Ohtani’s New Baseball Contract

I was reading about Shohei Ohtani’s new contract with the Las Angeles Dodgers. If the name rings a bell, that is because he both bats and pitches. He is today’s Babe Ruth. He played with the Los Angeles Angels in 2023, led the American League with 44 home runs and pitched over 130 innings with a 3.14 ERA.

I am more an NFL than an MLB fan these days, but it is hard to ignore this guy’s athletic chops. It is also hard to ignore his new contract.

•  Contract totals at $700 million
•  He will draw “only” $2 million for the first 10 years.
•  He will draw the deferral (that is, $68 million annually) beginning in 2034 and through 2043.

At $700 million, Ohtani’s is the largest MLB contract ever, but what caught my eye was deferring 98% of the contract for over a decade. Do not be concerned about his cash flow, however. $2 million a year is sweet (that is way over CPA bank), and I understand that his endorsements alone may exceed $50 million annually. Cash flow is not a problem.

Why would Ohtani do this?

For one, remember that athletes at his level are hyper-competitive. There is something about saying that you received the largest contract in MLB history.

Why would the Dodgers do this?

A big reason is the time value of money. $100 ten years from now is worth less than $100 today. Why? Because you can invest that $100 today. With minimal Google effort, I see a 10-year CD rate of 3.8%. Invest that $100 at 3.8% and you will have a smidgeon more than $145 in ten years. Invest in something with a higher yield and it will be worth even more.

Flip that around.

What is $100 ten years from now worth today?

Let’s make it easy and assume the same 3.8%. What would you have to invest today to have $100 in ten years, assuming a 3.8% return?

Around $70.

Let’s revisit the contract considering the above discussion.

Assuming 10 years, 3.8% and yada yada, Ohtani’s contract is worth about 70 cents on today’s dollar. So, $700 million times 70% = $490 million today.

My understanding is the experts considered Ohtani’s market value to be approximately $45 million annually, so our back-of-the-envelope math is in the ballpark.

Looks like the Dodgers did a good job.

And deferring all that money frees cash for the Dodgers to spend during the years Ohtani is on the team and playing. He may be today’s Ruth, but he cannot win games by himself.

There is one more thing …

This is a tax blog, so my mind immediately went to the tax angle – federal or state – of structuring Ohtani’s contract this way.

Take a look at this bad boy from California Publication 1005 Pension and Annuity Guidelines:

          Nonresidents of California Receiving a California Pension

In General

California does not impose tax on retirement income received by a nonresident after December 31, 1995. For this purpose, retirement income means any income from any of the following:

• A private deferred compensation plan program or arrangement described in IRC Section 3121(v)(2)(C) only if the income is either of the following:

1.    Part of a series of substantially equal periodic payments (not less frequently than annually) made over the life or life expectancy of the participant or those of the participant and the designated beneficiary or a period of not less than 10 years.

Hmmm. “Substantially equal periodic payments” … and “a period of not less than 10 years.”

Correlation is not causation, as we know. Still. Highly. Coincidental. Just. Saying.

Ohtani is 29 years old. 98% of his contract will commence payment when he is 40 years old. I doubt he will still be playing baseball then. I doubt, in fact, he will still be in California then. He might return to Japan, for example, upon retirement.

That is what nonresident means.

Let me check something. California’s top individual tax rate for 2024 is 14.4%.

COMMENT: Seriously??

Quick math: $680 million times 98% times 14.4% equals $95.96 million.

Yep, I’d be long gone from California.

 

The Gig Economy

Say that I retire. Perhaps my wife wins the lottery or marries well.

I get bored. Perhaps I would like a little running-around money. Maybe I flat-out need extra money.

I find a website that connects experienced tax practitioners to people needing tax services. There might be specializations available: as a practitioner I might accept corporate or passthrough work, for example, but not individual tax returns. I could work as much or as little as I want. I might work Friday and Saturday afternoons, for example, but not accept work on weekdays. I could turn down or fire clients. I could take time off without fear of dismissal.

There would have to be rules, of course. Life is a collection of rules. I might have to provide my state license to substantiate my credentials. I might have to post an E&O policy. It seems reasonable to expect the website to impose standards, such as for professional conduct, client communications, timeliness of service and so on

How would I get paid?

I am thinking that I would bill through the website. An advantage is that the website can devote more resources than I care to provide, making the arrangement a win-win-win for all parties involved. The website would collect from the client and then electronically deposit to my bank account.

Here is my question: is the website my employer?

Don’t scoff. We are talking the gig economy.

