The Marlins and Blue Jays agreed to a blockbuster trade earlier this week that sent Jose Reyes, Mark Buehrle and Josh Johnson to Toronto. There are clear tax ramifications for everyone involved in the trade, and as an accountant who works in this field and consults with players and agents, I find it very interesting on a number levels.
However, what makes it more interesting than the average trade isn’t simply the tax rates of the countries, states and cities involved. Nor is it the effective state and city tax rates each team will experience — based on where they play spring training, the rates of their home states and cities, the rates of all other jurisdictions in which they will play and the amount of time spent in these jurisdictions. Per the effective rates, the difference between Florida and Ontario is reduced, but still substantial, since Florida has no state tax.
As I’ve explained here before, the specific state and city tax rates matter to an extent, but because of how the jock tax works, the effective rate is more telling. It’s for this reason that the AL West may soon become a big area of interest among free agents: it now features three teams without state or local taxes in the Astros, Rangers and Mariners. The Astros also spend spring training in the non-taxed state of Florida.
Even with the state and provincial tax ramifications, what piqued my interest the most with this deal is how Canada disallows certain allowable deductions in the United States.
There are numerous types of deductions available to athletes, on expenses ordinarily incurred based on their profession, that are deductible on an individual tax return. Many of these expenses are deductible as a miscellaneous itemized deduction subject to a 2% floor of adjusted gross income. Some of the expenses are deducted elsewhere, as an adjustment to income, or as a charitable contribution.
These include moving expenses, penalties and fines, agent fees, clubhouse dues, union dues, conditioning expense and, in cases where the player takes an insurance policy out on himself, insurance expense.
Certain moving expenses are deductible in both the United States and Canada if a few tests are met. These generally relate to the distance of the move and time spent working at the new job. Qualified expenses in this area — the cost of traveling to the new location and packing and shipping goods and belongings — are shown as an adjustment to income rather than an itemized deduction from adjusted gross income. The player has to actually move to a new residence, instead of merely renting a place for a couple of months, which occurs albeit infrequently.
Penalties and fines represent somewhat of a gray area but are rather frequently accepted by the IRS and the Canada Revenue Agency as ordinary and necessary in the course of business. Though penalties and fines can get itemized, subject to a 2% floor, they can also get deducted as a charitable contribution if the payment goes directly to a charity. This is often the case with team-imposed penalties and fines.
Players can also deduct agent fees and clubhouse and union dues in the United States. However, according to the Canada Revenue Agency’s ruling several years ago, agent’s commissions are not deductible. This is a big deal, considering that players tend to pay their agents 3-5% of their salaries in commissions.
While Canada allows a deduction for “legal expenses incurred by the taxpayer to collect or establish a right to salary or wages owed to the taxpayer by the employer or former employer of the taxpayer,” the revenue agency does not consider agent fees or commissions to fall under this definition.
In an audit of Florida Panthers defenseman Michael Caruso’s 2008 tax return, the revenue agency ruled that Caruso’s agent’s services did not establish a right to salary or wages, but were rather for the negotiation of the contract itself. Therefore, there was no right to the salary or wages until after the agreement was signed, which is after the agent did his work. By this logic, they disallowed agent fees as a deductible expense.
Clubhouse dues, which are basically tips paid by players and coaches to a clubhouse manager, are also disallowed in Canada, even though they are ordinary in the course of business and paid by members of every team. One major league player I spoke to said that everyone on his team paid $70/day in clubhouse dues, not including tips, which vary among players primarily based on their salaries. With tips included, dues vary among players but can quickly add up, and disallowing deductions ranging anywhere from $15,000-$40,000 — if not more — is significant.
These are just two examples of the tax code differences of both countries but they illustrate how tax rates aren’t the only material concern for athletes getting traded to, or considering signing with, a Canadian-based team.
The difference between the federal tax rates in Canada and the United States, as well as the effective state and city tax rates of the Marlins and Blue Jays for the upcoming season — we’ll discuss this more for the entire league over the next couple weeks — means that the players involved in the trade will now face a much different tax situation.
However, rates alone aren’t the only aspect of their tax situation impacted. Reyes, Johnson and Buehrle will all pay more tax this year, even with the foreign tax credit taken into account for the income U.S. residents earn in Canada. Not getting to deduct certain material expenses compounds the issue and sheds light on the differences in athlete taxation between the United States and Canada.