Athletes Find New Way To Avoid Taxes
Restructured contracts may help franchises who have a certain competitive disadvantage.
It felt groundbreaking when Shohei Ohtani did it with the Los Angeles Dodgers over a year ago. By the time Frank Vatrano did it with the Anaheim Ducks earlier this month, it was a certified California trend.
Athletes, like everyone else, don't like paying taxes. California has a top marginal income tax rate of 13.3 percent, plus there's the top federal rate of 37 percent, so high-earners like athletes are forking over a lot of hard-earned money. But if the team a player wants to sign with is in California, what can they do to avoid the state's high taxes? As Ohtani and Vatrano have now done, they can defer the income until they likely won't be living in the Golden State anymore.
Ohtani famously signed a record-breaking $700 million contract with the Dodgers in December 2023—but with $680 million of that contract deferred, to be paid out equally from 2034 through 2043. If he doesn't live in California during that decade, he could save between $90 million and $100 million in state taxes. The Dodgers didn't stop there. "With Ohtani, [Mookie] Betts, [Blake] Snell, [Freddie] Freeman, [Will] Smith, Tommy Edman, Teoscar Hernández and J.D. Martinez,…the Dodgers owe eight players a little more than $1 billion in deferred money from 2028 to 2046," ESPN's Alden Gonzalez wrote in December.
The other two teams with combined deferrals above $100 million are, unsurprisingly, also in high-tax states: The New York Mets (top marginal income tax rate of 10.9 percent, plus more if the player lives in New York City) and the Boston Red Sox (top marginal income tax rate of 9 percent).
The numbers in Vatrano's deal are not nearly as eye-popping as Ohtani's, but show how it's not just superstars that are thinking about how to legally avoid California's taxes. Vatrano's total contract is $18 million, with $3 million paid out in each of the next three seasons, and $9 million deferred. Similar to Ohtani's deal, the deferred money will be paid out over 10 years, starting in 2035, when Vatrano will be in his 40s and likely retired from playing in the NHL.
The key to avoiding taxes on deferred payments is paying them out in equal amounts over at least a decade. "A 1996 federal law forbids states from taxing retirement income on out-of-state residents when payments are made in 'substantially equal periodic' amounts over at least 10 years," The Athletic's Evan Drellich explained.
Those deferred payments won't just help athletes avoid taxes—they might help ease the pain felt by franchises in high-tax states when they're negotiating with players in free agency.
Plenty of factors go into a free agent athlete's decision on where to sign: taxes, cost of living, and climate, not to mention team-related factors. But research has shown state income taxes really do hold back teams in high-tax states. For example, over the span of an 82-game season in hockey or basketball, the difference between a team in a high-tax state versus a state with no income tax may be as much as seven or eight wins, according to Erik Hembre, who was an assistant professor of economics at the University of Illinois Chicago when he published a paper on this topic. "For each percentage point increase in state income tax rates, team winning declines by 0.70 percentage points," the paper says.
"It's enough to like upgrade your team a little bit, but it's not going to be the difference between championship and not championship," Hembre says. "If we look at free agent signings last year that would be like the Sacramento Kings got OG Anunoby instead of Malik Monk."
Hembre's research looked at how teams have been affected by changes in taxation, either from relocation or states (and Canadian provinces) changing their tax rates. His evidence also shows the effects of taxation largely didn't come into play until free agency started to take off in the late 1980s and throughout the 1990s.
"NBA average team payroll is something like $170 million," Hembre says. "If you kind of think about California versus Texas, something like a 10 percent marginal tax rate to 0 percent marginal tax rate, if all of that is being absorbed by the teams, that difference, that's about an extra $17 million in spending."
That's why it's no surprise that expansions and relocations in the four major professional sports leagues seem to somewhat favor low-tax states over high-tax states. The NHL recently expanded in Washington and Nevada, both with no income tax. The NFL's Raiders moved from California to Nevada, as the MLB's Athletics are attempting to do (though as the Los Angeles Rams' move from Missouri to California shows, it's not a hard-and-fast rule and other factors come into play).
If athletes are finding new ways to avoid paying state taxes on a portion of their income, the harm high taxes cause teams might be diminished—unless the tax man finds a way to get those tax payments anyway. "States do not like to give up that revenue if they have a claim on it, so I'll be curious to see if it ends up lowering the marginal tax rate," Hembre says.
Should, or could, leagues do anything to fix the advantage for teams in states with no income tax? The Athletic's Michael Russo talked to several NHL players about it last year: They mostly said something should be done about it, but weren't sure what. "There are just too many variables to really control," NHL deputy commissioner Bill Daly said.
Hembre has one idea that might work: base salary caps on expected posttax salary instead of pretax salary. "That should, at least in theory, kind of mitigate it in part," Hembre says.
That would be a simple solution. Or perhaps high-tax states should look at all the people (athletes or not) moving to low-tax states and take the hint.