The issue has gained notoriety as states – New Jersey and California come to mind – have gone after companies like Uber and Lyft. From these states’ perspective, the issue is simple: if there is more than a de minimis interdependence between the service recipient and provider, then there must be an employment relationship between the two. Employment of course means FICA withholding, income tax withholding, unemployment insurance, disability insurance (in some cases), workers compensation and so on.

Let us be honest: employment status is Christmas day for some states. They would deem your garden statue an employee if they could wring a dollar out of you by doing so.

New Jersey recently hit Uber with a tax bill for $650 million, for example.

The employee-independent contractor issue is a BIG deal.

What in the world is the difference between an employee and an independent contractor?

People have been working on this question for a long time. The IRS has posited that employment means control – of the employer over the employee – and also that control travels on a spectrum. As one moves to the one end of the spectrum, it becomes increasingly likely that an employer-employee relationship exists.

The IRS looks at three broad categories:

(1)  Behavioral control

(2)  Financial control

(3)  Relationship of the parties

The IRS then looks at factors (sometimes called the 20 factors) through the lens of the above categories.

·        Can the service recipient tell you what, where, when and how to do something?

·        Is the service recipient the only recipient of the provider’s services?

·        Is the service relationship continuing?

Answer yes to those three factors and you sound a lot like an employee.

Problem is the easy issues exist only in a classroom or at seminar. In the real world, it is much more likely that you will find a mix of yes and no. In that event, how may “yes” answers will mean employee status? How many “no” answers will indicate contractor status?

Answer: no one knows.

Some states have taken a different approach, using what is called an “ABC” test. There was a significant case (Dynamex) in California. It interpreted the ABC test as follows:

(1)  The service provider is free from the direction and control of the service recipient in connection with the performance of the work.

(2)  The service provider performs work outside the usual course of the service recipient’s business.

(3)  The service provider is customarily engaged in the independent performance of the services provided.

I get the first one, but I point out that it is rarely all or nothing. If we here at CTG Command bring on a contractor CPA – say for the busy season or to collaborate on a tax area near the periphery of our experience – we would still have expectations. For example,

·        our office hours are XXX

·        reviewer turnaround times to tax preparers are XXX

·        responses to client calls are to occur with XXX hours or less

·        responses to me are to occur within X hours or less

·        drop-dead due dates are XXX

How many of these can we have before we fail the A in the ABC test?

Let’s look at B.

We are a CPA firm. Odds are we are interested in experienced CPAs. It is quite unlikely that we will have need of a master plumber or stonemason.

Have we automatically failed the B in the ABC test?

And what does C even mean?

I am a 30+ year tax CPA. I am a specialist and have been for many years. I would say that I am “customarily engaged” in tax practice. Do I have “independent performance,” however?

If I interpret this test to mean that I have more than one client, it somewhat makes sense, although there are still issues. For example, upon semi-retirement, I would like to be “of counsel” to a CPA firm. I have no intention of working every day, or of being there endless hours during the busy season. No, what I am thinking is that the firm would call me for specialized work – more complex tax issues, perhaps some tax representation. It would provide a mental challenge but not become a burden to me.

Would I do this for more than one firm?

Doubt it. I point to that “burden” thing.

Have I failed the C test?

I am still thinking through the issues involved in this area.

Including non-tax issues.

If I take an Uber and the driver gets into an accident – injuring me – do I have legal recourse to Uber? Seems to me that I should. Is this question affected by the employee-contractor issue? If it is, should it be?

This prompts me to think that the law is inadequate for a gig economy.

There is, for example, always some degree of control between the parties, if for no other reason than expectation is a variant of control. Not wanting to lose the gig is – at least to me – an incident of control to the service recipient. Talk to a CPA firm partner with an outsized client about expectation and control.

Why cannot CTG Command gig an experienced tax professional – say for a specific engagement or issue - without the presumption that we hired an employee? I can reasonably assure you that I will not be an employee when I go “of counsel.” You can forget my attending those Monday morning staff meetings.

Am I “independently performing” if I have but one client? What if it is a really good client? What if I don’t want a second client?

Problem is, we know there are toxic players out there who will abuse any wiggle room you give them. Still, that is no excuse for bad tax law. Not every person who works – let’s face it – is an employee. The gig economy has simply amplified that fact.

NCAA: From Cream Cheese To Endorsements

You may have read that the NCAA voted to allow students to benefit financially from the use of their name, image or likeness.

In truth, their hand was forced when California Governor Newsom signed the Fair Pay to Play Act on Lebron’s television show “The Shop.” Other states, including Florida, were also lining up on the issue.

Newsom was striking at an organization that realized over a $1 billion in revenues last year from “student-athletes,” all the while banning players from receiving any compensation other than scholarships.

