Yankees Re-Sign Derek Jeter, Lower Luxury Tax Calculation

Worth noting: Joel Sherman of the New York Post suggests that pretty much everything written below is wrong.

It is certainly possible that I’ve interpreted the luxury tax calculations incorrect. The post will be updated once I have clarification.

Derek Jeter is going to stay with the Yankees, surprising absolutely no one. This was never really in doubt, especially because Jeter had the right to ensure he played 2014 in New York, thanks to a player option that was added to the end of his three-year, $51 million option on the deal he signed in 2010. He could have exercised his right to become a free agent, but heading into his age-40 season and coming off the worst year of his career, interest probably wouldn’t have been overwhelming. And it’s unlikely he wanted to end his career in any other uniform, so this was always the expected outcome.

However, the actual announcement sheds some fun light on the details of how the CBA works and how the luxury tax is calculated. The Yankees could have just let Jeter exercise his player option — listed as $8 million, but reported by Jon Heyman to actually be worth $9.5 million — but instead, they signed him to a new contract that will pay him $12 million next year instead. Why the $2.5 million to $4 million raise over what his own player option called for?

Three words: the luxury tax. The Yankees have been desperately trying to get under the $189 million threshold, and by paying Jeter more, their tax calculation is actually going to go down.

Here’s how this works. On multi-year deals, the luxury tax takes the average annual value of the deal and applies it evenly to each year, so the actual salary earned by the player in that season is less important than the total figure earned during the life of the deal. Because Jeter’s expiring deal was for $51 million over three years, if he had exercised his $8 (or $9.5) million option, that would have been a continuation of the deal, so the calculation would have been $59 (or $60.5) million over four years, or essentially $15 million per year.

Because this is a new contract and not a continuation of the old contract, Jeter will count $12 million against the team’s luxury tax payment for 2014 instead, so by paying Jeter more than he was scheduled to make, they’ve actually lowered their luxury tax calculation by about $3 million. Which, you know, is pretty silly, but this is how the calculations work.

$3 million might not seem like a huge deal, but there’s a huge difference for the Yankees in having their calculation come in at $188 million instead of $189 million. Because they are a multiple time payer of the luxury tax, they pay a 50% tax on the amount they are over the threshold. If they get under the $189 million figure even just once, then they can safely go back over the tax in subsequent years, but their tax rate will be reset to the lowest figure of 17.5%. If they can get under $189 million this year — A-Rod’s suspension should help in that regard — then they could bounce their payroll back into the stratosphere for 2015 and pay much less in tax in the future.

For instance, let’s say they get under the $189 million threshold this winter, then bounce their 2015 payroll up to $250 million after a big off-season spending spree. Instead of paying a 50% tax on a $60 million overage, they’d pay a 17.5% tax on that overage, so their 2015 tax bill would be $11 million instead of $30 million.

Maybe the Yankees have enough money where they don’t really need to worry about $10 million here or $20 million there, but they’re still a business, and every business in America tries to pay as little in taxes as possible. In this case, the Yankees were able to potentially lower their tax rate by re-signing one of their most marketable players. Seems like a pretty decent use of a few million to me, even if Jeter is no longer what he once was.




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Dave is a co-founder of USSMariner.com and contributes to the Wall Street Journal.

26 Responses to “Yankees Re-Sign Derek Jeter, Lower Luxury Tax Calculation”

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  1. Brett says:

    I believe there are revenue sharing implications of getting under the luxury cap for a year, as well, and that’s where the huge savings are coming from. The particulars are escaping me at the moment, though.

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    • Nyyfaninlaaland says:

      The RS implications come with the potential returns on Rev Sharing contributions based on the 15 or so markets that are being phased out of receiving as I recall. But I think the potential pay back is now viewed as less then some originally speculated.

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  2. Jetrer says:

    This is not how luxury tax works for player options, at least according to the CBA. Player options where the buyout is less than half of the option value are treated the same as guaranteed years for luxury tax purposes, which would make Jeter’s original deal 4/$56M ($14M AAV) for luxury tax purposes. The $1.5M bonus earned for winning the Silver Slugger in 2012 would be applied in the year paid – 2014. This would seem to make the price of Jeter’s 2014 option for luxury tax purposes $15.5M ($14M AAV + $1.5M award bonus).
    It also appears in the CBA that because of this rule, some of the last contract would carry over to 2014, beyond the new 2014 contract, because what he’d been paid from 2011-13 would be more than the amount that was taxed in those years.. This amount would be about an additional $6M if new contract was signed as an extension, or up to $9M if he declined his player option and became a free agent before signing the new contract.

