The most consequential tax bill since 1986 was passed in late 2017 (the law known as the Tax Cuts and Jobs Act, P.L. 115-97), and it had a profound impact on professional athletes' tax situations. Some of the provisions were positive, some negative, and some were downright terrible. As is always the case, proper advance planning is imperative to maximize the benefits and take advantage of what the tax law giveth.
Let's review the changes.
- Federal individual income tax rates decreased, specifically an almost 3% drop of the top rate to 37%, which applies to taxpayers with taxable income of more than $500,000 for single filers and more than $600,000 for married couples filing jointly. Also, the rates are inflation-adjusted. This can add up to significant dollars, particularly in a year where the athlete gets a large signing bonus. Proper withholding is necessary to avoid surprises when the returns are filed.
- Business expenses directly related to the generation of outside income, such as endorsement deals, card signings, and speaking fees, continue to be deductible. Thus it is important to document those expenses, such as travel, business meals (which are 50% deductible), and marketing agency fees. Expenses that relate to both the outside income and the athlete's activities with a professional team should be allocated, if possible, to maximize the deduction against the outside income.
- Entertainment expenses are no longer deductible, so tickets to games used for business purposes are not deductible, even against outside income. Meals at the event continue to be 50% deductible if they are purchased separately, or, if they are purchased together with the ticket to the event, if the cost of the meals is separately stated from the cost of the entertainment on one or more bills, invoices, or receipts.
- The 20% Sec. 199A qualified business income deduction is likely unavailable to professional athletes as they were carved out of the definition of qualified business income for specified service trades or businesses, unless their income is under $157,500 for single filers, $315,000 for married filed jointly, or $157,500 for married filing separately for 2018.
- Athletes with significant outside income could consider creating an S corporation to run their business through to save self-employment/payroll tax dollars. Be careful though, S corporations must pay "reasonable compensation" for the athlete's service to the corporation, which is subject to heightened IRS scrutiny.
- Miscellaneous itemized deductions are lost. Under prior law, most professional athletes received large deductions for agent's fees, union dues, and training expenses, to name a few. These types of expenses are no longer deductible unless they are directly related to the production of outside income. Discuss the purpose for these types of expenses with the vendor and document how they are related to the different income sources, if possible.
- Deductions for state taxes are limited to $10,000. This affects all athletes, even those who reside in states with no individual income tax, such as Florida, Nevada, Tennessee, Texas, or Washington. The loss of this deduction will be significant, particularly for those in higher tax states such as California, New Jersey, or New York. Planning is imperative for those residing in states with no income tax to minimize state tax on outside income and on games played in nontax states.
- Remember, a person's registering to vote or getting a driver's license in a state does not make him or her a resident. Facts and circumstances dictate residency, such as where the person spends the offseason and other free time and where the person attends community events, etc. Make sure the team knows the athlete's resident state early so withholdings can be done correctly. The whole state and local tax area is complex and proper expertise is necessary.
Some areas of continuing interest to professional athletes are unaffected by the new law and fall under none of these categories. Contributions to a foundation or donor-advised fund continue to be deductible, for instance, but could involve planning as to timing and amount. In fact, it is a good time to revisit all prior planning for direct or indirect impact of the new law.
The new tax law effective in 2018 is significant, complicated, and requires appropriate planning and guidance. The regulations in many instances are still unclear. Some of them have been clarified and others are expected to be soon. Advance planning is crucial for professional athletes to maximize the tax benefits of this major piece of tax legislation.
Ken Rubin, CPA, CGMA, is a partner at RubinBrown LLP in St. Louis. To comment on this article or suggest an idea for another topic, email Sally Schreiber, senior editor, at Sally.Schreiber@aicpa-cima.com.