Moments after the Atlanta Hawks made Alpha Kaba the final pick in the 2017 NBA Draft, the attention of the basketball world turned to what promises to be a frenzied free-agency period. Beginning July 1st, a bevy of big-name players hit the open market, including Chris Paul, Blake Griffin, Gordon Hayward, and the tattered remains of Derrick Rose.
Los Angeles Clippers guard Chris Paul, right, shoots as Utah [+]
For these free agents, there is much to consider in choosing their next team. Who offers the most established leadership? (Miami) The best weather? (Miami) The most accessible network of HGH dealers? (Miami)
Then, of course, there’s the little matter of money, and when it comes to extracting the most coin possible out of a contract, it typically behooves a free agent to do nothing at all, and simply re-up with their previous employer.
That’s because the NBA’s collective bargaining agreement affords advantages to a team in re-signing it’s own free agents, provided the team has so-called “Larry Bird rights” in the player. Generally, this requires the player to have been with the team for three consecutive seasons, though there are a host of other ways a team can obtain these rights.
Once a team has Bird rights in a player, it can offer a contract no other team can match. To illustrate, because Chris Paul has played the past six seasons with the Clippers, LA can offer Paul a five-year deal with annual raises of 7.5% – which under the current salary cap structure would amount to a $200 million deal over the five-year period. Any other team with hopes of luring Paul, however, is limited to offering a 4-year pact with 4.5% annual raises, for a total package of $152 million over the life of the deal. Thus, by re-signing with the Clippers, Paul would have the security of an extra year on his contract, plus another $48 million in the bank.
So it’s a foregone conclusion that Paul will re-up with LA, right? Not so fast. He may well be on the move to the San Antonio Spurs, for two compelling reasons.
First, money may not be the most important factor in Paul’s decision. At the age of 32, the point guard is in win-now mode, and his run in LA has proven maddeningly frustrating. Despite possessing a Big 3 of Paul, forward Blake Griffin and center DeAndre Jordan, the Clippers have been stuck in neutral during Paul’s tenure, leaving many to believe that it’s time for both Paul and Griffin to take advantage of their free agency and seek a change in scenery.
And it’s hard to envision a better landing spot for Paul than San Antonio, a franchise that over the past two decades has been every bit as stable (one coach) and successful (five NBA titles) as the Clippers have been dysfunctional (previous owner Donald Sterling was deposed after making racist comments) and disappointing (not a single trip to the conference finals).
But we’ll leave the team comparisons to the sports pages; in this space, we write about taxes. And tax considerations — both the existing law and potential changes proposed by the Trump administration — may well help Paul bridge the $48 million gap between offers from the Clippers and Spurs and land him in San Antonio.
State Tax Considerations
As a California resident, Paul currently pays state income tax of 13.3% on his earnings, the highest rate in the country. From there, things get a touch more complicated. In the U.S., the taxation of professional athletes is based on “duty days;” basically, the income they earn is apportioned to each state based on the number of days they compete or train within the state, and is then taxed in that state according to its tax rates.
Any income allocated outside the state and taxed in another jurisdiction– for example, when the Clippers play the Phoenix Suns and Paul is required to pay Arizona state tax on the allocated income – will generate a credit Paul can use against his California income tax. That way, Paul is not paying tax on the same income to both California and Arizona. But because California’s rate will always be higher than the other state, Paul will still pay an effective rate of 13.3% on his income.
To illustrate, if Paul had $10,000 of income allocated to a state with a 5% tax rate, California – as Paul’s state of domicile — will tax the income at 13.3%, or $1,330. The other state will tax the income at 5%, or $500. Finally, on his California return, Paul will get a $500 credit for the tax he paid to the other state, reducing his California tax to $830, but his total tax will still remain $1,330 ($500 to other state + $830 to California).
Thus, if Paul earns $200 million over the five-year life of a new deal with the Clippers, he will pay approximately $26.6 million in state income tax over that span.
