Income of $2 million, Taxes of $5 million?

By Marilee Corr Clark, Esq.

irs1Tax law is not normally associated with sports law.  However, a tax provision that still seems relatively unknown could easily cause a professional athlete to owe more in taxes than he has received in a given year.  The tax provision is Code § 409A, which was enacted in October, 2004 and generally effective on January 1, 2005.  The IRS has repeatedly pushed back the deadline for compliance, but as of December 31, 2008 all agreements need to comply. 

Essentially, 409A applies to arrangements where someone earns compensation in one year, but is not paid until a later year, i.e. deferred compensation.  The IRS regulations and guidance are very long, complex and still ambiguous in some regards, but whenever you see a contractual right to receive money that is not going to be paid until a later year, then you should recognize that you have a potential 409A problem.  How does this relate to professional athletes?  Signing bonuses, for one. 

birdcontractA signing bonus is compensation earned by joining a team, but it is frequently paid out over time.  For example, let’s say that Jim is an in-demand pitcher.  On January 1, 2009 he signs with a team that offers him a $10 million signing bonus to be paid over a five year contract term.  Without making sure that the bonus fits within an exception in the 409A regulations, Jim would be receiving non-qualified deferred compensation subject to 409A.  That means that Jim would have to pay taxes on $10 million of income in 2009 and be subject to a 20% excise tax on top of that. 

The result?  Jim is only paid the $2 million due for the first year’s payment, and already owes the IRS $2 million in excise tax plus income taxes of approximately $3 million.  You probably don’t want to be Jim, or the person that negotiated that “deal” for him.  With that example, you can see why it’s so important that players and the people who negotiate their pay be aware of 409A.  Again, if you see a situation where someone is earning pay in one year and getting paid in another, then find an attorney or an accountant who knows 409A. 

corr1Marilee Corr Clark is an associate at Rogin Nassau LLC in Hartford, Connecticut.  Her primary practice areas are taxation and commercial real estate transactions.  

Comments

  1. I’ve been interested in taxations for lengthier then I care to admit, both on the personal side (all my working life!!) and from a legal stand since passing the bar and following up on tax law. I’ve put up a lot of advice and redressed a lot of wrongs, and I must say that what you’ve put up makes complete sense. Please continue the good work – the more individuals know the better they’ll be outfitted to deal with the tax man, and that’s what it’s all about.

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  1. […] to Connecticut Sports Law as guest bloggers.  Ben Berger, Jarett Warner, Hanna Kim, Gary Solomon, Marilee Corr, Rob Romano, Tim Cedrone, and Dan Canavan – thank you for your fine […]

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