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    • Baltar says:

      I am not qualified to judge your interpretation, but why would the Yankees (with presumably the advice of many expensive attorneys, accounts, et. al.) make this move if it increases their luxury tax? Makes no sense to me.

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  3. TanGeng says:

    Hmm… I don’t know if it makes sense.

    Jeter signed for 16 million (2011,2012,2013) 8 million option (2014) 3 million buyout.
    Base AAV 14 million
    Bonus (silver slugger +1.5)
    Total AAV 15.5 million (previously applied)
    As long as Jeter exercises the option Yankees are charged for 9 million.

    If contract is terminated at 3 years. The AAV for previously years becomes 17.5 million.
    If this is the case, Yankees owe back charges at 6 million (3 years x 2 million per year). (which year does this get applied to?)
    If Jeter declines the player option, yankees buy him out at 3 million which triggers contract termination at 3 years and a 3 million buy out. 3 million is charged to 2014. The total there is 9 million but the timing of 6 million in back charge is crucial.

    If Yankees are giving Jeter 12 million, Yankees are doing the equivalent of Jeter declining, paying the buyout, and giving Jeter 9 million in salary.

    I guess the only way that it make sense is if back charges applied to previous years and not counting for 2014.

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    • quincy0191 says:

      I’m with you, but I don’t get similar numbers. I’m going to ignore the SS bonus, because I don’t think it gets counted in subsequent years (and if it does, it should be spread out, so it doesn’t matter much).

      Using a $9.5M player option price, the AAV of Jeter’s deal would be $14.375M (15,16,17,9.5). In re-signing him, the Yankees lower their luxury tax calculation by $2.375M, but raise their 2014 payroll by $2.5M.

      If they just let him exercise the option AND exceeded the luxury tax, they’d pay an overage on his salary of $7.1875M. With the new deal, exceeding the tax would force them to pay an overage of $6M, a $1.1875M savings. But they’re paying $2.5M in additional money, so if they go over the luxury tax, they actually LOSE $1.3125M.

      So what if they don’t exceed the tax? Well, if they don’t exceed the tax with the old contract, they’re paying him just $9.5M for 2014. If they don’t exceed the tax with the new contract, they’re paying him $12M, and they LOSE $2.5M.

      Therefore the only way this works is if they stay under the tax by somewhere between $1 and $2,374,999. In that scenario, the old deal would cost $9.5M+$90M+ for the 50% tax on their entire payroll against just $12M. But if they stay under the tax by $2.375M or more, all they’ve done is increase their 2014 commitment by $2.5M (since they would’ve stayed under anyway), and if they exceed it then they lose just over $1M since they’re paying more in the raise than they’d save in tax money.

      Considering the tiny, tiny size of that window and how uncertain payroll is going to be considering it’s Nov. 1, this is a really stupid decision.

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      • quincy0191 says:

        Addendum: I don’t understand why Jeter got $12M. A $10-11M salary would’ve been higher than the option price, so he still gets a raise, but the smaller difference in AAV between his original contract and the new one would’ve meant that going over the tax still resulted in the Yankees saving money ($1-2M raise, $2M+ tax savings). New York managed to give him just enough that there’s a very good chance they’ll lose money on the deal even with the different tax calculations; does anybody seriously believe they’ll stay under $189M?

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      • TanGeng says:

        Ahh I see. Actually I was being a bit loose with my numbers.

        The 4-year contract AAV is 14 million.
        The 3-year contract AAV is 16 million.
        The SS bonus is a 1 year bonus in 2014 @ 1.5million. (this is charged to a specific year)
        2014 would be 14 million + 1.5 = 15.5

        I’m just going to work with the assumption that Jeter’s new deal effectively makes his old deal a 3-year deal and gives him 12 million this year.

        I hadn’t factored in the possibility that the 6million would go on this year, 2013. If that does happen:

        Yankees pay additional 42.5% of 6 million. + 2.55 million luxury tax in 2013
        Yankees pay 12million instead of 9.5 million next year. +2.5 million in salary 2014
        Yankees get 12 million instead of 15.5 million luxury tax charge in 2014. -3.5 million luxury tax charge in 2014

        It looks like Yankees are paying 5 million now for 3.5 million of luxury tax space in 2014?

