By Dr. John Karaffa, CPA/PFS, CFP®, President of ProSport CPA PLLC
Successful college athletes are often treated like heroes on their campuses. They might feel like stars around town, and the 2 percent who are offered professional contracts will continue to attract attention. But heading into professional sports will come with more than a nice salary, as the tax authorities are keenly interested in garnering tax revenue from professional athletes.
These young women and men will be facing some big decisions and others will want a piece of their fortune and success. They can help to protect themselves with a basic understanding of tax laws and how they are affected moving from the college ranks to the pros.
Taxes Are the Biggest Expense
Taxes will be a new pro’s biggest expense moving into adulthood. It’s the truth that everyone faces. For the average professional athlete, 40-50% of their annual salary will go to the government. Whether they are making thousands or millions, their goal should be to pay the lowest legal amount of tax.
In 2013, the tax burden for professional athletes and other high-income taxpayers increased. The top marginal US Federal income tax rate rose from 35% to 39.6%. United States Social Security taxes reverted back to 6.2% in 2013 from 4.2% in 2012. In California, the millionaire’s surtax brought the top rate to 13.3%.
The enactment of the Affordable Care Act carried some additional taxes for the wealthy:
An additional 0.9% Medicare surcharge tax on single individuals earning more than $200,000;
An extra 3.8% levied on Net Investment Income (NII) for high earners; The NII surcharge also applied to capital gains, increasing the max rate from 15% to 23.8%.
States Levy Jock Taxes
States and some cities have passed laws—known as Jock Tax laws—aimed at taxing the income of visiting team personnel. Taxes under these laws can be quite high, with rates in many states close to 10%. California’s 13.3% millionaire’s surtax is imposed on athletes under this law.
Considering these tax rates, the state of residency determination is an important decision. Tax laws in a player’s home state, college state, and location of professional team factor into their decision of where to legally declare residency.
Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming have no state tax. Residents of New Hampshire and Tennessee only pay tax on their dividend and interest income from investments. In addition to and distinct from US taxes levied at the federal and state level, cities and localities may levy and collect taxes. Each jurisdiction is autonomous from one another and from the federal government. Each administers its revenue collection efforts independent of other taxing entities.
Laws regarding college income need to be understood, as well. Universities are required to report students’ financial information to the government. Scholarships, stipends, and summer employment all create tax-reportable income. If reported incorrectly, taxes could be levied on items that are not required to be taxed. A topic less spoken about involves improper benefits received by college prospects and athletes. Tax laws could be broken if income is received, but not reported. Internal Revenue Service Publication 525 states, “…income is taxable unless it is specifically exempted by law. Income that is taxable must be reported on your return and is subject to tax.” The consequences for under-reporting income can be severe.
Complex Pro Filings
Federal, state, city, and locality tax laws make tax filings complex and often complicated for any professional athlete, but especially one new in his or her career. For example, a National Basketball Association (NBA) rookie will be required to file tax returns for the US, state of residency, every state where his team played, and several cities.
Keeping track of sports-related expenses might seem tedious, but it could potentially result in large tax deductions. The key is reporting those deductions on the correct tax return schedules to maximize their impact.
Athletes who go overseas for their professional careers will need to consider the foreign tax laws of their team’s country. United States citizens working overseas are still required by law to file an income tax return. They are also legally required to report all foreign income and any foreign bank accounts to the US.
Because of the complex tax laws, college athletes and new pros often discover the need for professional coaching on and off the field. Qualified Certified Public Accountants (CPAs) who are experienced with professional athletes’ taxes can help them during this exciting, but often costly, transition. An athlete with an injured knee would consult a sports orthopedist, not a general practitioner. In the same way, a professional athlete should consult a sports tax accountant who understands how to successfully navigate the Jock Tax environment. Too much is at stake.
Dr. John Karaffa, CPA/PFS, CFP® is the founder and president of ProSport CPA PLLC, a Virginia-based accounting firm exclusively for professional athletes. Since his basketball-playing days at Butler University and professionally in Germany and New Zealand, Karaffa has amassed more than 25 years of extensive tax, accounting, and financial education experience. Karaffa earned his Doctor of Business Administration in 2010 and has taught university tax, accounting, and personal finance courses since 1999. Karaffa’s work has been featured nationally in Accounting Today, GQ, Fox News, and the Journal of Accountancy. He uses his tax preparation expertise and professional sports experience to coach, mentor, and educate clients to make good financial and life decisions.