How Tax Reform Impacts Baseball

Last week, colleague and attorney extraordinaire Nathaniel Grow sent me an article — specifically, an Accounting Today piece by Michael Cohn — regarding potential changes to major-league baseball trades as a result of the recent tax reform law. I decided, using that piece as a start, to determine what impact the legislation would have on MLB teams generally, if any at all.

As it turns out, the new law does impact them. A lot.

Let’s begin with some background. What we colloquially refer to as the “tax reform law” is actually more properly called by its title, the Tax Cuts and Jobs Act. The law made sweeping changes both to individual and corporate tax rates and regulations. Most of it is outside the scope of our concern here. It’s essential to remember, however, that baseball teams are all businesses. There are, of course, different types of business ownership structures — some are corporations, some are partnerships, some are limited liability companies — but the underlying point is that they are all business entities of some sort or other. And so the changes in the tax code impact how every team operates.

Now, a fair warning: this involves a discussion of tax law, which isn’t famous for producing scintillating content. Also note that what follows represents a gross oversimplification for purposes of brevity. In other words, don’t go doing your taxes based on the information provided here.

Ready? Let’s go.

For businesses, the most recognizable change in the law is the reduction in the corporate tax rate to 21%. On the surface, that sounds good for baseball teams: paying a lower tax rate would appear to mean more money for them. But, as with all things legal, it’s not quite that simple. That’s because available tax deductions have been greatly reduced, as well. A tax deduction is basically a provision that allows one to lower the amount of income exposed to taxation. A tax deduction is not a direct reduction of a tax bill; however, less taxable income earned can mean less taxes owed. And that’s why, at tax time, some people take advantage of what are known as “itemized deductions.”

It used to be that your business could take a client to a Yankees game and deduct the expense. But after passage of the Tax Cuts and Jobs Act, many of those deductions are no longer available. Explains U.S. News and World Report:

Before the tax bill, companies could deduct 50 percent of a variety of business entertainment expenses, such as client meals, event tickets, charitable event tickets and membership fees. Under the new law, no deduction is allowed for any activity generally considered to be entertainment, amusement or recreation. No deduction is permitted related to a facility used in connection with entertainment, amusement or recreation. Deductions are also disallowed for membership dues with respect to any club organized for business, pleasure, recreation or other social purpose.

For companies, that means no more deductions for client entertainment expenses such as that stadium suite or corporate sky box. No more deductions for client outings with tickets to the big game. The Joint Committee on Taxation estimates the change will bring in $23.5 billion in tax revenue over the next decade. But for team and stadium owners, the deduction elimination could lead to a significant revenue loss.

But that’s not the biggest impact. Under old law, you could deduct your individual state income tax from your federal taxes. But the new law caps that deduction at $10,000, which means that, for players signing multi-million dollar contracts, states without income taxes will become heavily favored. That’s because a player is taxed based on the rate of the state in which he plays on a specific day, and a player spends at least half of his time playing at his home park. So, for practical purposes:

the AL West becomes the most attractive for tax status. The World Series champion Houston Astros, along with the Texas Rangers and Seattle Mariners, all have no state income tax. That means a player on one of those teams would play 99 or 100 of 162 games in states with no tax.

But it’s worse yet: that $10,000 cap also must include property and sales taxes that were previously deductible, and aren’t now. As Newsday explains, a player on the Angels with a $10,000,000 annual salary will lose $650,000 by playing half of his games in California.

Now, some teams can balance out this disadvantage by including what’s called a tax equalization clause in their player contracts. That just means the additional tax liability is absorbed by the team, though — a tax hit the team didn’t have before, and a disincentive to sign free agents who demand it. Given the size of the tax bills, it could be a significant one, especially for players like Bryce Harper expected to command mega-contracts next offseason. If Bryce Harper signed with the Dodgers for $40,000,000 annually, he could lose millions of dollars in additional taxes relative to a team like the Astros or Marlins (yes, I know).

Recognizing this, states like New York have proposed potential workarounds by shifting liability to business owners in the form of payroll taxes, which are still deductible. That would mitigate the tax hit somewhat, but nothing’s been enacted yet. And if we’re looking ahead to the 2018-19 offseason, with stars like Harper, Josh Donaldson, Clayton Kershaw, and Manny Machado all up for mega-contracts, these tax issues could very well impact where they go.

