Checking the Numbers: Withholding Aplenty

A couple of weeks ago I discussed “the jock tax” in this space, which is the nickname given to the tax liability incurred by non-residents on income earned away from their home state. The moniker is derived from the simple fact that athletes are much more vulnerable to this tax due to their big salaries and schedules being in the open.

To summarize, baseball players are liable for tax to their state of residence as well as the state in which their team plays. When they travel on the road for games, their salary is prorated to the time spent in those road cities and states and those portions of income are taxed. The units of measurement to prorate the salaries are duty days or games played, which is not uniform across all cities and states. The difference between the two is off days. There are 162 games in a baseball season and around 220 duty days. In baseball, the difference between prorating salary based on games or duty days is minuscule and immaterial, which came in handy for this exercise.

Most states offer credits to their residents for taxes paid to other states, which prevents players from being grossly over-taxed, but given the lack of uniformity across the various taxing jurisdictions, the fact that some states do not even have an income tax (Florida, Washington, Texas, I’m looking at you), and the varying rates in the cities and states, it is certainly possible for a player on one team to pay much more tax than a player on another team. This can be very interesting when analyzing a contract because the gross salary received across multiple offers to a free agent can turn out very differently depending on the teams making the offer, a facet of analysis rarely explored.

A tremendous dialogue opened up after that last article, and I was asked about the possibility of applying the different jurisdictional tax rates to the schedule for the upcoming season in to build the equivalent of park factors for state and city taxation. With the help of subscriber Tony Franco, this challenge was accepted and, as the kiddies say, “pwned.” We began by researching and compiling the tax rates in each state—or province, thank you very much Toronto—in which a major-league team plays. Next, we scoured the web and my various tax guides for the city withholding rates, though there are relatively few major-league cities with some form of local tax in addition to the state-withholding rate.

In fact, 20 of the 30 teams play in cities without a local tax. The cities with local withholding rates are: Baltimore, Detroit, Kansas City, St. Louis, New York (x2), Cincinnati, Cleveland, Philadelphia, and Pittsburgh. Even amongst those nine cities, the rates are wildly divergent, ranging from one percent all the way up to 3.65 percent. Guess which city has that higher tax rate? It should also be known that, in certain cases like Philadelphia, I am using the non-resident local tax rate; for Philly, the non-resident rate is around 3.5 percent, while the rate for residents is closer to 4 percent.

After all of the relevant rates were compiled, the final step involved applying those rates to the actual schedule. Since we were not using salaries as the input, the output was determined by prorating the games played in each city by the total number of games, and multiplying by the combined tax rate of the home state and city. Luckily, as I mentioned before, the difference between using the more common duty days method and the games played method is immaterial since the denominators are both so large. Before getting into the results, however, I need to explain the assumptions I made throughout the course of this study, as they are of particular importance to taking in the results.

The first assumption was that the credits certain home states give for taxes paid to other states will wash out. This is probably not entirely true, given that some states will limit their credits to their specific withholding rate. In other words, if I am a resident of Pennsylvania with a 3.07 percent income tax and I make money in Massachusetts, which has a 5.3 percent tax rate, the credit in my home state will be limited to 3.07 percent of the total tax incurred in Massachusetts. In cases like this, more tax would be paid. Cases like this will occur, for sure, but I have seen enough accounting literature on multi-state returns to feel comfortable with the assumption.

Secondly, for states and cities with marginal tax brackets—as in, the more you make, the more you are taxed—I took the average of the rates that would be applicable given the major-league minimum salary. In Minnesota, for instance, the rates ranged from 5.35 percent to 7.85 percent, so the rate used in this exercise was 6.6 percent, the average of the two. If this exercise was tailored to a specific individual, I would obviously look to use the actual rates, but to get a sense of the overall team effect I decided to go with the averages as opposed to spending countless hours inputting every single player on a team and his salary. Just know that these are the averages being used and not the exact rates specific to certain players and their prorated income earned in those jurisdictions.

Lastly, I assumed that every player is not a resident of the state in which his home team plays. This is very obviously not 100 percent accurate, but again it represented an example in which only marginal accuracy would be gained by spending more time than made sense. This comes into play in situations like what happened to Sammy Sosa back at the beginning of the decade, where he played for the Cubs and was a resident of Illinois. Though Illinois provided credits for taxes paid to other states, its tax code had a stipulation against such credits for athletes who both played and lived in Illinois. Additionally, the state of residency comes into play when taxing non-salary income, like endorsement compensation. Derek Jeter was involved in a court case centered on this topic when New York City tried to claim that he was a resident of the city in an effort to tax his endorsement money, when he indicated his primary city of residence was Tampa, Florida. The latter scenario is not applicable to the tax on salary, which is the point of this piece, and while the former will certainly occur, I genuinely do not think it would have a material effect on the results of this study.

With the disclaimers out of the way, how do the results look? The tables below break the teams up into their respective divisions, with the effective tax rate players can expect to see by playing for those teams in the upcoming season. By effective tax rate I am not saying that the Yankees are at 7.6 percent because the average New York rates add up to 7.6 percent, but rather that, if you prorate the tax rates of the jurisdictions based on the games played there and add up the results, Yankees players can expect to see 7.6 percent of their income, give or take based on the assumptions presented above, go toward state and city taxes.

The main reason that some teams may have an effective rate that looks much different than the rates of the home city and state is the schedule. A team like the Orioles, for instance, has to play the Yankees, Red Sox, and Blue Jays umpteen times, all of whom have high rates in their respective cities. This is different than a team that gets to play the Marlins and Braves 18 times each. Of course, as Tony and I finished our research, the state of Illinois raised its income tax. Damn Illinois always making things difficult! [Ed. Note: You don't know the half of it.]

Does it really come as a surprise that the Yankees players will incur the most tax? The New York state and city taxes are high as it is, but like the Orioles the Yankees have to play against several high-tax teams many, many times. The teams with very low effective rates are those without state income tax in their home state. What makes this particularly interesting is how the Rangers and Mariners are in the same division and play each other so many times during the year; maybe that rivalry should be named the Tax Heaven Rivalry. The AL Central seems to have the least disparity amongst the teams, which is noteworthy given that the Tigers, at 5.304 percent, define the median of the group. Additionally, the Royals represent the average of the group, as their 5.091 percent comes closest. The New York teams occupy the high end of the range, with the Astros at the other end.

The next step in an exercise like this is to program the same spreadsheet to factor in the various brackets in each pertinent state and city, so that an end user can input a player and his salary, as well as his home team, and basically come up with a gross-to-net calculation of take-home pay. This way we could come pretty darn close to definitively comparing offers from teams. Then again, there are always going to be quirks, such as some Yankees players negotiating state and city tax payments into their contracts to avoid having this much withheld, but hey, that is accounting for you.

 The percentages shown above might not seem like all that much, but for a player making $2 million, who is already losing a high percentage of that salary to the federal government, the difference between signing a one-year deal with the Astros and the Mets can amount to over $100,000 of tax liability.

Hopefully, these articles have shed some light on how zany the jock tax can be. Going forward, my hope is that they can serve as a foundation for future studies that attempt to compare offers to free agents by factoring in the tax effect.