By Michael D. Foster
With the first two weeks of the NBA season cancelled and the length of the labor dispute between the owners and players uncertain, professional athletes from the United States are increasingly expressing interest in playing on teams abroad, even for short periods while the lockout continues. Playing abroad may require creative tax planning in order to avoid incurring significant additional taxes.
Overview
NBA players who choose to play outside the U.S. during the lockout will likely do so in one of two ways. One will be for players to compete with a foreign team either temporarily or on a long-term contract. Second, a group of U.S. athletes could collectively tour in one or more foreign countries playing either local competition or against one another.
Contract with Foreign Team. A U.S. athlete who signs a multi-year contract to play for a foreign team may face complex tax issues. For instance, the U.S. athlete may become an income tax resident in the home country of his or her team. In addition, a multi-year contract creates the likelihood that the U.S. athlete’s “tax home” [1] will shift to the foreign country, which would cause living expenses in that country to become personal and non-deductible for U.S. income tax purposes. If the U.S. athlete remains outside of the United States for a sufficiently long period of time, such as 330 days in any 12-month period, [2] he or she will qualify for the foreign earned income exclusion, which will reduce the athlete’s U.S. income tax liability.
The NBA lockout appears to be creating a new category of U.S. athlete playing for a foreign team, namely the short-term foreign contract. These contracts are being offered to NBA players for the length of the lockout. These short-term contracts are unlikely to cause an athlete’s tax home to shift from the United States to the foreign country. As a result, the U.S. athlete will be able to deduct any foreign living expenses that are not reimbursed by the foreign team.
Barnstorming Tours. The “barnstorming” athlete has been around since at least 1908 when professional baseball players first began traveling to Japan for promotion and exhibition games. International barnstorming as a major economic activity probably first took hold with Babe Ruth’s 1934 barnstorming tour of Japan, which was an enormous financial and cultural success. [3] Generally speaking, barnstorming tours should operate in a manner similar to concert tours, in which a centralized withholding agreement with the foreign government is negotiated in advance, with the promoter responsible for paying the foreign tax obligation of each of the players.
If U.S. athletes organize an international barnstorming tour themselves, presumably the portion of profits in excess of each player’s per game fee would be taxable, or non-taxable, in accordance with the laws of each country where games are played, as modified by any applicable income tax treaty.
Preliminary Review of Status
With the proliferation of foreign-born players coming to the United States to play professional sports, questions can arise as to the tax residency for those players. So, first it is necessary to identify the country where each player is actually an income tax resident for tax purposes. Obviously, U.S. athletes and green card holders will be treated as U.S. tax residents, and are taxable in the United States on their worldwide income. Many players who are not citizens or green card holders may also be considered U.S. tax residents even for income earned outside the United States. [4] However, in an extended lockout, some players may lose their status as U.S. income tax residents. As a result, it’s important to review the tax status of non-citizen non-green card holders if they join a team outside the United States, even temporarily.
Foreign Tax Credits
In addition to tax in the foreign country where the athlete is performing, the U.S. athlete has the added burden of being subject to U.S. income tax on that same income. If the tax paid by the U.S. athlete in the foreign country is equal to or less than the U.S. tax on that same income, the U.S. athlete will enjoy a foreign tax credit in the United States for the tax paid overseas. [5] If the foreign tax is lower than the U.S. tax, then the U.S. athlete will owe the IRS the difference. However, many foreign countries impose rates of income tax that are higher than those in the U.S. In those instances, the U.S. athlete won’t be able to fully utilize the foreign tax credit arising from the higher foreign tax paid by the athlete. For those athletes, there are potential planning alternatives that can reduce the overall foreign tax to an amount no greater than the U.S. tax on that income. If the foreign tax credit cannot be fully utilized, the U.S. athlete will end up paying tax at a higher rate overall than would have been imposed had he been subject only to U.S. tax.
In addition to federal tax on the foreign earnings, most state income tax regimes also impose state income tax on the earnings of its residents, regardless of where it is earned. Foreign tax credits, even those pertaining to regional or local foreign taxes, will not qualify as a credit against the state tax liability of a U.S. athlete.
Planning Suggestions
Use of Personal Service Corporation. The NBA and other U.S. professional sports leagues do not permit players to provide their playing services to their teams through personal service corporations. Even if they did, it is unlikely that the IRS would permit such an arrangement without a challenge. However, the nature of the relationship between a U.S. athlete and a foreign professional sports team, particularly on a short-term contract, or a U.S. player on a barnstorming tour, may result in a situation in which a U.S. athlete playing in a foreign country for a limited duration could utilize a personal service corporation to provide his or her services. Such a corporation would be an S Corporation for U.S. income tax purposes in order to utilize the foreign tax credit. The objective of such a structure is to be able to ensure the deductibility of the various expenses a U.S. athlete incurs on a short-term foreign contract or a barnstorming tour for U.S. tax purposes.
Prenegotiated Agreement. Many foreign countries allow foreign athletes and entertainers to enter into negotiated agreements establishing a net income tax liability for limited stays with agreed upon deductions incorporated into the agreement. Particularly when excess foreign tax credits are a risk, the U.S. athlete should consider whether a prenegotiated tax agreement can be made with the appropriate jurisdiction. These types of arrangements are the norm with barnstorming tours. Yet, while these arrangements are often available on the federal level, they may not be for regional or municipal tax purposes.
Bifurcation of Income. Certain types of foreign income may be subject to foreign tax at a lower rate than personal service income. For example, some countries impose no tax on royalty payments, while others impose a flat tax of between five and fifteen percent. When structuring a contract for a U.S. athlete, tax planners should consider whether a portion of the fee to be paid should be allocable to the use of the U.S. athlete’s name and likeness for marketing and other promotional purposes.
Other Foreign Source Income. A professional athlete may already have endorsement income or royalty income from foreign countries that can be utilized in the foreign tax credit limitation computations. As a result, planners should review all existing contracts to determine whether any such contracts are generating foreign source income, if the full use of the foreign tax credit is an issue.
Tax Indemnity or Gross-Up. For U.S. athletes with sufficient negotiating leverage, a tax indemnity or gross-up that causes the athlete to be paid additional sums that equalize the U.S. and foreign taxes is a relatively simple solution, although difficult to obtain.
Conclusion
Overall, the opportunity for a U.S. athlete to perform outside the country can be financially and personally rewarding. The complexity of the U.S. tax rules for residents working abroad, coupled with the laws and procedures of the foreign country or countries where an athlete will be working, requires special care when negotiating a new contract. Only with proper planning can all of the tax risks, hurdles and opportunities in this situation be addressed.
Michael D. Foster is a partner in the Los Angeles office of Venable LLP where he specializes in domestic and international taxation.
1 Internal Revenue Code Sections 911(d)(3) and 162(a)(2)
2 Internal Revenue Code Section 911(d)(1)
3 See www.baberuthcentral.com for more
4 IRC Section 7701(b) contains the income tax residency rules for non-U.S. citizens
5 IRC Section 901