Mind you, this is the same organization that used to ban schools from serving bagels with cream cheese. The NCAA argued (with a straight face somehow) that a bagel was a snack but a bagel with cream cheese was a meal. Meals were a no-go.

The tax hook for this post came from North Carolina (U.S.) Senator Richard Burr, who indicated he would introduce a bill to tax scholarships if the student-athlete also earns money from endorsements.

Methinks that Senator Burr is not a fan of the new rule.

Alternatively, he may subscribe to the new-economics theory of taxing something until it stops doing whatever triggered its taxation in the first place.

Did you know that some scholarships are already taxable?

Yep, the plain-old variety.

Scholarships used to be tax-free until 1980. The Code was then changed to look at whether services were being performed as a requirement for receiving the scholarship. Teaching assistantships would now be taxable, for example.

There was further change in 1986, when the Code began taxing scholarships used for living expenses.  If one received a scholarship, it was now important to determine whether it was for tuition or for room-and-board. Tuition was tax-free but room-and-board was not.

COMMENT: This change seems erratic to me, considering that The College Board has reported that living expenses make-up over half the cost of undergraduate education.

Scholarships for non-degree students next became taxable.

I would have to think about what national existential peril we barely avoided with that change to the tax law.

Senator Burr would add another exception-to-the-exception if you could buy a jersey with someone’s name on it. Alabama’s Tua Tagovailoa comes to mind. Your being able to buy a jersey with his name and number would make his scholarship taxable. It probably means little in Tua’s case, as he is projected to be a first round NFL draft selection. Take someone in a less prominent sport and the result might not feel as comfortable.

Then again, someone less prominent would probably not get into a payment-for-name, image-or-likeness situation.

New York And State Donation Programs

You may have read that the new tax law will limit your itemized tax deduction beginning this year (2018).

This is of no concern to you if you do not itemize deductions on your personal return.

If you do itemize, then this might be a concern.

Here is the calculation:

        *  state income taxes plus

        *  local income taxes plus

        *  real estate taxes plus

        *  personal property taxes

There is a spiff in there if you live in a state without an income tax, but let’s skip that for now.

You have a sum. You next compare that sum to $10,000, and

… you take the smaller number. That is the maximum you can deduct.

Folks, if you live in New Jersey odds are that real estate taxes on anything is going to be at least $10 grand. That leaves you with no room to deduct New Jersey income taxes. You have maxed.

Same for New York, Connecticut, California and other high tax states.

Governor Cuomo said the new tax law would “destroy” New York.

Stepping around the abuse of the language, New York did put out an idea – two, in fact:

·       Establish a charitable fund to which one could make payments in lieu of state income taxes. When preparing one’s individual tax return, one could treat contributions to that fund as state taxes paid. To make this plausible, New York would not make the ratio one-to-one. For example, if you paid $100 to the charitable fund, your state tax credit might be $90. Surely no one would then argue that you had magically converted your taxes into a charitable deduction. The only one on the short end is the IRS, but hey … New York.

·      Have employers pay a new payroll tax on employee compensation, replacing employee withholding on that compensation.  Of course, to get this to work the employee would probably have to reduce his/her pay, as the employer is not going to keep his/her salary the same and pay this new tax.

Other states put out ideas, by the way. New York was not alone.

I somewhat like the second idea. I do however see the issue with subsequent raises (a smaller base means a smaller raise), possibly reduced social security benefits, possible employer reluctance to hire, and the psychological punch of taking a cut in pay. Ouch.

The first idea however has a sad ending.

You see, many states for many years thought that there were good causes that they were willing to subsidize.

·       Indiana has the School Scholarship Credit. You donate to a scholarship-granting charity and Indiana gives you a tax credit equal to 50% of the donation on your personal return.

·       South Carolina has something similar (the Exceptional SC), but the state tax credit is 100%.

New York and its cohorts saw these and said “What is the difference between what Indiana or South Carolina is doing and what we are proposing?”

Well, for one thing money is actually going to a charitable cause, but let’s continue.

This past summer the IRS pointed out the obvious: there was no charity under New York’s plan., The person making the “donation” was simultaneously receiving a tax benefit. That is hardly the hallmark of a charitable contribution.

Wait, wait, New York said. We are not giving him/her a dollar-for-dollar credit, so …..

Fine, said the IRS. Here is what you do. Subtract the credit from the “donation.” We will allow the difference as a deductible contribution.

In fact, continued the IRS, if the spread is 15% or less, we will spot you the full donation. You do not have to reduce the deduction for the amount you get back. We can be lenient.