Nor is that the end of it. It also used to be that players could deduct their agent’s commission and union dues. Now they can’t do that anymore, either. Those dues are relatively cheap — $17.6 million total last year, and $80 daily per player. But agent commissions are a lot more, sometimes at 4-5% of total contract value. So Bryce Harper can’t deduct the $20 million fee Scott Boras would get on his upcoming $400 million contract. And this creates a powerful incentive for players to seek out the least expensive representation.

This could all lead to pretty significant changes in free agency, assuming teams and players care about these tax issues. And we’ve seen teams move away from free agency already, instead relying on trades for roster construction. Except… the tax law impacts that, too. The reason is how trades are characterized in law. When teams conduct a trade, they’re not actually exchanging people. People aren’t property, and therefore can’t be bought, sold, or traded for each other. Instead, what baseball teams do is trade the rights to employ people, as memorialized in the contracts between the team and player. In other words, teams are swapping contracts.

It used to be that trading players was considered a “like kind exchange.” That’s a technical way of describing a swap for items of the same kind — as opposed to one party using money to acquire an item from another party. You can find like-kind exchanges in Section 1031 of the Internal Revenue Code — or, you could find them there until tax reform made like-kind exchanges of non-real property assets taxable. In other words, teams now have to pay taxes on trades they make, depending on whether or not they realized a “taxable gain” from the trade. And if you’re talking about deals for stars on big contracts, that matters, but potentially not in the way you think.

According to the tax law firm of Seward and Kissell,

[t]he value of a player rests in his or her future performance, which is difficult to predict. Teams may have to adopt or develop a method of valuing player contracts for tax purposes, such as actuarial values based on player age and the average length of a professional sports career. Teams trading players would then recognize gain or loss on a contract when a player is traded equal to the difference between the contract’s actuarial (or other) value and the team’s basis in the contract.

That’s right: the contract value isn’t the thing. The asset value is. So let’s say that the Angels dealt Albert Pujols to the Orioles for Austin Hays, and the O’s assumed all of Pujols’s contract. (Yes, this is a stupid trade that would never happen, but just go with it.) Common sense dictates that the Angels would have to pay taxes for being relieved of Pujols’ salary burden. But that’s not how it would work. Instead, the Angels would be taxed on the difference in projected player surplus value between Pujols and Hays, which is obviously quite sizable. And the Orioles would take on a negative-value asset, which means (in theory) they could get a tax reduction or even a refund (depending, obviously, on many other factors).

Now this is, to a large degree, speculative because we don’t know how the IRS is going to allow teams — and their very creative accountants and attorneys — to value assets. But if they value assets in any way similarly to how FanGraphs does, we could see a massive change in how trades are conducted. All of a sudden, negative-value assets could have positive tax repercussions, which means they have some value to ownership.

That means trades of superstars would be disincentivized because of the massive gain realized by the acquisition. In theory, this could — emphasis could — create a significant incentive to invest in free agency to avoid negative tax repercussions. Unfortunately, remember that this also makes free agency more expensive for teams in states with income taxes. And that means that the net effect of the tax reform law could be to depress spending overall — not good news for the MLBPA after this offseason.

We hoped you liked reading How Tax Reform Impacts Baseball by Sheryl Ring!

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Sheryl Ring is an attorney and the Director of Fair Housing at Open Communities, a non-profit in the Chicago suburbs. You can reach her on twitter at @Ring_Sheryl. The opinions expressed here are solely the author's. This post is intended for informational purposes only and is not intended as legal advice.

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ScottyB
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Member
ScottyB

My wife is a stage actress, and like most in her profession, is being hurt by the tax bill- for many of the points Sheryl makes in this excellent article. Most stage actors make only $30-$70k a year, but were at least able to deduct many expenses (agent fees, union dues, promotional materials, headshots, coaching, copies, postage, travel in search of work), offsetting much of their tax burden. No more.
At least baseball players get paid enough that the lowered overall tax rates really help them, offsetting much of what this article discusses.
(Also, thank you for correctly adrressing how state income tax works for athletes, actors and other who travel for work. So many other sports articles oversimplify this issue).

CliffH
Member
CliffH

“promotional materials, headshots, coaching, copies, postage, travel in search of work”

This stuff isn’t deductible? I think it would be, plus she would get the standard deduction on top of that because these deductions would come off the top as business expenses. She can also form an LLC and take a 20% reduction in taxable income off the top. Someone making $30-70k is probably not paying much federal income tax.

