Michael Jordan, The Grizzlies And The Jock Tax

I have been reading recently that the jock tax may be affecting where athletes decide to play. For example, Ndamukong Suh, an NFL defensive tackle formerly with the Detroit Lions, was wooed by the Oakland Raiders but opted instead to sign with the Miami Dolphins. I can understand a top-tier athlete not wanting to play for a team as dysfunctional as the Raiders, but one has to wonder whether that 13.3% top California tax rate was part of the decision. Florida of course has no income tax.

Let’s not feel sorry for Suh, however. His contract is worth approximately $114 million, with $60 million guaranteed.

So what is the jock tax?

Let’s say that you work in another state for a few days. You may ask whether that state will want to tax you for the days you work there. Some states tell you upfront that there is no tax unless you work there for a minimum number of days (say 10, for example). Other states say the same thing obliquely by not requiring withholding if you would not have a tax liability, requiring you (or your accountant) to reverse-engineer a tax return to figure out what that magic number is. And then there are … “those states,” the ones that will try to tax you just for landing at one of their airports.

Take the same concept, introduce a professional athlete, a stadium and a game and you have the jock tax.

It started in California. Travel back to 1991 when Michael Jordan led the Bulls to the NBA Finals. After the net was cut and the celebrations finished, Los Angeles contacted Jordan and informed him that he would have to pay taxes for the days that he spent there.

Illinois did not like the way California was treating their favorite son, so they in turn passed a law imposing income tax on athletes from other states if their state imposed a tax on an Illinois athlete. This law became known as “Michael Jordan’s Revenge.”

How do you allocate an athlete’s income to a given city or state? That is the essence of the jock tax and what makes it different from you or me working away from home for a week or so.

If we work a week in Illinois, our employer can carve-out 1/52 of our salary and tax it to Illinois. Granted, there may be issues with bonuses and so on, but the concept is workable.

But an athlete does not work that way. What are his/her work days: game days? Game and travel days? Game, travel, and practice days?

Let’s take football. There are the Sunday games, of course, but there are also team meetings, practice sessions, film study, promotional events, as well as minicamps and OTAs and so on. Let’s say that this works out to be 160 days. You are with Bengals and travel to Philadelphia for an away game. You spend two days there. Philadelphia would likely be eying 2/160 of your compensation.

This method is referred to as the “duty days” method.

Cleveland separated from the pack and wanted to tax players based on the number of games in the season. For example, the city tried to tax Chicago Bears linebacker Hunter Hillenmeyer based on the number of season games, which would be 20 (16 regular season and 4 preseason). Reducing the denominator makes Cleveland’s share larger (hence why Cleveland liked this method), but it ignores the fact that Hillenmeyer had duty days other than Sunday. What Cleveland wanted was a “games played” method, and it was shot down by the Ohio Supreme Court.

Cleveland also had an interesting twist on the “games played” method. It wanted to tax Indianapolis Colts center Jeff Saturday for a game in 2008.  However, Saturday was injured and did not play in that game, making Cleveland’s stance hard to understand. In fact, Saturday was injured enough that he stayed in Indianapolis and did not travel with the team, now making Cleveland’s position impossible to understand. Sometimes bad law surfaces when pushed to its logical absurdity, and the Ohio Supreme Court told Cleveland to stop its nonsense.

Tennessee wrote its jock tax a bit differently. Since the state does not have an income tax (more accurately, it has an income tax on dividends and interest only) it could not do what California, Illinois and Ohio had done before. Tennessee instead charged a visiting athlete a flat rate, irrespective of his/her income. For example, if you were a visiting NBA player, it would cost $2,500 to play against the Memphis Grizzlies.

Tennessee also taxed NHL players (think Nashville Predators) but not NFL players (think Tennessee Titans).

I guess the NFL bargains better than the NHL or NBA.

One can understand the need to fund stadiums, but this tax is arbitrary and capricious. What about a non-athlete traveling with the team? That $2,500 may be more than he/she earned for the game.

Tennessee has since abolished this tax for NHL players but has delayed abolishment until June 1, 2016 for NBA players.

In other news, NFL players remain untaxed.

We have talked about the denominator of the fraction to be multiplied against an athlete’s compensation. Are you curious what goes into that compensation bucket?

Let’s answer this with a question: why do so many athletes chose to live in Texas or Florida? The athlete may have an apartment in the city where he/she plays, but his/her main home (and family) is in Dallas, Nashville or Miami.

