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Exploring How State Taxes Really Affect NBA Contracts

Apr 6, 2014; Miami, FL, USA; New York Knicks forward Carmelo Anthony (7) walks back to the bench during the second half against the Miami Heat at American Airlines Arena. Miami won 102-91. Mandatory Credit: Steve Mitchell-USA TODAY Sports

When free agency rolls around, NBA players are overwhelmed with factors affecting their decision. While many will claim that winning is their sole motivation, this just isn’t true; we’re human beings, and we want to get paid. We also want to, amongst other things, live in an area with nice weather and where our family can feel comfortable.

NBA players earn a whole lot of money. As the average American household earns somewhere around $50,000 per year, very few NBA players make less than $1 million annually.

When you’re making this much money, financial planning is key. A professional athlete has a brief shelf life relative to other careers, so maximizing earnings while you can is crucial. Taxes are an important part of this.

People often cite the difference in state income tax rates as a major factor. Some places, like Texas, don’t have state income tax. Other places, like New York, have quite a significant state income tax. The highest marginal state tax rate in New York state is 8.82%; this may not seem earth shattering for most people, but when you’re figuring out which state to sign a maximum contract in, it makes a difference. The question is, just how much of a difference?

Before we dive into the messy part of this analysis, a few important points should be made. The American tax system is complex, so there are a few concepts that need to grasped at a basic level to understand this analysis.

In America, tax brackets are used. You can see a screenshot of the 2013 federal bracket below, which I grabbed from Forbes.

Picture 13If you earn $400,000, you will not be taxed 39.6% of $400,000. You will pay 10% federal tax on your first $8,925 of earnings. Then, on your next $27,325 of earnings, you will be taxed 15%. This trend continues all the way up to the maximum 39.6% bracket. So, if you earn $500,000 in a year, only $100,000 of that will be subject to the 39.6%.

Additionally, you can’t compute your taxes by simply plugging your earnings into the bracket. Not all income is treated the same; earning a wage or salary from your employee is not taxed the same as dividends from stocks or proceeds from bonds. For the purpose of this piece, we’ll be looking at salaries, as that is how players are payed by their teams.

Players are taxed where they earn their income, not necessarily where they live. This means that you can’t simply duck New York state taxes by buying a house in Texas and claiming residence there. What does this mean for NBA players? It means that the playing field is leveled a bit in terms of state income taxes.

Only paying New York state taxes on 41 games is better than 82 games, particularly when you consider that a few of those games will be played in states with no state income tax, such as Florida or Texas. Likewise, the benefit of no state income tax in Texas is reduced when you still have to travel out of state for many of your games. For reference throughout this piece, the map below shows the maximum tax percentage by state.

income_rates_large

My first tax professor explained the “ability to pay” as the driving force behind the American tax system, and I think this is a good starting point. Essentially, those who have the ability to pay tax will pay the most, and vice versa. One factor that reduces an individual’s ability to pay federal income tax is how much they have to pay in state income tax. The theory behind this is that if Carmelo Anthony makes as much in New York as LeBron James makes in Florida, Melo’s federal tax bill will be reduced because he has to pay much more in New York State tax.

This comes to life in something called itemized deductions. At a basic level, once an individual’s income is determined, certain deductions are made from the income to arrive at their taxable income. Items such as state and local income taxes, donations to charity, business or medical expenses that are not reimbursed, and mortgage interest can all be deducted in some manner. Many people don’t have significant expenses here, so they claim the standard deduction; which is $6,100 in 2013 for a single individual.

Individuals who make a lot of money often do not claim the standard deduction. This is because these high income earners often tends to have a lot of expenses that can be deducted; think about how much they spend on business travel, how much they pay to their respective state, what they donate to charity, etc.

This is where state income taxes matter for NBA players deciding between signing for the Houston Rockets and the New York Knicks come into play; in the itemized deductions, which will be subtracted from the player’s income to arrive at how much they can be taxed.

Contracts are complicated in the NBA, but for assumption purposes, let’s talk about a high level player like Carmelo Anthony, who had plenty of suitors this offseason. Some of them, the Rockets, Mavericks, and to an extent the Heat, play in states with no state income taxes. Then, there were the Bulls, Knicks, and Lakers.