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        • triple-A city says:

          Well, $5MM now for $3.5MM tax space and also the right to a rebooted tax bracket, which is worth tens of millions on its own. Right? That seems wise to me but you people seem to have a much deeper and more thorough understanding of this than I do.

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        • quincy0191 says:

          @Triple-A:

          $5M for $3.5M of tax space (those aren’t the number I get, but there’s clearly some confusion and it’s close enough) is a great idea…if you need the $3.5M. If you’re going to exceed the cap anyway (most likely) or stay under it anyway, you’re just paying more for no reason. The only way this makes sense for New York is if they stay under the cap by an amount less than the raise they gave Jeter, which seems extremely unlikely.

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  4. NattyNation says:

    This may be an elementary level question, but say the Yankees added a player option at $1M to the deal, would that further drive down the AAV?

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  5. Anon21 says:

    If Sherman’s correct, what’s the Yankees’ motivation for doing this deal? Surely there was virtually no risk that Jeter would elect free agency…

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    • Ryan says:

      Perhaps the Yankees were mistaken about the way the luxury tax works as well? If so, it sounds like there could be a malpractice claim brewing for any Yankee lawyers who went over the deal.

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      • NS says:

        Stranger things have happened, but it seems likelier that Joel Sherman is wrong rather than highly paid professionals in the field whose living depends directly on getting these things right.

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    • TanGeng says:

      I’m pretty sure Sherman is wrong.

      It looks like Yankees just moved 6 million of 2014 luxury charge to this year, 2013, as a result of this deal. They’re paying an additional 2.5 million in 2014 for that.

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  6. Hoplite says:

    Who originally wrote this article? It wasn’t Dave Cameron. The original article and all it’s comments are gone.

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  7. Will says:

    Sherman seems to be back tracking a bit. Depending on how luxury tax underpayment is handled, Yankees are either going to have AAV that is $2mn higher in 2014, or $3.5mn lower with a penalty on $6mn under-reported AAV paid retroactively.

    The math and relevant CBA passages are here: http://www.captainsblog.info/2013/11/01/method-or-madness-a-closer-look-at-derek-jeters-contract-extension/20911/

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  8. pft says:

    Sherman is definitely wrong, that penalty won’t be applied in 2014. AAV drops from about 14.5 to 12. It does cost them significantly more money overall (about 9 million), just not all of it for 2014 (increased salary in 2014 offset by lower AAV) , which just goes to show the 189 goal is really a mandate.

    If Jeter was the man the Yankees fans think he is he would have taken a 1 million dollar deal with playing time incentives bringing it up to 9.5 million. Instead he negotiates for a raise, guaranteed regardless of playing time, knowing the team is going to cut salaries.

    Jeter gets about 20 million in revenue from endorsements to go along with his lifetime MLB earnings of 250 million, so 2 -3 million is chump change for him.

    I don’t blame Jeter, he is just doing what mere mortals do, go for as much as you can get. But lets end the myth he is something more than that. Watch him kick and scream when they try and move his living statue from SS to 3B as he shatters UZR’s worst ever ratings.

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    • DNA+ says:

      The Yankees didn’t want to sign Jeter to a one year deal with incentives. They don’t treat their franchise icons like that. …besides, how would the players union look at a player declining their own option in order to negotiate a worse deal?!

      …we get that you dislike Jeter, but if you have to invent absurd fantasies in order to paint him as a bad guy, you might want to reevaluate your dislike for the guy.

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  9. jtmorgan says:

    I think he old contract was just a way to try to lower their tax hit in years 2011-2013, but when the new CBA got renegotiated and increased the Tax they would be paying in the following years they got in a sticky situation since they were going to have to pay for the difference this year.

    I don’t think they believed to Jeter would accept his player option unless many incentives were acheived but at $9.5MM with a $3MM buyout this wasn’t happening. They had to increase his pay because he wasn’t going to agree to a $6.5MM contract (since he could just decline and get $3MM of the $9.5MM). On the open market he would have made somewhere in the range that he really is receiving $9MM just off name value from some team even coming off the injury riddled season.

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  10. Hurtlockertwo says:

    AND Jeter gets a raise for being injured all year, go figure.

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    • DNA+ says:

      He didn’t get a raise. He is taking a pay cut in 2014. He is just taking less of a pay cut than if he simply took his option.

      …and he didn’t get less of a pay cut than he otherwise would have because he was injured. He got it because he is Derek Jeter.

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