Taxation Of World Cup Players

 

I was reading a U.S. Representative criticizing the taxation of FIFA winnings:

We want to encourage these people to come over here and spend their money, and then we take a big chunk of it.”

I get it, but I would like to hear more about taking a big chunk of residents’ money before overly concerning ourselves with nonresidents.

Let’s take a (very) general walkthrough of the taxation of FIFA players.

Resident versus Nonresident

A resident of the U.S. is taxed on worldwide income. It doesn’t matter whether you work in the U.S.; in fact, it doesn’t matter if you live in the U.S. If you are a resident, you are subject to U.S. tax.

The easiest way to be a resident is to be born here. There are special rules for U.S. births who did not grow up here, but we will leave that issue alone.

The next way is to obtain a green card, which requires one to go through the immigration system.

A third way is to spend too much time here – which the tax Code terms “substantial presence.” There is math involved, as follows:

·      Present in the US for at least 31 days during the calendar year, AND

·      Present in the US for at least 183 days during the current and preceding two years. Days in the preceding year count at a 1/3 rate; days in the second preceding year count at a 1/6 rate.

Have a German company send an employee to a U.S. office for two or three years and he/she will likely meet the substantial presence test. He or she is not a U.S. citizen but is a U.S. resident under the substantial presence test.

It is unlikely that a FIFA player is going to trip the substantial presence test.

Meaning the FIFA player is a nonresident.

And his/her income taxation changes. The player is now concerned only with U.S.-source income.

One can get mystical when talking about U.S. source.

Does a Swede receiving interest from loaning money to a U.S. business have U.S.-source income?

Does a Brazilian receiving dividends from a multinational corporation have U.S.-source income?

We leave the mystical and return to the concrete when discussing services: if you perform services here – say a player in the World Cup - you will have U.S.-source income.

Divide U.S.-Source Income into Categories

There are two main categories of U.S.-source income, and they are critical in understanding nonresident taxation.

Effectively Connected Income

There should be a trade or business as a first step if we want ECI. It can be humble – a restaurant, dry cleaner or liquor store – but there has to be enough regular and continuous activity to rise to the level of a trade or business. That trade or business activity in turn must take place within the U.S. Meet both criteria and you have ECI.

BTW compensation for the performance of services within the U.S. - like playing soccer - is normally considered ECI.

Fixed, Determinable, Annual, or Periodical (FDAP) Income

The easy definition is any income that is not ECI.

Examples would include interest, dividends and royalties.

Think of FDAP as investment income – not trade or business income – and you get the idea. In days past it would have been a check that arrived in your mailbox.

Allocating Compensation to the U.S.

Only compensation earned while in the U.S. will be subject to U.S. taxation. Sounds fair, but translating that concept to actual numbers can be tricky.

Here is one suggestion: divide the numbers of days in the U.S. by 365 days.

Problem: athletes have seasons. They are not office workers with 9 to 5s and two weeks annual vacation. Using 365 as a denominator does not seem to fit our FIFA discussion.

How about using the number of games as the denominator?

Better, but what about team meetings, practices, press conferences, mandatory league events? Should we include those days in the denominator?

Seems right.

How about bonuses?

There is a can of worms.

This concept BTW is sometimes referred to as “duty days.”

The point is to come up with a ratio, with U.S. duty days as the numerator and total duty days as the denominator.

Allocating Noncompensation to the U.S.

We are talking name/image/likeness, endorsements and things related. Chances are these payments are referred to as royalties.

How are we supposed to reasonably allocate this to the U.S.? Lionel Messi and Cristino Ronaldo are already famous and earning their NILs and endorsements without entering the U.S. I could argue that a reasonable allocation to the U.S. would be zero (-0-).

If there was a product endorsement, a reasonable allocation might include dividing the amount of product sold in the U.S. by total product sold worldwide.

I am not as sure what to do with indirect endorsements, such as wearing Nike products on a regular basis.

Yep, room here for disagreement.

Tax Deductions

There is a significant difference between the taxation of ECI and FDAP income:

You are allowed to deduct expenses against ECI.

You are not allowed to deduct expenses against FDAP.

And you can immediately see the tax planning: move income between ECI and FDAP as necessary and as possible.

Withholding

You may have read that the IRS was taking 30% off the top of FIFA winnings.

True but misleading.

The 30% was withholding.

The player still has to file a nonresident tax return.

Granted, the default rate for FDAP income is 30%, so that income bucket might be a push.

But ECI allows for deductions and graduated tax rates.

Depending upon the amount of deductions and his/her run through the tax rates, that 30% withholding might be excessive. The player might be entitled to a refund.

