James Harrison Spends A Fortune To Play In The NFL

In the 2002 NFL draft, he was considered too short (6’ - 0”) to play linebacker and too light (240 lbs) to play defensive line. The Pittsburgh Steelers put him on their practice squad. He was released three times before finally finding a home with Pittsburgh in 2004. In the 2009 Super Bowl, he intercepted Kurt Warner, returning the ball for a 100-yard touchdown. It stood for a while as the longest play in  Super Bowl history.

His on-field behavior has not harmonized with the NFL’s recent penchant for mitigating on-field collisions. He is a ferocious player, drawing fines for a helmet-to-helmet hit on a quarterback (Colt McCoy) and knocking-out two wide receivers on the same team (Mohammed Massaquoi and Josh Cribbs of Cleveland).  His estimated NFL fines for 2010 alone are estimated at $120,000.

He has now come to Cincinnati and will play with the Bengals. His name is James Harrison, and he is our strong-side linebacker on Sundays.

He has also been in the news recently talking about his training and conditioning regimen:

My body is what helps me to make money. Whatever there is that I need to do to try and make myself better or get myself healthy, I’m going to do it. It wouldn’t be unreasonable to say that I spend anywhere between $400,000-$600,000 on body work, as far as taking care of my body, year-in and year-out.

As far as training, I have a hyperbaric chamber. I rent a hyperbaric chamber when I’m in Arizona. I have massages and I bring people in from New York, Arizona to where I’m at…I have a homeopathic doctor and I do a lot of homeopathic things. It’s just a lot, supplements, so on and so forth.”

Can you imagine? This man spends the equivalent of an upper-income bracket on being able to go on game day. It would go along way to easing the pain if some (or all) of the cost could be tax –deductible. 

Let’s walk through it. 

• Is any of this deductible as medical expense?

The tax rule here is that the expense be for the “diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body.” How do we apply this to an NFL linebacker, whose job is to participate in the equivalent of 50 to 60 car crashes a game, 16 games per year?

There is little question that some expenses will qualify. For example, a massage prescribed by a doctor pursuant to a treatment regimen will qualify as a medical expense. It is the nature of the treatment, not its practitioner, that determines deductibility.

Another requirement is that the treatment would not have been incurred for nonmedical reasons.

The last part gives us pause: can one persuasively argue that a hyperbaric chamber or acupuncture were not incurred for nonmedical reasons? Playing football is not an AMA-recognized medical disorder. We may lose many of Harrison’s expenses through this net.

•  Is any of this deductible as an employee business deduction? 

An important point to remember is that Harrison is an employee of the Bengals, the same way I am an employee of my firm. There is a requirement that employee business expenses be “ordinary and necessary.” I cannot deduct my gym fees, for example, but can he?

Harrison is in the trade or business of playing football. “Ordinary and necessary” should be defined in relation to his playing football. He has a much closer nexus to gyms and dieticians than I do, for example. I would be hard-pressed to argue that a trainer is “ordinary and necessary” to my trade or business of being a tax CPA. Put me on a pro sports team, however, and one has a completely different argument.

Think about it this way: Harrison signed a $4.4 million dollar deal with the Bengals. NFL contracts are different from NBA and MLB contracts, as those are guaranteed. Only $1.2 million of Harrison’s contract is guaranteed. The balance is contingent on his making the team and reaching certain performance incentives.  Stating this another way, $ 3.2 million of his contract is not guaranteed, which is a lot of motivation to spend $400,000 to $600,000 to stay in shape. Would you spend it? I would, without hesitation. 

This not to say that the IRS may not challenge him.

Do you know Lamar Odom? He is an NBA player for the Los Angeles Clippers,  although many may know him as husband to Khloe Kardashian. The IRS disallowed $172,000 in fitness fees and $12,000 in NBA fines on his 2007 tax return. Odom was then living on a modest $9.3 million salary, so he did what any other financially-pressed American would do – he contested the IRS adjustment.

He argued the following:

(1)  As an NBA player he is obligated to stay fit, healthy and in NBA-level condition. This is not the same as you or me playing weekend pick- up ball. Odom was expected to perform as a professional basketball player throughout the basketball season.

(2)  IRC Section 162(f) disallows deductions for fines and penalties. Odom’s fines were not of the type described in that Code section, because his fines were league-imposed and not government-imposed.  NBA Commissioner David Stern may think of himself as the law, but his authority is not same as a policeman writing a speeding ticket. Odom further argued that league fines are becoming common for professional athletes. Because of this, they have become “ordinary and necessary” expenses.

The case was settled before being decided, and the IRS was prohibited from talking about the matter. There was no written opinion or ruling. We nonetheless learned that the IRS threw in the towel on the fitness fees and fines and contented themselves by assessing some small tax on game tickets that Odom had distributed.