Steve Balboni
Member
Member

Are actors eligible for that 20% deduction? They carved out a lot of “goodwill” type businesses.

Also, a lot of those actor expenses were below the line itemized deductions, lost to the 2% floor and AMT. That’s why loan-outs are prevalent in that industry.

alexj
Member
alexj

The service business limitation doesn’t apply if taxable income is under $315k

Shalesh
Member
Shalesh

The tax law raises the standard deduction to $24k for a family or to $12k for an individual. The whole point is so that tax compliance is simpler, people don’t have to itemize. Economists have called for “widening the base, lowering the rates”, which is what the tax law does. I doubt your wife’s headshots and acting classes cost more than $12k and her income tax rate probably came down as well.

The tax cuts poll amazingly as if they were tax increases. Every working person and business in America should get a tax cut except for high-income or high-property wealth people in high-tax states.

Paul-SF
Member
Paul-SF

Well, the problem is that the tax cuts for individuals are temporary while the tax cuts for corporations are permanent, and when the temporary individual cuts expire, projections indicate the overall effect of the bill will be an increase on many individuals.

I agree that in the short-term, the effects are likely to be neutral-to-beneficial for most schlubs like us (I’ve already seen an increase in take-home pay because of the changes in the withholding tables), but it’s not too amazing why it polls like a tax increase: because as written it ends up being a tax increase for a lot of people.

Steve Balboni
Member
Member

Temporary = 10 years. (And woe to that future congress that allows it to sunset (e.g., Congress + Obama extended the Bush tax cuts for all the schlubs).)

Even if 2028 reverts to 2017 rates, why do you call that a “tax increase”? It’s just the same old taxes after a 10 year tax holiday.

Paul-SF
Member
Paul-SF

Because the law also changes the way in which the IRS calculates tax brackets, using a lower level of inflation than used under current law. Which means those tax brackets will snap back into slightly different places, and people earning the same amount in 2028 will be in higher tax brackets than those earning that amount in 2017. The Tax Policy Center estimates taxes in 2028 will increase *relative to 2017* for 53 percent of the population. It won’t be for the top-earning 53 percent of the population either.

Steve Balboni
Member
Member

So the tax “increase” is baked into the delta between the old and new method for calculating inflation, TPC forecast inflation under both methods and finds a tax increase for a majority of people in the bottom brackets?

That’s interesting analysis, I haven’t heard that complaint before (heard plenty of others, though). What’s the magnitude? What’s the actual dollar amount of the increase for a $40,000 taxpayer?

Paul-SF
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Paul-SF
mikejunt
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Member
mikejunt

Also, this is cut is offset by the removal of personal and dependent exemptions. For myself, a single person, doubling the standard deduction lowers my taxable income substantially and will give me a decent cut (until they sunset).

For my assistant manager, married with 3 kids, the lost of the dependent exemptions outnumbers the change to the standard deduction, and provides him with basically no difference in taxable income.

This is the first tax cut in the history of the country that rewards single people with no kids and doesn’t help families.

Shalesh
Member
Shalesh

Your Assistant Manager got a $1,400 child tax credit for each of his three kids so I’m sure he’s a big beneficiary. “Doesn’t help families” just proves my point that the messaging against the tax cuts has been better so far than the messaging for it, though the polls seem to be coming around as Americans see their paychecks. Wait till your Assistant Manager fills out his return in a month.

Corporate tax cuts are more vulnerable politically than individual tax cuts. Thus, make them permanent and dare the other party to raise individual taxes (which couldn’t be made permanent for budget scoring purposes). I doubt we see individual taxes go back to the Obama rates and deductions. Even if they did, how would going back to the Obama rates count as an increase from the Obama rates?

mikejunt
Member
Member
mikejunt

His return will be for taxes from 2017 which are not at all affected; he won’t see a change on a tax return until April, 2019.

The per-dependent exemption was $4150. The tax credit does not replace it, and does not apply to all dependents.

You don’t really know what you’re talking about.

eddiestilson10
Member
eddiestilson10

Well said sir

aschrag83
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Member
aschrag83

I guess it’s good messaging to pretend the $1400 refundable portion of the CTC is all brand new, but $1000 of it already existed under previous law.

