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.

A Slice of Apple And A Double Irish, Please

Apple has been dragged before Congress for interrogation over its tax planning and practices. Let’s talk about some of them.

Apple’s headquarters are in Cupertino, California. It also has an office in Reno, Nevada, 200 miles away. California’s corporate tax rate is 8.8%. Nevada’s corporate tax rate is zero. Here is a pop quiz: what would you do if you were Apple’s state tax advisor?

You would try to move income otherwise reportable to California to Nevada, that’s what you would do. How would you do this? Would you move employees, lease an office, manufacture iPhones there? Nah. Think along other lines. Apple has cash. Boats and barges of it. It has to manage and invest that cash. Where are you going to advise them to manage it?

You got it: it’s going to happen in Nevada. Let’s set up a subsidiary called Braeburn Capital (get it?). Apple has earned approximately $2.5 billion in interest and dividends since opening Braeburn. What has Apple accomplished? It has saved 8.8% California state tax on that $2.5 billion, that is what it accomplished.

California has of course whined and sputtered and complained. What about their roads and schools and hospitals? Well, Nevada also has roads and schools and hospitals. There is a price point to everything. I may like an iPhone, but I am not going to pay thousands of dollars for it. Sounds to me like California priced itself out of the market.

Steve Jobs several years ago approached the city of Cupertino about a new headquarters for Apple. The city council, seeing an opportunity to get more than its fair share, inquired about Apple providing free wireless internet service. Maybe pony rides too. Steve Jobs responded that Apple paid taxes, and that the city should provide free internet service – and the pony rides. He continued:

“That’s why we pay taxes. Now, if we can get out of paying taxes, I’ll be glad to put up Wi-Fi.”

Jobs pressed on, noting that – if Cupertino did not want them – Apple could just move. Cupertino backed down. One council member complained, wondering what it would take to make Apple feel “more connected.”

COMMENT: I do not need to feel “more connected” to the government. Good grief. Has a flying saucer landed and disembarked these people?

Let’s talk next about Apple and international taxes. This has been the topic of recent Congressional hearings before the Senate Permanent Subcommittee on Investigations. Senator Levin, head of the committee, blasted Apple for using “offshore entities holding tens of billions of dollars, while claiming to be tax resident nowhere.”

One quick moment to explain – again – that the United States imposes a worldwide tax system. A U.S. person, including a domestic corporation, is supposed to pay U.S. tax, no matter where the sale occurred, whether the money was earned inside or outside the U.S. or whether the money returned – or will ever be returned – to the U.S. There are tax deferral provisions, fortunately; otherwise, no U.S. company would be able to compete internationally. Apple has aggressively used those deferral provisions, thereby provoking the senator’s wrath.

One of Apple’s subsidiaries - iTunes S.à r.l.’s – is located in Luxembourg. What does it do? It collects roughly a quarter of iTunes worldwide sales. If someone in Europe or the Middle East or Africa downloads from iTunes, the sale is recorded here. Remember: these are downloads, not an automobile or a wide-screen TV. Downloads can be located anywhere. Apple could download from a satellite circling the earth, if it wanted to. Luxembourg presents a low tax – and friendly - environment. With that, downloads are moved away from Germany, Britain - or the United States.

Senator Levin sees tax avoidance. Me? I see common sense.

BTW, note the market that iTunes S.à r.l.’s serves. We will come back to this.

Apple was one of the first to utilize a tax stratagem that has become known as the “double Irish.”  More specifically, they used a “double Irish” with a “Dutch sandwich.” This is esoteric stuff. Let’s review in general what the tax advisors did, other than think about ordering lunch.  

It takes two Irish companies to make this work (hence, the “double” Irish). The first company (Irish #1) enters into an intellectual property (“IP”) arrangement with Cupertino. Apple transferred its IP rights for Asia, African and the Middle East to Irish #1 back in 1980. At that time, Apple approached the IRS to have it review its advance pricing agreement with Irish #1, which established how the IRS would treat transactions between the two for tax purposes. The deal was favorable for Irish #1, which is to say that Irish #1 paid considerably less to Cupertino than it made selling the IP to other affiliates. 

NOTE: More income, lower expense to Irish #1. The purpose is to keep the income outside Cupertino – which is to say, outside the U.S. 

Someone has to sell the actual product: the iPods or iPhones. Enter Irish #2, which is owned by Irish #1. In fact, it is 100% owned, which allows Irish #1 to make a critical tax election with the IRS: a “check the box” election. While in place, this election means that the IRS will treat Irish #1 and Irish #2 as though they were one company. This is key, as the illusion will stop the IRS from claiming “foreign base company income.” It takes at least two companies to generate foreign base company income, and you do not want foreign base company income. It means that the U.S. will immediately tax you without waiting for you to send the money back to the U.S.  Ireland does not have an equivalent to the U.S. "check the box."

Irish #2 manufactures and/or sells the product. The product is high-tech, so Irish #2 has to pay for the IP. Who does it pay? It pays Irish #1, of course. Cupertino can “control” the amount of income left in Irish #2 by adjusting the amount it pays Irish #1. What profit remains in Irish #2 is taxable to Ireland at 12.5%.

