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Multistate taxes hit athletes the hardest

Part I: There’s no place like home

Professional athletes seem to have it all. They get to play sports for a living, travel around the country, spend lots of money, live in big homes, drive fancy cars, and gain notoriety and fame. The lifestyle of a professional athlete though can be quite taxing, literally. Professional athletes must navigate a complex scheme of state and local tax laws, and are subject to taxation in nearly every destination in which they perform over the course of a season. While there is a widespread perception that athletes are subject to a unique set of taxes specially designed for athletes, often referred to as “jock taxes”, that is not entirely accurate.

Many of the taxes that professional athletes are subject to are in fact applicable to all taxpayers. Nonetheless, professional athletes are arguably more heavily impacted by multistate taxes than taxpayers of virtually any other profession. This is a result of several factors—athletes frequently travel to perform in numerous taxing jurisdictions, are highly compensated, and are easily identifiable when they perform in a particular taxing jurisdiction. This is part one of a three-part series designed to raise awareness of the state and local tax issues surrounding professional athletes.

This article will highlight the issue of determining tax domicile for professional athletes. Subsequent articles will discuss apportionment methods and the determination of income, resident state tax credits, deductibility of expenses, and tax compliance considerations.

Domicile: Home is where the heart is

The state in which a taxpayer is domiciled is the state the taxpayer will file a resident tax return, and pay tax on all income earned. As the U.S. Supreme Court eloquently stated: “[D]omicile in itself establishes a basis for taxation. Enjoyment of the privileges of residence within the state, and the attendant right to invoke the protection of its laws, are inseparable from the responsibility for sharing the costs of government.” Lawrence v. State Tax Comm’r, 286 U.S. 276, 279 (1932).

Determining an athlete’s resident state or domicile, though, is often a challenge and their domicile may vary from year to year depending on a number of factors. Athletes typically own multiple residences and often move during the course of a season due to where they are drafted, traded, and sign via free agency. It may not be uncommon for an athlete to be considered a resident of one state one year and a resident of another state the next, even though the athlete has maintained the same residences throughout this period of time. Nevertheless, a taxpayer may only be a resident of one state for tax purposes.

[A]n individual has only one domicile, which is generally the State with which he is currently most closely connected, but which may be a State with which he was closely connected in the past. Traditionally, an individual has been said to acquire a new domicile when he resides in a State with "the absence of any intention to live elsewhere," or with "the absence of any present intention of not residing permanently or indefinitely in' the new abode." The concept of domicile has typically been reserved for purposes that clearly require general recognition of a single State with which the individual, actually or presumptively, is most closely connected. Martinez v. Bynum, 461 U.S. 321, 340 (1983) (Marshall, J., dissenting) (internal citations omitted).

Domicile is generally determined by an intent to permanently establish a residence, and many states, such as Ohio and Minnesota, have established a bright line rule of spending a statutorily defined period of time in a state. While Minnesota and Ohio both have a similar 183-day rule to establish residency, the rules differ in their applicability. Ohio’s 183 contact period test results in a presumption of residence, while Minnesota’s 183-day rule is a bright line test. Illinois, on the other hand, determines domicile solely based on a subjective intent standard. See Illinois Section 100.3020 Resident (IITA Section 301) (d). The summer of 2014’s NBA offseason highlights the challenges athletes will encounter in determining their tax domicile.

To build the next super basketball team, the Cleveland Cavaliers have engaged in a variety of player transactions this summer. LeBron James signed with the Cavaliers as a free agent to bring his talents back to northeastern Ohio from Miami, Florida, and Andrew Wiggins, along with other assets, was shipped off to the land of 10,000 lakes in exchange for all-star Kevin Love. With all of these changes, each of these players is going to need a championship caliber tax professional to determine their tax domicile for 2014.

Andrew Wiggins is from Toronto, played basketball at the University of Kansas, was drafted by the Cleveland Cavaliers, and then traded to the Minnesota Timberwolves. Any one of these four places are potential tax domiciles for Mr. Wiggins, but Mr. Wiggins isn’t in Kansas anymore. If Mr. Wiggins intends to make Minnesota his home for a permanent or indefinite period of time, then Minnesota will likely be considered his tax domicile. However, if he maintains a home in Minnesota, but intends to make someplace else his permanent residence, then Mr. Wiggins will not be considered a Minnesota resident. He will have failed to meet the state’s 183-day rule for his 2014 tax year, and will have to pay tax only on income earned in Minnesota. Mr. Wiggins will be required to keep accurate records to verify that he spent more than 183 days out of state. Evidence considered to establish a domicile includes:

  • Location of residence or residences and the duration owned or rented
  • Address where mail is received

  • Location of employment and where wages are earned

  • Duration of a player contract

  • Investment in or management of a business

  • Charity work

  • Amount of time spent in state versus out the state (many states use a 183-day rule)

  • State where the athlete is registered to vote

  • State where the athlete’s drivers license is issued, vehicle registration or other licenses and permits

  • Where the athlete’s children attend school or qualify for in-state tuition

  • Membership in country clubs, social, or athletic organizations

LeBron James, on the other hand, has things much easier, and not just because he can now lob layup passes to Kevin Love and receive alley-oop passes from Kyrie Irving. LeBron James will either be considered to be domiciled in Ohio or Florida. Florida does not have an income tax. Therefore, a principal tax consideration for LeBron should be to shield as much of his income from being subject to Ohio income tax. However, it is not a positive factor that his Miami home is listed for sale. LeBron James may have waited till early July to make his “Decision Part II” for one very important reason: He will have less than 183 contact periods in Ohio (assuming of course that he did not have contact periods earlier this year in Ohio, nevertheless, it still illustrates the rule), to not be presumed domiciled in Ohio pursuant to O.R.C. § 5747.24. By not being considered an Ohio resident for 2014, LeBron has potential to save an enormous amount in Ohio income tax.