CliffH
Member
CliffH

“I guess it’s good messaging to pretend the $1400 refundable portion of the CTC is all brand new, but $1000 of it already existed under previous law.”

Well it used to phase out at a much lower income. Also keep in mind a $1400 credit is about the same as a $4150 deduction for many people. I have a bunch of kids and I definitely come out ahead although there are many reasons for that.

eddiestilson10
Member
eddiestilson10

Pretty sad even a baseball blog gets spammed by an ignorant conservative troll.

OddBall Herrera
Member
OddBall Herrera

Troll? I see a person making cogent points – you can accept his arguments or not, but he’s contributed a lot more value to this conversation than you have so far.

OddBall Herrera
Member
OddBall Herrera

It does help families, it’s just at around 3 kids it doesn’t. I have one child and can tell you that it was a significant change in income.

Interesting thing is – the average houshold in the U.S. has under 3 people in it (per https://www.census.gov/prod/cen2010/briefs/c2010br-14.pdf)

So saying that this doesn’t help families is ignoring the fact that 60% + percent of families have only one or two children, at which point the child tax credit does generally outweigh the loss of the dependent exemption.

Shalesh
Member
Shalesh

Thanks Oddball, I appreciate it! I probably shouldn’t have written at the level of a specific family’s situation. Thanks for clarifying that the tax cuts aren’t as beneficial for families with 3+ children.

Pepper Martin
Member
Pepper Martin

“High-income or high-property wealth people” is a very very very broad oversimplification of things. Every single person I know who owns a house pays more than $24K in property taxes and personal income taxes. I’m not talking mansions. I’m talking a regular-old three bedroom, two bath house on a 1/8th of an acre or a 1/4 acre of property, where property taxes can be expected to run around $18,000 per year. And if you make enough money to be able to afford that modest house, you’re absolutely paying more than $6,000 in state income tax.

Basically, this law specifically targets places that care enough about their public schools to fund them well. It definitely constitutes a tax increase for me — I don’t own a home, but my state and local income taxes are far in excess of $24,000 a year. I make enough money that it doesn’t really affect me either way, but it’s still disheartening to think about how it’s going to affect my ability to buy a home down the road when my kid’s old enough to start kindergarten and I have to move out of Brooklyn.

Shalesh
Member
Shalesh

So at a 2-3% property tax rate, that implies a house in the $600k – $900k range. So, maybe only the top decile of Americans can afford a home in that range or higher. This is where they drew the line.

The tax does motivate states to lower their property and income taxes. WA, TX, FL don’t care about their public schools? Do children in NY schools perform much better than in low-tax states? Or is your cost of labor just higher than everywhere else …in public schools, dock workers (longshoremen’s unions), Metropolitan Transit Authority (see the NYTimes series on the “most expensive mile of subway track on earth”), etc? And your zoning laws more restrictive and project-labor agreements make all building more expensive…

Pepper Martin
Member
Pepper Martin

PLA’s do make buildings more expensive, but they also guarantee that construction workers aren’t being exploited.

And yes, I would certainly say that places like Florida and Texas don’t care about their public schools. On Long Island, where I’m hoping to be able to buy a house some time in the next 5 years or so, the average amount spent per pupil per year is about $23,000. In Florida, that number is about $7,000. In Texas, it’s about $6,000. And you get what you pay for. In my public high school graduating class of 120 people, every single graduate went on to a 4-year college; 20 people went to Ivy League schools, and half of the graduating class went to Universities ranked in the top 50 nationwide in the USNews rankings. There’s a reason that people pay that kind of premium to live in places like that.

Shalesh
Member
Shalesh

Does all of NY state look like your wealthy neighborhood in Long Island? I’m sure there are wealthy neighborhoods in FL, TX, and WA that have the same achievement levels and maybe higher, perhaps at the same cost, perhaps lower. I don’t think the relationship of gov’t service quality to spend is linear, ie pouring more and more money into a broken model doesn’t make it better.

More likely, most of NY state looks like most of America. My public school class of 650 had a much more diverse distribution of talent than yours did. (Ie, many who are more trades-material than college-material.) No way my neighborhood could have supported $23k/yr per pupil. That might be more than my neighborhood could support for college, in fact.

Sounds like you’ll be fine in any tax regime. Most people want lower rates and competent government services. If they want better, they’ll pay a premium for something in the private sector like most Democratic Party politicians do when they send their kids to private schools.