In 1965 Sugar Ray Robinson found himself in a fight with the IRS. There were several items on the docket, three of which attract our interest as we discuss professional athlete expenses. The IRS tried to disallow a deduction for fight tickets which Leonard had given away. The Tax Court disagreed, finding that some number of the tickets could be reasonably connected with Sugar Ray’s trade or business as a professional boxer. The IRS tried to disallow deductions for Ray’s manager, as well as training facilities preparatory to a fight. Once again, the Court decided that the expenses were reasonably connected. The Court would allow the deductions as long as other requirements – such as substantiation – were met.

The Court decided that Leonard had substantiated the expenses for the training facilities and allowed the deduction. Sugar Ray could not substantiate his manager expenses, so the Court disallowed that deduction.

NOTE: I admit that I am curious how Sugar Ray could not document the amount he paid his manager. I suspect there was another entire sub-story buried in there.

The Court’s reasoning in the Sugar Ray case is still tax law, and hopefully Harrison’s tax advisor has apprised him of it. Harrison needs to be meticulous in documenting his expenses. He does not need to give the IRS an easy way to disallow his business deductions simply because he cannot produce the paperwork.

There is another tax technique that comes to mind: incorporating “James Harrison Inc” as a brand. Don’t laugh. The PGA golfers do it. The idea here is to place off-field income, such as endorsements, within the corporation. The corporation now has an income stream, and with it the corporation will issue a W-2 to Harrison. It will also adopt a medical reimbursement plan. To the extent that Harrison incurs medical expenses, he will submit his expenses to the corporation for reimbursement. The corporation will get a deduction and Harrison will get reimbursed. This sidesteps the nasty 7.5%-of-AGI limitation on the individual income tax return. By the way, that limitation goes to 10% next year, as part of the ObamaCare tax increases. Good thing Congress stepped-in there to close that abusive tax shelter of deducting doctor and medical bills.

What are the odds that Harrison will generate enough endorsement income to fund this technique? Do you remember his famous quote about Roger Goodell, the NFL Commissioner who kept fining him for excessive on-field hits?

     

If that man was on fire and I had to pxxx to put him out, I wouldn’t do it.”

I’m not sure what quotes like that do to Harrison’s endorsement value. Among some of my friends, I suspect they would increase it.

Good luck, James, and welcome to Cincinnati.

NFL's Romanowski, Horses And A Hobby

He was a feared NFL football player. He played in the league for 16 seasons, winning 4 Super Bowls. He was ... volatile, at best. In 1997 he broke the jaw of Carolina Panthers quarterback Kerry Collins. He spat in the face of San Francisco 49ers wide receiver J.J. Stokes during a Monday night game.  In 2003 he confronted a player on his own team, ripping off that player’s helmet and crushing his eye socket with a punch.

His name is Bill Romanowski (BR). And he now has entered the tax literature.

BR decided to get into horse breeding – sort of. There is a Code section that disallows losses incurred in what the IRS considers a “hobby.” The IRS understands that one can try and fail in a business venture, but it wants the venture to truly be profit-driven. It is not interested in allowing losses from a weekend racecar hobby, or Tennessee walking horse competitions for one’s teenage child, or (more recently) owning an Amway distributorship. There are numerous factors to consider: one’s past experience and familiarity with the business or industry, development of a business plan, reaction to and modification of that plan when confronted with losses, and so on.

Horse breeding is a likely area for hobby-loss challenge by the IRS. It is also (or at least used to be) a popular tax shelter area. BR got involved and combined the two, to a financially detonative extent.

BR and his wife for many years used a financial planner by the name of Kathy Lintz. It sounds like she did a good job, including managing their portfolio and providing them a monthly stipend. Ms. Lintz also collected financial information for their tax returns and engaged a CPA. She would review the completed tax returns before sending them to the Romanowski’s.

During 2003 BR had tax issues with a real estate investment in Colorado. Ms. Lintz put BR in touch with Rodney Atherton (Atherton), a partner at Greenberg Traurig in Denver. BR went to Denver to discuss real estate, at which time Atherton told BR about a horse-breeding business, ClassicStar, which had retained his firm. It sounds like the meeting went well, as BR retained Greenberg Traurig. BR also wanted more information about the horse breeding deal.

BR received documents frequently associated with a tax shelter:

1. a 53-page opinion letter from the law firm Handler, Thayer& Duggan, LLC regarding tax aspects of horse-breeding;
2. a 22-page opinion letter from the accounting firm Karren, Hendrix & Associates regarding tax aspects of the horse-breeding business, and
3. a 6-page opinion letter from Karren Hendrix & Associates regarding tax aspects of NOLs generated from a horse-breeding business.

OBSERVATION: Folks, I am a career tax CPA. I have received and reviewed attorney opinion letters over the years. Allow me to assure you that such letters are not normal business practice. It is however normal tax shelter business practice. And your first clue that you are leaning a bit far over the ledge.

How did the deal work? It was relatively simple: BR would lease mares owned by ClassicStar, which in turn would provide boarding and care for the mares and breed the mares to stallions. Any foals produced from the breeding would belong to the Romanowski’s.

