San Francisco Chronicle - (Sunday)
Ohtani’s Dodgers deal could avoid state taxes
Baseball phenom Shohei Ohtani reportedly deferred most of his salary under his blockbuster $700 million, 10-year contract with the Los Angeles Dodgers so his new team could pursue more high-priced players. It has been reported that the contract would also let him avoid California’s league-leading state income tax if he is not a California resident when the big money starts pouring in. But is that really true?
Instead of raking in $70 million a year over the next 10 years, the 29-year-old pitcher/slugger will receive just $2 million per year. The remaining $680 million will be paid out, interest free, over 10 years starting in 2034. The San Francisco Giants were willing to make the same deal but lost out to their archrivals.
California taxes its residents on income earned anywhere in the world. It also taxes nonresidents on California-sourced income, such as rental income on California property, income from a California business or for services performed in California — including sporting events played in the state.
There is an exception, however, for retirement income that could apply in Ohtani’s case.
A federal law prohibits states from taxing retirement income received by nonresidents after Dec. 31, 1995. Before that, California taxed out-of-state residents on pensions earned while working in this state.
The law clearly applies to income from “qualified” retirement accounts such as pensions, 401(k) plans and Individual Retirement Accounts. But it can also apply to “nonqualified deferred compensation plans,” when certain conditions are met, according to an article in Sportico. “Those conditions include payments that are not less frequently than annually, occur during a period of not less than 10 years and are ‘substantially equal.’ What this means is that if Ohtani resides in a state without an income tax (when he gets the deferred payments), he and his CPA could argue he is not subject to any state income tax — including from California — on grounds his deferred payments ought to count as retirement income. He would still have to pay federal income taxes,” it said.
“Because of that, I believe he won’t have to pay (state income tax) on the deferred income if he moves out of California,” said the article’s co-author Robert Raiola, director of the Sports & Entertainment Group at accounting firm PKF O’Connor Davies in New Jersey.
Others agree.
“If the contract is structured properly, California will not be entitled to tax on the payments if he lives out of state. Based on the sophistication of the parties involved, I would bet that it is structured properly,” said John Sensiba, managing partner of Bay Area accounting firm Sensiba San Filippo.
Others are not so sure. “While there are strong protections for qualified retirement plans, there are also strict rules for those protections to apply. Given the amounts and nature of the agreement, I am skeptical the deferred compensation will escape California tax completely,”
Chris Parker, a partner with accounting firm Moss Adams, said via email.
He noted a California regulation that says “non-resident actors, singers, performers, entertainers, wrestlers, boxers, etc.” must include in their taxable gross income the “gross amount” received for performances in the state. The question, then, is what is the gross amount received for performances in California?”
Depending on the language of the contract, it’s “certainly possible” that the state could argue that the deferred portion is included in gross income, Parker added.
California’s top tax rate is currently 13.3% which includes an extra 1% tax on annual income over $1 million to fund mental health services. That’s already the highest top rate in the nation. Next year, the top rate will effectively rise to 14.4% for most private-sector workers because California will apply the payroll tax that funds state disability and family leave benefits to an unlimited amount of income. The tax, which varies by year but will be 1.1% next year, previously applied to a limited amount of annual wages ($153,164 in 2023).
The Franchise Tax Board is notorious for tracking down high-income earners who move out of California and claim they no longer owe state income tax. California has complicated rules for determining state residency.
The FTB did not respond to a request for comment.
H.D. Palmer, a spokesperson for the California Department of Finance, said via email that the department “does not evaluate any individual’s estimated tax liability.” But the finance department staff said that in general, “deferred compensation is taxable only when an individual receives it, so a non-resident who receives deferred compensation that’s not sourced to California would generally not pay California taxes.” His staff asked the FTB to define “not sourced to California” in the context of deferred compensation.
The FTB replied in part: “The timing of the payments and timing of generating taxable California source income is a fact-specific finding that would depend upon the unique facts and circumstances of a taxpayer as well as the terms of any compensation agreement.”
Many corporate executives who max out their 401(k) plans defer additional income until they retire under deferred compensation agreements, generally because they think they will be in a lower tax rate after they retire than while they’re working, said Michael Agresti, a tax partner with LSL, an accounting firm in Orange County. If structured correctly, people who earned the money in California generally won’t owe California tax on it if they retire out of state, he said.
But there are risks: Money in a nonqualified deferred compensation agreement is not set aside in a separate account for the employee, nor is it protected by the federal retirement-security laws that govern qualified plans. If the company went bankrupt, the executive could lose that money. That can be a big risk with companies, but “I would imagine in (Ohtani’s) situation the risk is pretty low,” Agresti said.
Ohtani’s reason for deferring his salary, according to sources in his camp, was to help the Dodgers lure other high-priced players and vie for a World Series championship. To even the playing field, somewhat, Major League Baseball imposes a “competitive balance tax,” also known as a “luxury tax,” on teams that exceed a certain predetermined payroll.
“Those who carry payrolls above that threshold are taxed on each dollar above the threshold, with the tax rate increasing based on the number of consecutive years a club has exceeded the threshold,” MLB says.
According to The Athletic, Ohtani’s salary deferral reduces the present value of his contract to $460 million instead of $700 million. As a result, only $46 million a year will count toward the Dodgers’ luxury tax calculations instead of $70 million.
Ohtani’s salary deferral is not the first in major league baseball, but it’s certainly the biggest. Current Dodger Mookie Betts has deferred $115 million of his salary until 2033 through 2044 and his teammate Freddie Freeman has $57 million in deferred income payable from 2028 through 2040, according to the Associated Press.
Going back further, when pitcher Max Scherzer signed with the Washington Nationals in 2015, he deferred half of his seven-year $210 million contract. And former All-Star outfielder Bobby Bonilla, who hasn’t played since 2001, is still receiving deferred salary payments from the New York Mets and Baltimore Orioles. The Mets, however, are paying 8% annual interest on Bonilla’s deferred salary payment, which will continue until 2035, according to CBS Sports.