Baseball Star Shohei Ohtani's New Contract Is a Massive Tax Avoidance Scheme. Nice!
He could save $98 million by dodging California's state income taxes with his unusual, eye-popping contract.
Baseball superstar Shohei Ohtani signed a new 10-year contract this week with the Los Angeles Dodgers, who have promised to pay an eye-popping $700 million.
But unlike most sports contracts, that $700 million won't be doled out over the 10-year term of the deal—and, as a result, both Ohtani and the Dodgers are poised to dodge (sorry) some of the taxes they might be otherwise obligated to pay on the record-breaking deal.
The 29-year-old Ohtani will collect $2 million in each of the next 10 years. The rest of Ohtani's $68 million salary will be deferred for a decade, and the Dodgers will owe it to him in annual installments starting in 2034. By the time Ohtani collects the last of those payments in 2043, he'll be 49 years old (and almost certainly well into retirement).
Because he'll be playing most of his games in high-tax California, taking most of his pay via what's effectively a fixed annuity gives Ohtani the possibility of avoiding some massive tax payments. "By the time he starts receiving the $68 million payments, he may be able to avoid state income taxes by living someplace like Florida without an income tax, or by moving back to Japan," The Wall Street Journal reported this week.
(Ohtani won't have to get by on a mere $2 million per year, of course, as he earns an estimated $40 million annually via endorsements.)
California has the country's highest state income tax rates. The top marginal rate is currently 13.3 percent, including a special 1 percent tax on income over $1 million, and the rate is set to rise to 14.4 percent next year.
By taking most of his pay in what's effectively a fixed annuity rather than getting it all in his paycheck, Ohtani could save as much as $98 million in state taxes if he relocates out of California by 2034, according to an analysis by the California Center for Jobs & the Economy.
That report also highlights how dependent California is on high-earning individuals—you know, the same people the state seems determined to keep driving away by hiking taxes. According to the analysis, "the amount of income tax Ohtani could save annually by changing his residence in 2033 is equivalent to the total tax liability of the bottom 1.78 million tax filers in 2021."
It's a uniquely structured contract for a uniquely talented ballplayer. Ohtani has excelled as both a pitcher and a hitter during his career, which has included time in the Japanese and American major leagues. He's certainly the best two-way player the world has seen since Babe Ruth—and arguably the best ever (though comparisons are difficult given how much the game has changed since the Bambino's days, the rarity of two-way players in professional baseball, and the lack of certainty about whether Ohtani will continue pitching after suffering a serious arm injury this year).
If Ohtani retires after his new contract expires in 2033, he'll be able to claim that the deferred payments from the Dodgers are retirement income—and the federal tax code explicitly forbids states from trying to tax the retirement income of individuals who no longer reside in the state where they once worked. In other words, Ohtani could move to one of the nine states without an income tax and likely avoid paying taxes on those future $68 million annual payments, explains Sportico, a trade publication focused on the business side of professional sports.
California might try to contest that, however. The California Franchise Tax Board tells Sportico that its determination about future tax liability would depend "upon the unique facts and circumstances of a taxpayer as well as the terms of any compensation agreement." Meanwhile, the San Francisco Chronicle reports that California's "complicated rules" for determining state tax liability include regulations allowing the state to tax "non-resident actors, singers, performers, entertainers, wrestlers, boxers" and others based on the gross amount they are paid for activities that occurred in the state. That could be construed to give the state a chance to go after Ohtani's deferred payments.
Regardless of how all that shakes out, there's another wrinkle to the brilliant tax avoidance scheme built into Ohtani's record-breaking deal. By deferring a large portion of his compensation, the Dodgers might also reduce their own tax burden—not to the state government, but to Major League Baseball (MLB).
That's because of the MLB's so-called "luxury tax," a redistributionist scheme that is meant to limit how much money richer clubs spend on players in the name of maintaining competitive balance. Implemented in 2002, the luxury tax applies to teams with payrolls that exceed a level determined annually by the MLB. Teams that exceed the threshold pay a 22.5 percent tax on every payroll-dollar above the threshold, and the percentage of the tax escalates for teams that exceed the threshold in consecutive seasons.
The luxury tax threshold for next season is $237 million. If Ohtani's contract was structured in a more typical way, the $70 million owed to him would account for nearly one-third of what the Dodgers could spend on payroll before hitting the tax threshold. However, with the deferments in place, Ohtani's contract will count as $46 million in the eyes of the MLB's luxury tax accounting system, according to ESPN's Jeff Passan. That means the team will have the chance to spend more money on other players before triggering the luxury tax punishment.
That's not a matter of public policy, since the luxury tax is an internal MLB matter that all the clubs have agreed to follow. And the MLB's collective bargaining agreement is clear: There is no limit to how much money a player and team can agree to defer.
Still, there's a lesson there about how taxes warp incentives for individuals and corporations. In some ways, it's like how historical taxes on windows created weird incentives for architects and homeowners. If attics are exempt from taxes, more houses will have attics. If there are ways to avoid a punitive tax that comes with signing expensive ballplayers, teams will find new ways to sign expensive ballplayers.
And if California is going to tax wealth at an exorbitant rate, wealthy people will find ways to avoid earning money in California.