But what if Paul heads to San Antonio? Texas has no state income tax; as a result, Paul’s earnings would only be taxed to the extent he has duty days allocated outside of Texas. Sweetening the deal further, as a member of the Southwest Division, the Spurs play two road games apiece against the Houston Rockets and Dallas Mavericks. And if you’re one of the 6% of public school graduates who understand basic geography, you’ll recognize that those teams are also located in Texas, and so that income also escapes tax. In addition, the Spurs will play one road game each year against the Miami Heat and Orlando Magic, who are located in Florida, which also does not have an income tax. And lastly, they will play two road games each year against the Memphis Grizzlies, where a $2,500 per game “privilege tax” on athletes maxes out at $7,500 annually. Thus, in total, the salary earned from 49 of Paul’s 82 game days would largely go untaxed at the state level.
For the sake of argument, let’s assume that the NBA season comprises 270 duty days, from the beginning of training camp until the playoffs mercifully conclude in late June. Let’s further assume that the average state income tax rate in those states the Spurs compete in outside of Texas is 5%.
We’ve already determined that Paul will play 49 games in states with no income tax, meaning he will play 33 games in states with a tax. If we assume another 33 of travel days allocated to taxable states –purely a shot-in-the-dark estimate — and five playoff games located in taxable jurisdictions, we get a total allocation of duty days of 71/270, meaning 26.2% of Paul’s total earnings of $152 million over the life of his contract – or $40 million — will be subject to state income tax. At an average rate of 5%, Paul would pay approximately $2 million of state income tax over the four-year period. So in summary: $26 million in state taxes on $200 million of earnings if Paul stays in California (net of $174 million); $2 million in state taxes on $152 million if Paul heads to Texas (net of $150 million).
Of course, those numbers don’t take into consideration Paul’s federal income tax, which would surely be impacted by his state tax liability, right? Well, this is where free agents like Paul would be wise to keep an eye on the tenuous state of tax reform, as changes to federal tax law proposed by President Trump could mean the difference of millions of dollars during their next contract.
Changes to Federal Tax Law
In computing federal tax liability, individuals are permitted to deduct the state income taxes they pay. Thus, while Paul would pay a much larger state tax burden if he re-signs with the Clippers, under current law the blow would be softened by the fact that Paul would deduct the $26 million in state taxes on his federal return, where it could save him — ignoring alternative minimum tax and overall itemized deduction limitation implications for simplicity’s sake – 39.6 cents on every dollar, meaning the real after-tax cost of the state taxes would be only $15.7 million.
President Trump, however, has proposed eliminating the deduction for state and local income taxes. This would hit taxpayers in high-tax states like California, New York and New Jersey hard, as they would now receive no federal benefit for their state tax burden. As a result, the true cost of Paul’s $26 million in state tax would be….$26 million.
Of course, the impact of the law change would not be limited to professional athletes. High-earners in the aforementioned high-tax states would feel far more motivation to flee those states for more tax-friendly jurisdictions than they already do, and as you might imagine, this has the governors and Congressmen and women of those states in panic mode.
Whether a change as drastic as the elimination of the state and local tax deduction is able to navigate the political minefield and come to fruition remains to be seen, but should it do so, it could certainly influence where free agents choose to ply their trade. As indicated above, by re-signing with the Clippers, Paul would net approximately $173.4 million over the life of a five-year deal after state income taxes. Moving to the Spurs, however, would net Paul $150 million over four years, bringing the difference in contracts down from a gross amount of $48 million to an after-state tax amount of less than $24 million.
Of course, $24 million is still a lot of cash, but you have to consider that after a move to Texas, Paul’s considerable endorsement income would also escape state income tax. It is reported that Paul earns $8 million annually in endorsement income from State Farm and others; over a four-year life of a Spurs contract, he would walk away with $32 million net of state tax, whereas in LA he would net only he would pocket only $27 million after state tax (no federal taxes are factored in since they would be the same in both situations) That’s another $5 million removed from the excess offer LA can use to entice Paul, meaning he is left with the following decision:
Is the chance to start anew with the best franchise in the sport worth walking away from $19 million?