So what have New York and cohorts done to Indiana, to South Carolina and other states with similar programs?

You got it: they have blown up their donation programs.

Way to go.

Why did the IRS not pursue this issue before?

Well, before it did not matter whether one considered the donation to be a tax or a deductible contribution. Both were deductible as itemized deductions. There was no vig for the IRS to chase.

This changed when deductible taxes were limited to $10,000. Now there was vig.

There are about 30 states with programs like Indiana and South Carolina, so do not be surprised if this reaches back to you.

Paying Back The ObamaCare Subsidy

I do not see many tax returns with the ObamaCare health exchange subsidy.

Our fees make it unlikely.

However, take an ongoing client with variable income or business losses and we do see some.

I saw one this busy season that gave me pause.

Let’s discuss the McGuire case to set up the issue.

Mr. McGuire was working and Mrs. McGuire was not. In 2013, they applied with the Covered California and qualified for a monthly subsidy of $591, or $7,092 per year. They enrolled in a plan that cost $1,182 monthly. After the subsidy, their cost was (coincidentally) $591 monthly.

Mrs. McGuire started a job that paid $600 per week. She contacted Covered California, as she realized that her paycheck would affect that subsidy.

This being a government agency, you can anticipate the importance they gave Mrs. McGuire.

That would be “none.”

Several months later they did send a letter stating that the McGuires did not qualify for a subsidy.

The letter did not talk about switching to a lower cost plan. Or dropping the plan altogether. Or – be still my heart - provide a phone number to speak with an actual government bureaucrat.

It did not matter.

The McGuires had moved. They tried to get Covered California to update their address, but it was the same story as getting Covered California to update their premium subsidy for her new job.

The McGuires never received the letter.

It goes without saying that they never received Form 1095-A in 2014 either. This is the tax form for reporting an Exchange subsidy.

There are two main individual penalties under the Affordable Care Act:

(1) There is a penalty for not having “qualified” insurance. This is not the same as being uninsured. Have insurance that the government disapproves of and you are treated as having no insurance at all. 

(2) Subsidies received have to be reconciled to your actual household income. Make less that you thought and you may get a few bucks back. Make more and you may have to repay your subsidy. While technically not a “penalty,” it certainly acts like one.

The McGuires indicated on their tax return that they had health insurance (thereby avoiding penalty (1), but they did not complete the subsidy reconciliation (which is penalty (2)).

The IRS did, however.

Sure enough, the McGuires did not qualify for a subsidy. The IRS wanted its money back. All of it.

The McGuires fired back:

We would never have committed to paying for medical coverage in excess of $14,000 per year.”

True that.

We cannot afford it and would have continued to shop in the private sector to purchase the minimal, least expensive coverage or gone without coverage completely and suffered the penalties.”

That is, they would have avoided penalty (2) by not accepting subsidies and instead paid penalty (1), which would have been cheaper.

If we are deemed responsible for paying back this deficiency, it would be devastating and completely unjust. ….  The whole purpose of the Affordable Care Act was to provide citizens with just that, affordable healthcare. This has been an absolute nightmare and we hope that you will rule fairly and justly today.”

Here is the Tax Court:

But we are not a court of equity, and we cannot ignore the law to achieve an equitable end.”

Equity means fairness, so the Court is saying that – if the law is otherwise bright-line – they cannot decide on the grounds of fairness. 

Although we are sympathetic to the McGuires’ situation, the statute is clear; excess advance premium tax credits are treated as an increase in the tax imposed. The McGuires received an advance of a credit to which they were ultimately not entitled.”

The McGuires had to pay back $7 grand, despite the incompetence of Covered California.

Ouch.

Let’s return to CTG Galactic Command. How did my client get into a subsidy-repayment situation?

Gambling.

The tax Code is odd about gambling. It forces you to take gambling winnings into income. The subsidy calculation keys-off that income number.

Wait, you say. What about gambling losses?

The tax Code requires you to take gambling losses as an itemized deduction.

The subsidy calculation pays no attention to itemized deductions.

Win $40 grand and the subsidy calculation includes it. Your household income just went up.

Say that you also lost $40 grand. You netted nothing in real life.

Tough. The subsidy calculation does not care about your losses.

Heads you lose. Tails you lose. 

That was my client’s story.

Now You Say You're Leaving California

I have stumbled into our next story of outrageous state tax behavior.

I was skimming (quickly, trust me) the Supreme Court decision in Franchise Tax Board v Hyatt. It involves a resident of Nevada who sued California. California invoked sovereign immunity, a legal doctrine arising from the era of royalty and asserting that the king can do no wrong and is therefore immune from legal action.