(Note: I included the Heat because there were some rumblings, legitimate or not. It was probably not going to happen, but it was a scenario people were talking about.)

Just to use a nice round number for all teams involved for comparison purposes, let’s assume that Carmelo Anthony had a $20 million annual deal on the table from these teams. The real number varied from team to team, but using the same figure will be good for this purpose.

Playing for the Knicks, Bulls, or Lakers, Melo would have gotten a federal tax benefit because he is paying higher state taxes, but the benefit isn’t as strong as you may believe. Because professional athletes make so much, some of the tax benefits available to more modest earners are phased out. The itemized deduction is limited to the lesser of:

1) 3% of Adjusted Gross Income over $250,000 for a single earner

2) 80% of the itemized deductions that would otherwise be available if not for the limit

The first limit applies for a player earning $20 million annually, and the itemized deduction would be limited to $592,500.

In English, what does this mean?

Basically, in either situation, this player can only deduct $592,500 from his adjusted gross income to arrive at his taxable income. State taxes, charitable contributions, and mortgage interest are three of the bigger items included here. The New York player will clear this limit easily, meaning he will just have to “eat” a large portion of the state income taxes he has paid.

It should be noted that even if Melo played for the Rockets, Mavericks, or Heat, he could reach this $592,500 without paying state income taxes in Texas or Florida. With state tax on away games, donations to charity, the interest on their luxurious homes, and the property tax on their fleet of cars, $592,500 really isn’t as much as it seems.

As previously mentioned, the New York player will not pay New York income tax for all 82 games. However, since it has one of the higher state tax rates and I’m trying to show the higher end of the difference, I assumed that this player is indeed taxed in New York for the entire season.

He will pay roughly $1.7 million in state tax in New York, and much of this amount will likely provide little relief on his federal tax bill.

To illustrate the lower end of the difference, let’s assume that Melo in New York pays no state income tax while he plays away from home. This would lead to a state tax bill of about $840,000, which again, would mostly provide no relief on the federal tax bill.

You can see a screenshot of the “quick and dirty” calculations I ran for the three states where Melo would have paid state tax; New York, Illinois, and California. The assumption is 82 games in the state, which as we know, isn’t true. However, as we pointed out above, the limit on itemized deductions all but makes a more detailed calculation unnecessary.

With the property taxes Melo will pay on his cars, houses, and his charitable contributions, he’ll hit this limit regardless of what state he’s in.

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The difference amongst scenarios is a few hundred thousand dollars. Is this worth stressing over?

I’ll never say that a few hundred thousand dollars isn’t a lot of money. However, when this conversation arises with players like LeBron James, Chris Bosh, Carmelo Anthony and Dwight Howard, there are more important considerations.

For a player likely on his last big contract, it would make more sense to stay home and grab the extra guaranteed year that your hometown team can offer through your Bird Rights, even if that means staying in a place with higher state income taxes.

Players sometimes have bonuses set up in their contracts. You may save a few hundred thousand by going to Texas and paying less in state taxes, but you may be better paying more in state taxes and surrounding yourself with teammates who can help you get that bonus money.

And let’s not forget endorsements. Sure, you’ll pay your fair share of income taxes in a bigger market like California or New York. However, the exposure for a player making $20 million annually could very well lead to an extra endorsement deal or two that will easily offset the state taxes.

This is a much tougher conversation with players that earn less money. However, the conversation often arises with the stars, and the fact of the matter is there are more important financial factors. Instead of talking about how much money Melo would have saved in state income taxes playing for the Houston Rockets, we should probably recognize that a 30 year old should be more concerned with the extra year of guaranteed near-maximum money.

 

Mark Evans

Mark is an accountant for PwC and a sad Boston Celtics fan. You can follow/tweet at him @JrMarkyMark

5 Comments

  1. I’m not an expert in US tax Law, but two things came to my mind: you forgot the tax of the city of New York, which you have to pay in adition to that 8.82%. And you are making your calculations using the player salary. Which, depenfing on tge player, is not right. Other incones are taxed too. For example, for Lebron, being in LA means he has to pay extra taxes for the 50 millions he makes in endorsements and the 30 millions benegits he got from his shares in Beat. 12% of 100 millions is way more than 12% of 20 millions.
    Taxes matter.

    • Obviously there are other factors, but as the title suggests, we just focused on how they change the value of a contract.

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