I doubt that FIFA players would have much in the way of deductions, however, as I expect the club to absorb team and travel expenses.

Filing the Tax Return

Nonresident aliens have their own tax form:

If the athlete received a W-2, it would go on line 1a.

If the athlete was self-employed, the net business income would go first on Schedule 1 and then on line 8.

Line 9 is the sum of all income in the ECI bucket.

NOTE: Nonresident aliens are normally not subject to self-employment tax.

What about FDAP income?

It has its own schedule.

Tax Treaties

Treaties can override what we just discussed above.

Let’s look at an example.

Sergio Garcia was a professional golfer and party to a famous tax case involving services, FDAP and a treaty. It goes without saying that the IRS and Garcia did not agree on how to allocate U.S.-source income. The Tax Court finally decided that the NIL/endorsement/whatever-you-want-to-call-it was not so intertwined with his performance of services as to require it to be allocated the same as compensation for services. The Court said that 35% were for services and 65% were royalties.

So what, you ask.

Garcia was a resident of Switzerland.

Switzerland has a tax treaty with the U.S.

Which includes the following language:

Royalties derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State.”

“Contracting State” is a common term in tax treaties.

Garcia was a resident of Switzerland which in turn was a Contracting State meaning that royalties received by Garcia were taxable only to Switzerland.

That 65% representing royalties was not taxable by the U.S.

You see the power of a treaty.

Central Withholding Agreement

This is a way to negotiate with the IRS to lower the 30% withholding rate for personal services (such as a nonresident athlete or performing artist).

The IRS has a specialized unit for this work, and - not surprisingly - there are fairly strict timelines for request and approval.

State and Local Income Taxes

We are talking about the jock tax.

Most states use some version of “duty days” that we discussed above. California famously counts every practice held at an opponent’s facilities during a game week. The point, of course, is to increase the numerator (that is, the duty days allocated to California).

Certain cities will also pile on, for example:

New York City                 3.8% tax rate

Philadelphia                     3.4% tax rate

Cleveland                         2.5% tax rate

Mind you, this is on top of the state tax.

And tax treaties do not apply to state and local taxes.

Spain

What is Spain’s equivalent to the U.S. tax regime?

Well, the automatic withholding is less: 24% (reduced further to 19% for a resident of another EU country).

The top tax rate will hurt, though. The maximum national rate tops out at 47%, with certain regional authorities increasing it to 54%.

The maximum U.S. tax rate by contrast is 37 percent.

Tax Preparer Gives Gambler A Losing Hand

 

I am looking at a bench opinion.

The tax issue is relatively straightforward, so the case is about substantiation. To say that it went off the rails is an understatement.

Let us introduce Jacob Bright. Jacob is in his mid-thirties, works in storm restoration and spends way too much time and money gambling. The court notes that he “recognizes and regrets the negative effect that gambling has had on his life.”

He has three casinos he likes to visit: two are in Minnesota and one in Iowa. He does most of his sports betting in Iowa and plays slots and table games in Minnesota.

He reliably uses a player’s card, so the casinos do much of the accounting for him.

Got it. When he provides his paperwork to his tax preparer, I expect two things:

(1)  Forms W-2G for his winnings

(2)  His player’s card annual accountings

The tax preparer adds up the W-2Gs and shows the sum as gross gambling receipts. Then he/she will cross-check that gambling losses exceed winnings, enter losses as a miscellaneous itemized deduction and move on. It is so rare to see net winnings (at least meaningful winnings) that we won’t even talk about it.

COMMENT: Whereas the tax law changed in 2018 to do away with most miscellaneous itemized deductions, gambling losses survived. One will have to itemize, of course, to claim gambling losses.   

Here starts the downward cascade:

Mr. Bright hired a return preparer who was recommended to him, but he did not get what or whom he expected. Rather than the recommended preparer, the return preparer’s daughter actually prepared his return.”

OK. How did this go south, though?

The return preparer reported that Mr. Bright was a professional gambler ….”

Nope. Mind you, there are a few who will qualify as professionals, but we are talking the unicorns. Being a professional means that you can deduct losses in excess of winnings, thereby possibly creating a net operating loss (NOL). An NOL can offset other income (up to a point), income such as one’s W-2. The IRS is very, very reluctant to allow someone to claim professional gambler status, and the case history is decades long. Jacob’s preparer should have known this. It is not a professional secret.

Jacob did not review the return before signing. For some reason the preparer showed over $240 grand of gross gambling receipts. I added up the information available in the opinion and arrived at little more than $110 grand. I have no idea what she did, and Jacob did not even realize what she did. Perhaps she did not worry about it as she intended the math to zero-out.

She should not have done this.

