The Jock Tax

Last season, Cliff Lee had seemingly narrowed his suitors down to the Rangers, Yankees and an unidentified team. About that time, some analysts began to approach his free agency differently.

Instead of analyzing average annual values — or where the deal ranked historically — folks began to calculate which of the two offers would give Lee the most profit, given the tax rates in New York and the lack of one in Texas. While the federal tax code is uniform, the rates across states and cities are wildly divergent. With that in mind, it stood to reason that Lee could conceivably take home more net compensation in a deal that, on the surface, appeared lesser in value than other offers.

Stories that marry together my careers — accountant and baseball analyst — are always intriguing. But I’ve noticed errors in these analyses. Primarily, the new-wave tax articles were ignoring the fact that Lee gets taxed in every city and in every state in which he plays.

This concept is nicknamed “the jock tax,” where states and cities tax non-resident athletes who earn income in their territories. This tax applies to everyone working in multiple states — but because athletes’ salaries are widely known, and team schedules are common knowledge, it’s easy for taxing authorities to apply the tax to athletes.

For more of a history lesson on “the jock tax,” peruse my first article on the subject. But instead of digging deep into the history, we’ll summarize its importance, explain how it impacts this free-agent class and discuss a nifty tool I created that analyzes these transactions.

The first key is that an athlete is liable for taxes in two primary states: his actual state of residency and the home state of his employer. A Phillies player whose residence is in Alabama owes tax to both states. Some states offer credits for taxes paid elsewhere to avoid double taxation, but there are convoluted rules in certain states where double taxation occurs.

In 1999, Sammy Sosa played for the Cubs and was considered a resident of Illinois. The Illinois Income Tax Act provided credits for taxes paid to other states for their residents, but not for residents of Illinois who played for teams within the state. Because Sosa played for the Cubs and made his residency in Illinois, he was taxed twice — whereas an Illinois resident playing for the Pirates would be taxed just once. Sosa filed to have parts of the act rendered unconstitutional but he ultimately lost the case.

Taxes are calculated using the “duty days” method. There are 220 duty days in a baseball season, and a duty day is really considered to be any day during the season where professional activities are undertaken. This includes traveling or off-days in a regular season. If Chase Utley travels to San Francisco on Monday to play a three-game set from Tuesday to Thursday, he’s liable for tax in San Francisco from Monday through Thursday.

And given even more convoluted rules, it’s possible he owes tax to Pennsylvania on Monday as well, since some states consider a travel day that began in their jurisdictions to be a taxable event. But duty days are used as the prorating tool for calculating tax liability in different jurisdictions.

If Player X makes $10 million and spends four duty days in Pittsburgh — 3.07% state rate for Pennsylvania, plus a 1% rate for Pittsburgh — he’s liable for $7,400 in taxes for that trip. The $10 million is prorated to around $182,000 for the four duty days, and tax is incurred on that prorated salary. From this little exercise, it’s clear that taxes for athletes add up.

But most cities don’t have local individual income taxes. Some states don’t have an income tax, either. Florida, Texas and Washington don’t levy statewide personal income taxes, which is why many athletes either flock to those destinations, or they try to establish residency there. Derek Jeter is clearly Mr. New York, but he was sued by New York City at the beginning of the millennium since he claimed he was a Floridian. If New York were his resident state, his salary and endorsement money would be hit much, much, much harder.

Because of the varying tax rates and unbalanced schedule where teams play divisional foes much more often, it’s possible for deals to net a player more while appearing less lucrative. To that end, I devised a spreadsheet with a friend, Tony Franco, that calculates the effective state/city tax rate for each team. The spreadsheet is based on the rates in their jurisdictions and the actual major league schedule.

Some teams have benefits: the Rangers and Mariners (remember that Texas and Washington have no state or local income taxes), play at least 90 of their 162 games against each other or at home. The Astros play 81 games without tax, and another 25 against divisional rivals with lower rates (Pirates, Cardinals, Cubs).

The Astros have the lowest effective state/city tax rates for 2012, with the Rangers and Mariners close behind. The team playing in a state that does have a personal income tax — with the lowest effective rate — is the Arizona Diamondbacks. Still, there’s a pretty big gap between the Astros, Mariners, Rangers, Marlins, Rays and then the Diamondbacks. Those first five teams range from 2.55% to 2.97%, whereas the Diamondbacks are at 4.54%. The Mets and Yankees are at the bottom of the list at 7.45% and 7.74%, respectively. The Phillies, Orioles and Blue Jays round out the bottom five: Ontario has a rather high provincial rate, and both Philadelphia and Baltimore have high local tax rates.

Keep in mind these figures are based on actual applicable rates and the actual major league schedule. However, it does assume duty days are taxable only to the destination, and it uses averages for cities and states with progressive rates (the more you make, the higher the tax). When discussing specific transactions, we’ll of course tailor it to the needs of the player in question. Fielder’s salary might require the high-end of a progressive tax rate for a specific city or state, while Willie Bloomquist’s would use the lower end.

When discussing the signings of Albert Pujols, Prince Fielder and whoever else inks a lucrative deal, the effective tax analysis can normalize the differences between offers accepted and offers declined. Incorporating tax analysis can help make sense of why certain players go for one deal over another, or why they seem to “leave money on the table” — when they’re actually putting more in the bank.