Handy, if you are the king  … or any of California’s countless government agencies.

This case goes back a long way. Gilbert Hyatt moved from California to Nevada in the early 1990s. More specifically, he said he moved in September, 1991. California says he moved in April, 1992.

COMMENT: Sounds like a “poe-tae-toe” versus “poe-taw-toe” moment, on first impression.

California said this meant he owed the state $10 million in taxes, interest and penalties from patent income.

            COMMENT: Of course.

Problem is that the California Franchise Tax Board took some … questionable steps in developing their case against Hyatt:

·        They went through his mail

·        They rifled through his garbage

·        They contacted third parties, including estranged family and people who did not have his best interests at heart

He brought suit … in Nevada courts. There was a previous Supreme Court decision (Nevada v Hall) that allowed a private citizen to bring legal action against a second state, without the second state's consent.

The jury verdict was almost $500 million in damages and fees.

Then California appealed, arguing that Nevada's law limited damages in similar suits against its own agencies to $50,000.  

California got the Nevada Supreme Court to reduce the verdict to $1 million. The Court reasoned that California went a bit further than Nevada would allow, so the $50,000 cap did not apply.

COMMENT: Folks, we need our own state. We could do whatever we want and then hide behind sovereign immunity, hakuna matata or whatever other multi-syllabic nonsense springs to mind.

California was still not happy, arguing that Nevada was exhibiting a “policy of hostility.”      

California appealed to the U.S. Supreme Court, arguing that the Full Faith and Credit Clause of the Constitution applied. The Supreme Court agreed, using words such as "comity" to reduce the damages to $50,000.

My thoughts?

I allow that there may have been a legitimate disagreement at the very beginning of this whole matter. Let’s say that you move most, but not all, of your possessions to another state. You leave some furniture there, as the realtor said that it would help to show and sell the house. You then have a California tell you that you had not really moved until the last chair and framed art had left the state. What are you going to do: sue? You are not moving back to California just to sue. That means that you are suing from another state and California is going to invoke the doctrine of the king’s pantaloons or whatever.

Still, doesn’t it feel … wrong … to have California going through your mail and trash, peering through your windows and contacting estranged relatives? This is behavior beyond the pale. We are not talking about homeland security, where some argument might possibly be made to excuse the king’s overreach. 

We are only talking about taxes.

1000% Political Sales Tax

Let’s return to the topic of state tax lunacy.

Our destination? California, a frequent contestant (if not winner) of the popular gameshow “Five Short of a Nickel.”

A citizen initiative posted on the California Attorney General’s website provides the following:

This initiative amends the California Constitution, Article 13, Section 35,(b).

It adds a section 3 as follows:

"For the privilege of influencing public elections and political issues, a sales tax of 1,000% (one thousand percent) is hereby imposed upon Political Advertisements. The proceeds of which shall solely benefit California public education. There shall be no further exemptions to this tax except as federally required or as passed by a California ballot initiative.

Political Advertisements shall mean any political advertising delivered within the state of California. This is applicable to both cash and barter transactions. This includes but is not limited to all media spending by political parties, political action committees or candidates.

This sales tax will not apply to the first $1,000,000 (one million dollars) of spending within a calendar year by any tax entity. However, if a group of tax entities are controlled or coordinated then this first one million dollar of sales tax relief shall only apply to the group of entities and not to the individual entities.

If a Federal District Court or Supreme Court of the United States find this tax to be too high, then this law shall immediately ratchet down to the highest acceptable level and remain in place.”

Well then.

And it perfectly typifies much of what has contaminated tax law in recent years:

(1) The insistence on wielding tax law to accomplish a social program, whether by granting a boon (such as the new markets tax credit) or striking a blow (such as the ACA penalty). 

(2) The delegation of actual tax writing to a non-electable bureaucracy. For example, what in the world does “Political Advertisements” mean? He or she who gets to define this term will rank among the most powerful of California politicos.

(3)  An ignorance if not contempt for tax doctrines, precedent or potential litigation. To begin with, the California Franchise Tax Board would have to defend a 1000% tax against a free speech challenge under the First Amendment. One also wonders whether the "takings" clause of the Constitution could be invoked. Is this really a tax issue or just the overheated opinion of a grievance dispenser?

Citizen initiatives are peculiar to California politics. They began as a way to limit the outsized influence of special interests but have devolved into a means to sidestep Sacramento, assuming one can recruit a deep-heeled supporter willing to fund the initiative. I trust there is little chance that this one will pass.

Nonetheless, let’s give a round of applause as we present the award to this week’s winner.