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.