Illinois: Cook County oversteps its boundaries by imposing controversial tax

This month, in Reed Smith LLP v. Ali, 2014 IL App (1st) 132646-U (2014), an Illinois Appellate Court affirmed a lower court ruling invalidating the Cook County Use of Non-Titled Personal Property Tax Ordinance (Cook County Tax). The court held that the ordinance was in violation of section 5-1009 of the Counties Code because the Cook County Tax imposed an improper use tax on the selling or purchase price of personal property.

The Cook County Tax

The Cook County Tax became effective April 1, 2013, after the Cook County Board of Commissioners enacted the Ordinance on November 9, 2012. The Ordinance stated that the purpose of the Cook County tax was to close a “widening tax loophole” by preventing taxpayers from avoiding sales tax by purchasing personal property in other counties. The Board recognized that taxpayers would frequently go to other counties to make expensive purchases of equipment or office supplies to save on sales tax, which in Cook County’s largest city, Chicago, is 9.25 percent. In addition to raising additional revenue, the Board sought to protect Cook County businesses.

The Cook County Tax imposes a tax on the value of non-titled personal property purchased outside Cook County when the property purchased is first used in Cook County. The Ordinance requires that every person who acquires such property in the course of business to register with the Tax Department. The Cook County Tax provided for an annual exemption of $3,500, but once a taxpayer exceeds the exemption amount, taxpayers were required to file monthly returns. Failure to register or file a return was considered a violation of the Ordinance and imposed harsh penalties and interest for failure to file or pay the tax, even granting Cook County the ability to impose liens and foreclose on property.

Challenging the tax

In May of 2013, two separate complaints, which were later consolidated, were filed seeking a preliminary injunction to block Cook County from imposing the Tax. The Plaintiff’s preliminary injunctions, previously discussed in the Aug. 1, 2013 update, were granted in July. Plaintiffs then sought permanent injunctive relief on grounds that the Cook County Tax violated Section 5-1009 of the Counties Code and the federal and state constitution.

As a threshold matter, Cook County argued that Plaintiff Reed Smith lacked standing to contest the ordinance. Reed Smith defiantly refused to register for the Cook County Tax or file a return. Reed Smith had purchased more than $3,500 worth of property outside Cook County and maintained a place of business located in Cook County, making it liable for the tax and subject to interest, penalties, and a lien on its personal and real property. Thus, the Illinois court found that Reed Smith had standing.

Striking down the Cook County Tax

Section 5-1009 of the Counties Code provides that “no home rule county has the authority to impose…a use tax based on…the selling or purchase price of said tangible personal property.” The court found that the Cook County Tax violated Section 5-1009 because it levied a use tax on the value of non-titled personal property. If property was delivered within the County or the purchaser resided or maintained their place of business within the County, then the property is "first subject to use" in the County on the delivered date. Since “mere residency” in Cook County or delivery of property within Cook County established the date of “first use”, the effective difference between the purchase date and the date of first use was eliminated. In the court’s view, the Cook County Tax “is in reality a sales tax.”

In Cook County’s defense, it argued that there are four acceptable methods of determining value. The court was unpersuaded because the methods provided would only result in a trivial differentiation from the purchase price or, in the case of obtaining an appraisal, was an impractical method. The court felt it unnecessary to address the federal and state constitutional arguments because the court only addresses constitutional issues as a matter of last resort.

Current tax situation in Cook County

Cook County is currently considering whether to appeal this decision to the Illinois Supreme Court. Because of the injunction, Cook County is not currently enforcing the Tax. Cook County Taxpayers should stay tuned to the county’s next move, and be aware of the Ordinance’s requirements in case the county decides to continue to pursue litigation to uphold the Tax. Interestingly, the court states that the tax is in reality a sales tax. Section 5-1009 does not prohibit a sales tax. Is it possible that if the tax really is a sales tax that Cook County could assess the difference between what taxpayers pay in other jurisdictions to eliminate the consideration of potential tax arbitrage in purchasing decisions? If Cook County decides not to pursue this matter further, Cook County may seek other avenues to meet budgetary constraints and close tax loopholes.

Medical marijuana patients high on state tax breaks

In November, voters in Alaska and Oregon will decide whether to legalize and tax recreational marijuana. While both states may be optimistic that such initiatives will raise additional tax revenues, Colorado is experiencing lesser tax revenues from legalization than expected. Through 2014, marijuana tax revenue from recreational use totaled approximately $12 million, a sum which was far below estimates of $33.5 million this year and the estimated $67 million in tax revenues for next year by the Colorado Legislative Counsel Staff.

In a recent study prepared by the Marijuana Policy Group for the Colorado Department of Revenue, medical marijuana patients are not purchasing marijuana in retail markets because the tax is considerably higher, prices are higher, and retail marijuana is available in relatively few markets. In order for revenue expectations to be met in Colorado and other states considering legalization and taxation, recreational retail and medical marijuana markets must be taxed equally or ease expectations.

For additional information regarding these subjects or any other multistate tax issues, please contact:

David M. Kall

Susan Millradt McGlone

Jeremy J. Schirra

Multistate Tax Services

Businesses must be vigilant and careful in managing their state and local tax liabilities and exposures. We understand this can be a daunting task. McDonald Hopkins Multistate Tax Services provides a broad range of state and local tax services including tax controversy, tax evaluation, tax planning, and tax policy. With professionals who have worked both inside and outside government agencies, our multistate tax team leverages its knowledge and experience to help clients control their complex multistate taxes.