How much would this cost BR? Karren Hendrix, who did accounting work for ClassicStar, sent an “NOL illustration” regarding BR to Atherton. In the NOL illustration, Karren Hendrix estimated that BR needed an NOL of over $13 million to offset his taxable income from 1998 to 2003.

In 2003 Atherton and BR again traveled to Kentucky. This time Mrs. Romanowski reviewed the materials and made the trip to Kentucky. They toured the ClassicStar operation, saw the horses, visited auction houses, and met with ClassicStar personnel.

The Romanowski’s decided to invest approximately $13 million.

OBSERVATION: Wow! I wonder how they came up with that amount?         

Ms. Lintz, the financial advisor, was adamantly opposed. She believed it a tax scheme and a threat to the Romanowski’s financial health.

BR blew her off.

The Romanowski’s created Romanowski Thoroughbreds, LLC, through which they would operate the horse activities.

In December 2003, the Romanowski’s wrote a $300,000 check to ClassicStar as a deposit. They then signed a mare lease and board agreement with ClassicStar. Pursuant to the agreement, Romanowski Thoroughbreds agreed to spend $13,092,072 on the breeding program to produce foals.

Mind you, when the Romanowski’s signed this agreement, they had not negotiated or seen any list of horse pairings. Rather, they relied on ClassicStar to pick the horse pairings and to set the fees and expenses they would pay.

Right....

They later received a list of the horse pairings they would receive. They would receive 68 pairings, but only 4 of the 68 pairings were to thoroughbreds. The remainder were to quarter horses.

NOTE: What?? Sounds to me like a good time to call the attorney and back out of this deal, right?

The Romanowski’s were assured by ClassicStar that they would substitute an unknown number of thoroughbred pairings for quarter horse pairings. Of course, nothing was written down.

Right....

Meanwhile, Ms Lintz became aware that Atherton was receiving a “due diligence fee” from ClassicStar. She was concerned, as she considered it a conflict of interest. Why? Because Atherton was the Romanowski’s attorney, and he was suppose to have their best interest at heart.

In February 2004, Ms. Lintz resigned as the Romanowski’s financial adviser, partially because of their investment in the horse program. Her resignation letter states that the Romanowski’s choose to “enter into an aggressive tax shelter.”

Later that month Ms. Lintz sent the Romanowski’s another letter identifying two independent horse and tax experts whom they could contact if they “need[ed] further assistance”. The letter stated that one of the experts told Ms. Lintz that  ClassicStar had “come on strong in the last couple of years” and that there had been “No scandals thus far” even though “some of the principals were involved in bad prior deals.”

OBSERVATION: Ms. Lintz sounds like a very attentive financial advisor for her clients.

Atherton of course denied receiving any improper payments from ClassicStar. What happened is – if Atheron referred a client to ClassicStar - ClassicStar would pay Atherton a percentage of the deal.  Atherton would escrow the funds and bill against them at a much higher hourly rate than his normal rate. For example, in an email to another client, Atherton wrote:

 “Here is what I propose, I simply bill my time on your clients at a premium--I usually bill 365 an hour. Are [sic] okay if I bill 1000 an hour   and just charge an hourly rate?

He of course never told the Romanowski’s about any arrangement.

NOTE: Nice guy. We will probably hear his name again when he runs for Congress.

In a completely unexpected development, ClassicStar filed for chapter 11 bankruptcy protection in 2007. The Romanowski’s filed claim in the bankruptcy court and also filed separate claims against ClassicStar and against Greenberg Traurig.

Fast forwarding, the IRS challenged the whole deal as a hobby, wanting back over $4.7 million dollars of tax refunds. Oh, they also levied an accuracy penalty of over $950,000 to boot.

They go to court. The experts trot out onto the field. The IRS expert asserts that the activity “had absolutely no chance of making a profit”.

The Romanowski’s expert counters:

 “that there was absolutely no chance that any of the non-Thoroughbred horses listed on * * * would produce profitable foals.”

The expert argued that the quarter horses “were obviously placeholders” and that if ClassicStar “had honored their contract and provided Thoroughbred mares of at least the same quality as those * * * [eventually bred for petitioners] then there was definitely profit potential.”

Wow! And this is the taxpayers’ expert?

The Tax Court decided against the Romanowski's. They now owed well north of $4 million in taxes. The Court did however let them off the hook for the accuracy penalties, though. The Court felt that their reliance on an attorney was sufficient to avoid the penalty. Small victory, I suppose.

MY TAKE: The IRS took a risk, as they have lost their share of horse-related litigation. The courts have been receptive to the “long shot” argument: someone could legitimately keep funding a losing business if the payday would be outsized. Why would the IRS pursue the case? There is one feature here the IRS likes: the recognizable taxpayer name. No one would note or remember if you or I lost a tax case. Substitute Brad Pitt, however, and you have something.

But quarter horses ...? What was Romanowski thinking? The only way Romanowski could have made money off this deal is if he bought a lottery ticket while he was visiting Lexington.