state, province or even city you live in. In addition, what may work for you, may not work for your teammate. Through proper arrangement of your affairs, you can stick handle yourself to the appropriate country!

Residency – Not A Decision To Be Left On Ice from Sports Agent Blog - Sports Business, Sports Law, Sports Negotiations, NCAA Rules

Football

• He also doesn’t like what the term “sports agent” implies and he wants to be more of a life-coach [Penn State's Chafie Fields: It's a Happy Valley for Player Turned Agent].
• Chris Duhon earning a larger base salary in 2010 than Tom Brady [In light of mega NBA deals, please don't say football players make too much money].
• For the ladies [The women of the NFL].
• Getting the fluff out of the way [D'Brickashaw's real deal? One year, $5.3225 million].

Baseball

• I always have to recognize young agents who are out there hustling [Eitan the Intern blog entry 3: Ask an Agent].

Basketball

• A state’s income tax can be a very important factor for large contracts [LeBron Can Make More With Heat Than Cavs].

Sports Law

• I would like to see a copy of the contract, as well [Competitive Eating and Uncompetitive Contracts].
• Makes you want to go to law school, no? [Theo Epstein, Juris Doctorate, Best GM in Baseball]

Shabbat Shalom: Friday Wrap-Up (7/9/2010) from Sports Agent Blog - Sports Business, Sports Law, Sports Negotiations, NCAA Rules

Drawing on the recent post by Darren in regards to the levels of US state taxes and the effect on player income [ "A Taxing Discussion"], I thought I would look at the tax rates and how they factor into soccer contracts on a worldwide scale.

The talk started with the recent Arsenal singing of Andrei Arshavin and him being upset about having the bulk of his wages taken by the current 40% upper level tax rate in England, after coming from paying only 13% in Russia. He even fired his agent as he was unimpressed with what he was able to deliver [ Arsenal Star Andrey Arshavin Sacks Agent Dennis Lachter]. News gets worse for those making over £150,000 a year as they will soon be paying 50% on their income.

Look at this in comparison to Spain. In an attempt to lure top CEOs to the nation, Spain passed a bill allowing the first five years of your higher tax rate to be cut to an attractive 24%, significantly lower than that charged by their English counterparts. Now look at where Kaka and Ronaldo have recently transferred to. That’s right, Spain. Ronaldo would have lost about £15 million over the life of his contract if he stayed in England. [ Premier League can't compete with low taxes in Spain]

English club Manchester United was linked with player Karim Benzema, who ended up signing with Real Madrid.  Could taxes have played a factor in that deal also?

Another great example is that of player Jermaine Pennant, who recently signed with Spanish team Real Zaragoza. Whilst still earning a fair amount, Jermaine is on the equivalent of £80,000 a week before tax, as his after tax wage is £40,000. His club is happy to foot the tax bill of £9,200 a week as it’s minimal [ Jermaine Pennant's switch to Real Zaragoza earns him '£80,000 a week']. Now picture him still playing in England. Assuming the close to £50,000 wage he is on, he would receive only £25,000 after tax, losing £15,000 a week on what he currently earns.

As previously mentioned, Russia has a low tax rate of 13%, so if you were a decent player who might be able to play at Championship level in England, would you consider a move to Russia for a better pay deal?

Spain is really the only threat to English football, as other major markets (France, Germany, Netherlands, Portugal) are all hovering around the 40-50% upper level tax bracket. [Source]

However it’s the minor leagues that could entice the lesser known players to countries such as the aforementioned Russia, Switzerland (13.2%) and Turkey (35%). Alread,y high profile players such as Harry Kewell and Milan Baros have made the switch to the Turkish League.  Alternatively, players could play in the U.A.E. which doesn’t have any tax at all!

So how can English football stop the exodus and prevent Spain from taking all the quality players?

The most obvious way is to simply equal the net pay as to which is offered elsewhere. Players and Agents alike have caught on about the tax rates and are now using it to their advantage. Players are already asking for their contracts to include the amount they receive after taxes are taken into account.

As it is now easier (and common) for a player to transfer across the world, the inevitability will be that clubs will have to fork out more money.

Why the Premier League can’t keep up from Sports Agent Blog - Sports Business, Sports Law, Sports Negotiations, NCAA Rules

I really have to hand it to my boys over at Sports Law Blog.  My favorite part of the site is the posts that include suggested new sports law review articles.  I don’t care how busy you are; you need to take the time to stay abreast of the latest news and happenings in your industry.  Reading this site is not enough.  Some law review articles can really take your practice to the next level.

In his most recent New Sports Law Scholarship post, Geoffrey Rapp lists some great reads.  I have already read through From parts unknown: WWE v. Jim Hellwig in the ultimate battle for character copyright, Signing bonus skimming and a premature call for a global draft in Major League Baseball, and the topic I would like to cover in this post: Taxing the business of sports. You may not be able to access these articles without a Westlaw or LexisNexis login.

So back to taxes and what you need to know.  You can save your clients money by knowing which states have state taxes, what those state taxes are, and which states have reciprocal agreements with other states.  For instance, did you know that Florida, Texas, and Washington have no tax on resident or nonresident income?  That means if you are an MLBPA certified agent, you want to keep the Mariners, Rangers, Astros, Rays, and Marlins on your radar.  Unless your client is offered a similar salary by one of those teams and another team in a high tax state (i.e. – California), tax concerns may not be as much of a concern.  But if your client is offered a $4 million per year deal from Oakland, Anaheim, or the Dodgers, and a $4 million/year deal with the Marlins and he does not care where he plays the majority of his games, you should advise him to head to the East coast Sunshine State.

The four major sports leagues have teams based in twenty states that have individual state income taxes.  And those states have nonresident tax laws.  This means that whenever your clients make money for playing in a state with state income tax, they have to pay a portion of their earnings to that state.  To make matters worse, some cities have their own separate, small income taxes.  Playing in Florida, Washington, or Texas won’t allow your client to avoid all income taxes (think Federal, as well), but it could save your client a lot of money (and Geico isn’t even involved).

States with high income tax rates for professional athletes: California (9.3%) – additional 1% if you make over $1 million, Minnesota (7.85%)

States with low income tax rates: Illinois (3%), Michigan (3.9%) – Detroit also has a 1.35% city tax, though.

Pennsylvania is tricky.  There is only a 3.07% state tax, but watch out for those city taxes.  In particular, Philadelphia wants that money.  2.801% city tax for residents. 3.7716% city tax for non-residents of Philadelphia.  Ohio can also be pricey because of a separate Cleveland and Cincinnati city tax.

It’s also good to understand reciprocal agreements between states, but I’ll leave that for a future post..maybe.

A Taxing Discussion from Sports Agent Blog - Sports Business, Sports Law, Sports Negotiations, NCAA Rules