Except it isn’t. Apple received a tax holiday for its first ten years in Ireland (this got them to 1990), and since then it appears to have negotiated its tax rate with Irish Tax & Customs.  This point is unclear, as the Irish government is prohibited from speaking on such matters. What has Ireland gotten in return? Apple now employs over 4,000 people in Ireland and is one of the country’s biggest employers.

Let’s go back to Irish #1. What does it pay Ireland? It pays nothing. Ireland looks and sees a nonresident company. Is Ireland blind? Well … Ireland will not tax nonresident operations of a nonresident company, and it considers a company to be nonresident if:

(1)            The company “controls” an Irish company that conducts a trade or business in Ireland, and

(2)            The company itself is “controlled” by one or more residents of a country with which Ireland has a double taxation treaty. 

OBSERVATION: Now you understand why this Irish has to be a “double.” One Irish company has to own another to put this plan into play.

To close the circle, let’s put the management and control of Irish #1 in the British Virgin Islands (BVI). The BVI does not levy a corporate income tax.

NOTE: Do you see what happened here? Profit is funneled to Irish #1, which does not pay tax to Ireland. The BVI has no tax. Irish #1 pays tax to nobody. Irish #2 pays tax to Ireland, but on greatly reduced profit.

And there you have a “double Irish!”

Let us step it up a notch. 

Let us introduce a third company. We will base this company in the Netherlands. We will call it “Dutch”. Why in the Netherlands? There are several reasons:

(1)            Both Ireland and the Netherlands are in the EU. EU members can move monies around with relative ease.

(2)            Holland’s corporate tax rate is 25%, not as attractive as Ireland’s 12.5%. Why would we send money there? The Netherlands will allow us to route profits through there if we agree to leave behind a small amount to be taxed.

(3)            The Netherlands will allow us to transfer money to tax havens on more favorable terms than Ireland. We intend to transfer the monies to the BVI.

We will place Dutch between Irish #1 and Irish #2. 

How do we get money into Dutch? Dutch will intercept sales bound for Irish #2. It’s not permanent: Dutch will forward those sales on to Irish #2. We will however leave some of Irish #2’s profit in Dutch for its trouble.

And Dutch will then move the profit – to the BVI.

You have just been served a double Irish with a Dutch sandwich. 

Congress blasted Apple because its subsidiaries reported approximately $30 billion in income from 2009 to 2012 but paid little to no tax. It is a fair point, but the following are also fair points:

(1)            Apple’ recent overseas sales have been approximately 60% of worldwide sales.

(2)            Apple keeps approximately $100 billion of its $150 billion cash war chest overseas. Its cash hoard seems – at first blush – in proportion to where it made sales.

(3)            Even with all this tax planning, Apple’s effective tax rate is roughly 14%. To put this in perspective, that is about the same as Samsung, Apple’s closest competitor. Where is Samsung headquartered? South Korea.

Could Apple have done even more? Yes, it could have. Remember my comment when we discussed iTunes S.à r.l.’s? This is the subsidiary that sells downloads to Europe, the Middle East and Africa. Whom does it not sell to? To the United States, Central and South America, that’s who. If Apple were truly concerned about eliminating its tax altogether, don’t you think it would have thought about this? It thought of near everything else.

It is difficult to consider the Apple hearings and not remember that Senator Levin was one of those who previously wrote the IRS demanding that it look into the tax exempt status of 501(c)(4)s, such as the  Club for Growth,  Americans for Tax Reform and Americans for Prosperity. In the summer of 2012, he demanded “why does the IRS allow 501(c)(4) organizations to self-declare?”

Uh, yeah. Thanks Carl. We know how well that turned out.

Ireland did not take well to Levin declaiming them as a “tax haven,” mentioning “Ireland” 37 times and “Irish” 29 times during Congressional hearings. The Irish Minister of State for European Affairs Lucinda Creighton travelled to Washington. She said:

“There is no doubt that some companies are taking advantage of the global legal and tax arrangements in a variety of jurisdictions.” 

“That is not something that Ireland can solve on its own. It is not something that the US or Ireland can solve together.”

Then she pointed out the obvious: the “extremely high corporate tax rate” in the U.S. is part of the problem. 

My take? 

Apple without a doubt pressed the pedal to the floor on its international tax planning. They are in good company, however, with Google, Yahoo, Dell, Pfizer and too many others to mention. Many tax advisors are concerned about this evolution of “stateless” income. “Stateless” means the income is not reported to or taxed by any country, and it is what Apple accomplished. It is one thing to arbitrage tax rates, as we did between California and Nevada. It is another to distill, filter and bottle the income to the extent it winds up being homeless.

I consider Apple to represent – to a great extent – the logical progression of our incoherent worldwide tax system. Congress thinks that multinationals will pay our highest-corporate-tax-rate -in-the-world just because… Well, why would they? Would you? The idiocy of this whole thing is thinking that Congress has a claim to money that someone – whether you, me or Apple - earned in Europe or Africa or Asia. The hubris and greed of Congress is stultifying.

Do you think that Irish Tax & Customs is wondering why Sen. Levin is thundering that Apple did not pay Ireland enough tax?