Let’s say the athlete receives a signing bonus. There is an extremely good argument that the bonus is not subject to the jock tax, as it is not contingent upon future performance by the athlete. The bonus is earned upon signing; hence its situs for state taxation should be tested at the moment of signing. Tax practitioners refer to this as “non-apportionable” income, and it generally defaults to taxation by the state of residence. Take residence in a state with no income tax (hello Florida), and the signing bonus escapes state tax.

Consider Suh and the Miami Dolphins. California’s cut of his $60 million signing bonus would have been almost $8 million. Florida’s cut is zero.

What would you do for $8 million?

Doing Business Across State Lines

Does your business lease property in another state? Do you have sales people who travel to other states?

You may have multistate tax issues.

There are many types of state and local taxes. Three of the most common are income tax, sales tax and use tax. These taxes may have different names in different states. For example, an income tax may be referred to as a franchise tax, or a sales tax may be called a transaction privilege tax.  The use tax is the twin to the sales tax: if the seller does not collect sales tax, then the purchaser may be required to separately pay use tax.

There is a new breed of state taxes that meld the above. Ohio has a commercial activities tax, which sprung into existence as a replacement to the Ohio franchise tax but bears closer resemblance to a sales tax.

Why should you worry about multistate issues?

A key reason is that states are facing severe budgetary pressures and are looking to aggressively assert their tax laws in order to increase their tax receipts. It used to be, for example, that you did not have to worry about collecting sales taxes for another state unless you owned or leased property in that state or kept employees there. This is now changing.   California, for example, wants Amazon to collect sales tax if it pays a fee to “affiliates” located in California. An affiliate (say a California band) has a hotlink on its website to Amazon. By clicking on that link, one is transferred to Amazon where one can buy the band’s CDs. California believes that is enough reason to pull Amazon into its sales tax regime.

California is not the only state moving to this "affiliate" sales tax theory. New York became the first to do so in 2008, and Connecticut, Illinois, Rhode Island and Arkansas have since passed similar laws.

Did you know that some states subject services to sales tax? If you are performing services in those states, you may have multistate tax issues.

If you do not know you have a liability, you cannot file. Did you know that there is no statute of limitations on how far back a state can go if you never file returns? You could wind up owing 10 years or more in back taxes, plus penalties and interest. Not a problem, you say, as I can file for refund in my state and get that money back. What if the statute of limitations for a refund has expired with your state, but there is no limitation in the new state demanding sales taxes. In that case, you are paying tax twice.

There is a long-standing tax theory called “nexus” that states have to meet in order to pull you into their tax regime. The states have been changing, and aggressively expanding, their definition of nexus. It may be that ten years ago you did not have nexus but that you do have nexus today.

Examples of nexus are:

• An office
• A phone line
• Inventory or supplies in the state
• Office equipment or other property
• Business license
• Employees acting on your behalf
• Employees attending a trade show in the state
• Independent contractors acting on your behalf
• Use of intangible property (like a trademark) in the state

Did you notice the one about the trade show? In 2007 the Texas Comptroller of Public Accounts determined that a seller of dental equipment who attended a one-day trade show was responsible for collecting sales taxes on any sales generated at the trade show. The decision is not totally unexpected, as the salesman did generate quite a few sales and attended the trade show annually. However, many if not most tax planners would have missed this sales tax exposure by reasoning that it is only one day.

States are changing how they are apportioning or allocating multistate income to their respective state. It used to be that states would weigh sales, property and payroll evenly. Many states are now moving to sales only, with no weighting for either property or sales. This is an effort to more out-of-state businesses into their tax system. Why, some states will require you to treat income sourced to a non-taxing state as attributable to them! This is the “throwback” rule, and it is a transparent effort to increase their own tax apportionment.

What if you form separate legal entities to avoid nexus? For example, a manufacturer could have plants in several states but have a separate company make all retail sales.  Some states will assert “affiliate” nexus if any of the affiliated entities have nexus. One equals all. Once an affiliate has nexus, all the affiliates have nexus. In an income-tax environment this is referred to as the “unitary” concept.

It is important that you work with an accountant or advisor proficient in these matters. If you find that you have an issue (especially if the issue has existed for several years) that advisor will be invaluable to you and your business. An experienced advisor may be able, for example, to limit the number of back years that have to be filed with a state, as well as any penalties.