The IRS adjusted the initial tax filing to disallow professional gambler status.

No surprise.

Jacob then filed an amended return to show his gambling losses as miscellaneous itemized deductions. He did not, however, correct his gross gambling winnings to the $110 grand.

The IRS did not allow the gambling losses on the amended return.

Off to Tax Court they went.

There are several things happening:

(1)  The IRS was arguing that Jacob did not have adequate documentation for his losses. Mind you, there is some truth to this. Casino reports showed gambling activity for months with no W-2Gs (I would presume that he had no winnings, but that is a presumption and not a fact). Slot winnings below $1,200 do not have to be reported, and he gambled on games other than slots. Still, the casino reports do provide some documentation. I would argue that they provide substantiation of his minimum losses.

(2)  Let’s say that the IRS behaved civilly and allowed all the losses on the casino reports. That is swell, but the tax return showed gambling receipts of $240 grand. Unless the casino reports showed losses of (at least) $240 grand, Jacob still had issues.

(3)  The Court disagreed with the IRS disallowing all gambling deductions. It looked at the casino reports, noting that each was prepared differently. Still, it did not require advanced degrees in mathematics to calculate the losses embedded in each report. The Court calculated total losses of slightly over $191 grand. That relieved a lot – but not all – of the pressure on Jacob.

(4)  Jacob did the obvious: he told the Court that the $240 grand of receipts was a bogus number. He did not even know where it came from.

(5)  The IRS immediately responded that it was being whipsawed. Jacob reported the $240 grand number, not the IRS. Now he wanted to change it. Fine, said the IRS: prove the new number. And don’t come back with just numbers reported on W-2Gs. What about smaller winnings? What about winnings from sports betting? If he wanted to change the number, he was also responsible for proving it.

The IRS had a point. It was being unfair and unreasonable but also technically correct.

Bottom line: the IRS was not going to permit Jacob to reduce his gross receipts number without some documentation. Since all he had was the casino reports, the result was that Jacob could not change the number.

Where does this leave us? I see $240 – $191 = $49 grand of bogus income.

My takeaway is that we have just discussed a case of tax malpractice. That is what lawyers are for, Jacob.

Our case this time was Jacob Bright v Commissioner, Docket No. 0794-22.

Fewer Like-Kind Exchanges in 2018

The new tax bill changed like-kind exchanges.

This is Section 1031, which was and is a tax provision that allows one to defer taxes on a property sale - if one follows the rules.

I suspect that almost every practicing tax accountant has met with a client who said the following:

·      I sold property last year,

·      I hear that there is a tax break if I buy another piece of property

Well, yes there MIGHT be a tax break, but you have to follow the rules from the beginning, not just months later when you meet with your accountant.

The normal sequence is to sell the property first. It doesn’t have to be that way – you can start with the buy – but that is unusual. The tax nerds refer to that as a “reverse.”

There are ropes:

(1)  You want the money held by a third party, such as an attorney or title company;

(2)  You have to identify the replacement property within 45 days (there is some latitude in identifying replacement properties); and

(3)  You have to complete the whole transaction – sell and buy – within 180 days.

(4) Anticipate that you will be buying-up: buy more than what you sold.

(5)  Debt is tricky. To be safe, increase your debt, at least a little bit.  

(6)  You never want to receive cash from the deal. Cash is income – period.

If you wait to until you meet with your accountant, then you have probably blown requirement (1).

The most common like-kind that I see – I kid you not – is vehicle trade-ins. They happen every day, to the point that we do not even pay them attention. In the tax world, however, trade-ins are like-kind exchanges.

The next most common are real estate exchanges. I have probably seen at least one a year for the last couple of decades. Those usually go through a title company or attorney, and I have the pleasure of looking over a binder of paperwork that would weigh down a Clydesdale.

There are others. One can like-kind exchange personal property, for example. The rules are stricter than the rules for real estate, and for the most part I have not seen a lot of those.

The new tax bill made a big change to like-kind exchanges.

How?

Because personal property no longer qualifies for like-kind treatment.

So much for trade-ins.

But there is another kind that I thought of recently.

Think sports.

Yep, back in 1966 the IRS considered player contracts – if done correctly – to be property qualifying for like-kind.

I am unsure how professional sports will work-around this change. It is not an area I practice, although I would have loved to.

Why did Congress mess with this?

It wasn’t about player contracts. It rather had to do with art and collectibles. It had become de rigueur to like-kind exchange in the art world, as buyers had come to view art as just another tradable commodity. Think stocks, but with the option of delaying taxes until the end of time. This reached the attention of the Obama administration, which began the push to eliminate them.

It took another White House, but it finally got done.