Yankees Re-Sign Derek Jeter, Lower Luxury Tax Calculation

Worth noting: Joel Sherman of the New York Post suggests that pretty much everything written below is wrong.

$12M deal actually will cost #Yankees more toward '14 luxury tax than if let Jeter just pick up his $9.5 million player option (cont)

— Joel Sherman (@Joelsherman1) November 1, 2013

Way luxury tax salaries, computed Jeter would have cost $10.75M on payroll if option picked up will cost $12.8M now #Yankees

— Joel Sherman (@Joelsherman1) November 1, 2013

It is certainly possible that I’ve interpreted the luxury tax calculations incorrect. The post will be updated once I have clarification.

Derek Jeter is going to stay with the Yankees, surprising absolutely no one. This was never really in doubt, especially because Jeter had the right to ensure he played 2014 in New York, thanks to a player option that was added to the end of his three-year, $51 million option on the deal he signed in 2010. He could have exercised his right to become a free agent, but heading into his age-40 season and coming off the worst year of his career, interest probably wouldn’t have been overwhelming. And it’s unlikely he wanted to end his career in any other uniform, so this was always the expected outcome.

However, the actual announcement sheds some fun light on the details of how the CBA works and how the luxury tax is calculated. The Yankees could have just let Jeter exercise his player option — listed as $8 million, but reported by Jon Heyman to actually be worth $9.5 million — but instead, they signed him to a new contract that will pay him $12 million next year instead. Why the $2.5 million to $4 million raise over what his own player option called for?

Three words: the luxury tax. The Yankees have been desperately trying to get under the $189 million threshold, and by paying Jeter more, their tax calculation is actually going to go down.

Here’s how this works. On multi-year deals, the luxury tax takes the average annual value of the deal and applies it evenly to each year, so the actual salary earned by the player in that season is less important than the total figure earned during the life of the deal. Because Jeter’s expiring deal was for $51 million over three years, if he had exercised his $8 (or $9.5) million option, that would have been a continuation of the deal, so the calculation would have been $59 (or $60.5) million over four years, or essentially $15 million per year.

Because this is a new contract and not a continuation of the old contract, Jeter will count $12 million against the team’s luxury tax payment for 2014 instead, so by paying Jeter more than he was scheduled to make, they’ve actually lowered their luxury tax calculation by about $3 million. Which, you know, is pretty silly, but this is how the calculations work.

$3 million might not seem like a huge deal, but there’s a huge difference for the Yankees in having their calculation come in at $188 million instead of $189 million. Because they are a multiple time payer of the luxury tax, they pay a 50% tax on the amount they are over the threshold. If they get under the $189 million figure even just once, then they can safely go back over the tax in subsequent years, but their tax rate will be reset to the lowest figure of 17.5%. If they can get under $189 million this year — A-Rod’s suspension should help in that regard — then they could bounce their payroll back into the stratosphere for 2015 and pay much less in tax in the future.

For instance, let’s say they get under the $189 million threshold this winter, then bounce their 2015 payroll up to $250 million after a big off-season spending spree. Instead of paying a 50% tax on a $60 million overage, they’d pay a 17.5% tax on that overage, so their 2015 tax bill would be $11 million instead of $30 million.

Maybe the Yankees have enough money where they don’t really need to worry about $10 million here or $20 million there, but they’re still a business, and every business in America tries to pay as little in taxes as possible. In this case, the Yankees were able to potentially lower their tax rate by re-signing one of their most marketable players. Seems like a pretty decent use of a few million to me, even if Jeter is no longer what he once was.