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 - a citizen. 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.

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.

 

Another Runaway FBAR Case

 

Let’s talk about the FBAR (Report of Foreign Bank and Financial Accounts). It currently goes by the name “FinCen Form 114.”

This thing has been with us since 1970. It came to life as an effort to identify foreign financial transactions that might indicate money laundering or tax evasion. 

Sounds benign.

The filing requirement applies to a United States person, defined as

·      A citizen or resident of the U.S.

·      A domestic partnership

·      A domestic corporation

·      A domestic trust or estate

 We’ll come back that first one in a moment.

Next, one needs a financial interest or signature authority in a foreign financial account to trigger this thing.

A foreign financial account includes a bank account, which is easy enough to understand. It would also include a broker account (think Charles Schwab, but overseas). Some are not so intuitive, though.

·      A foreign insurance policy with cash value is reportable.

·      A foreign hedge fund is not.

·      A foreign annuity policy is reportable.

·      A foreign private equity fund is not.

·      A foreign cryptocurrency account is not reportable.

Some require a google search to understand what is being said.

·      A Canadian registered retirement savings plan is reportable.

·      A Mexican fondo para retiro is reportable.

Next, the foreign financial account has to exceed a certain dollar balance ($10,000) at some point during the year.

That $10,000 balance has been there for as long as I can remember. You will have a hard time persuading me that $10,000 in 1986 is the same as $10,000 now, but that number is apparently eternal and unchanging.

The $10,000 is tested across all foreign financial accounts. If it takes your fourth foreign account to put you over $10 grand, then you are over. Testing is done. All your accounts are reportable on a FBAR.

Like so many things, the FBAR started with reasonable intentions but has morphed into something near unrecognizable.

Fail to file an FBAR and the standard penalty is $10 grand. Fail to file for two years and the penalty is $20 grand. Have two foreign accounts and fail to file for two years and the penalty is $40 grand.

And that is assuming the error is unintentional. Do it on purpose and I presume they will execute you.

I exaggerate, of course. They will just bankrupt you.

It puts a lot of pressure on defining “on purpose.”

Let’s look at Osamu Kurotaki (OK).

OK was born in Japan and lives in Japan. He obtained a U.S. green card, making him a U.S. permanent resident. One of the pleasures of being a permanent resident is filing an annual tax return with the United States, irrespective of whether you live in the U.S. or not. One can talk about a foreign income exclusion or foreign tax credit – which is fine – but that annual filing makes sense only if someone intends to eventually return to the U.S. It does not make as much sense if someone does not intend to return, someone like OK.

OK paid someone to prepare his annual U.S. tax return. He found a CPA who was bilingual.

In 2021 the U.S. Treasury assessed civil penalties against OK for more than $10 million. His footfall? He failed to file FBARs. Treasury also upped the ante by saying that his failure was “willful.”

Huh?

Treasury is requesting summary judgement that OK willfully failed to file FBARs, prefers waffle over sugar cones and rooted for the Diamondbacks in the World Series. 

The Court wanted to know how Treasury climbed the ladder to get to that “willful” step.

So do I.

Here is what the Court saw:

·      OK is a Japanese speaker and does not speak English “at all.”

·      OK relied on his bilingual CPA to make sense of U.S. tax filing obligations.

·      His CPA provided annual tax questionnaires in both English and Japanese. The English was for theater, I suppose, as OK could not read English.

·      The CPA’s translation now becomes critical. Here are instructions to the FBAR in English:

U.S. taxpayers are required to report their worldwide income; that is, income from both U.S. and foreign sources.”

·      Here is the Japanese translation:

U.S. resident taxpayers are required to report their worldwide income, that is, income from both US. and foreign sources."

OK told the Court that he did not think he had a filing obligation because he was not a “U.S. resident.”

I get it. He lives in Japan. He works in Japan. His kids go to school in Japan. He is as much a “U.S. resident” as I am a Nepalese Sherpa.

Except …

OK was green card – that is, a “permanent” resident of the U.S.

Technically …

The Court cut OK some slack. Technically - and in a law school vacuum - he was a “resident.” Meanwhile - in the real world – no one would think that. Furthermore, OK hired a CPA who made a mistake. Even a trained professional erred interpreting the Treasury’s word salad. 

The Court said “no” to summary judgement.

Treasury will have to argue its $10 million-plus proposed penalty.

And I believe the Court just outlined reasonable cause.

Perhaps OK should consider turning in that green card. 

Our case this time was Osamu Kurotaki v United States, U.S. District Court, District of Hawaii.

 

The New Israeli Trust Tax

Have you settled (that is, funded) a trust with an Israeli beneficiary?

I have not, but many have.

If this is you: heads up. The tax rules have changed, and they have changed from the Israeli side, not the U.S.

Until this year, Israel has not taxed a trust set up by a foreign person, even if there were Israeli beneficiaries. It also did not bother to tax the beneficiaries themselves. This was a sweet deal.

The deal changed this year. The Israel Tax Authority (ITA) now says that many trusts previously exempt will henceforth be taxable.

Israel is looking for a beneficiary trust, meaning that all settlors are foreign persons and at least one beneficiary is a resident Israeli.

EXAMPLE: The grandparents live in Cincinnati; the son moves to Israel, marries and has children; the grandparents fund a grandchildren’s trust.

A beneficiary trust can be either

·        A “relatives trust,” meaning the settlor is still alive and related (as defined) to the beneficiary

·        A “non-relatives trust,” meaning the settlor is not alive or not related (as defined) to the beneficiary 

EXAMPLE: The grandparents in the above trust pass away.

The tax will work as follows:

·        A relatives trust

o   Pay tax currently at 25% on the portion allocable to Israeli beneficiaries, or

o   Delay the tax until distributed to an Israeli beneficiary, at which time the tax will be 30%.

·        A non-relatives trust

o   Pay tax on income allocable to Israeli beneficiaries at regular tax rates (meaning up to 52%)

If one does nothing by the end of 2014, a relatives trust is presumed to have elected the “pay currently” regime.

The ITA has indicated verbally that any U.S. tax paid will be accepted as a tax credit against the Israeli tax, whether the tax was paid by the settlor (think grantor trust), the trust itself or the beneficiary.

The retroactive part of the tax goes back to 2006, and the ITA is allowing two ways for beneficiary trusts to settle up:

·        The trust can pay a portion of its regular tax liability, depending upon the influence on the trust by the Israeli beneficiary.

·        The trust can pay tax on the value of the trust as of December 31, 2013.

Again, the rules have changed, and – if this is you – please contact your attorney or other advisor immediately.