Multistate taxes hit athletes the hardest
Part III: Don’t turn it over—limit your tax exposure
Taxing professional athletes presents unique issues and creates opportunities for revenue officials due to the visibility of professional sports. In Part I, we discussed taxing resident athletes, while Part II, focused on the issues surrounding taxing nonresident athletes. Taxation of the same income by a taxpayer’s resident state and non-resident states can lead to concerns about double taxation on the same income.
Fortunately, most states generally provide for a system of resident credits and reciprocity agreements to diminish the effects of taxing the same income earned in nonresident jurisdictions. By claiming state tax credits and deducting expenses, athletes are able to alleviate the impact of multistate tax. The athlete faces challenges in complying with his or her multistate tax burden. Mitigating the impact of multistate taxation is critical because many states place an emphasis on enforcement. While athletes are used as an example, this same issue applies to other taxpayers working in multiple states.
Don’t get hit twice—resident state tax credits and reciprocal agreements
Each state has its own method for permitting taxpayers to claim resident tax credits for taxes paid to nonresident states. In Ohio, if a taxpayer qualifies as an Ohio resident during the taxable year and earned income subject to taxation by another state or taxing jurisdiction, then such taxpayer will qualify for an Ohio resident tax credit. The amount of the Ohio tax credit is determined by entering the portion of Ohio Adjusted Gross Income subject to tax by other states. When athletes file their resident tax returns, it is suggested that they list all sources of income on their return, including income earned out-of-state. For example, Ohio requires taxpayers to list states where they file an income tax return, and the Department of Tax regularly contacts taxpayers for a copy of the other state’s income tax return and seeks verification of payment.
Many states maintain reciprocity or reciprocal agreements with other states, which generally allows athletes and other taxpayers to exclude wages earned in reciprocating states. The manner in which such exclusion is accomplished varies among the states. Below are a few examples of states which maintain reciprocity agreements:
Illinois: Maintains reciprocity with Iowa, Kentucky, Michigan, and Wisconsin. Illinois residents include in Illinois income compensation earned in these states. On the other hand, due to reciprocal agreements between Illinois and these states, these states do not tax the compensation of Illinois residents. If an athlete performs in Illinois and is a resident of Iowa, Kentucky, Michigan, or Wisconsin, they are not required to pay Illinois income tax.
Michigan: Maintains reciprocity with Illinois, Indiana, Kentucky, Minnesota, Ohio, and Wisconsin. Michigan residents are exempt from income tax imposed by a reciprocal state on salaries, wages, and commissions earned for personal services performed in the reciprocal state. Conversely, if a resident of Illinois, Indiana, Kentucky, Minnesota, Ohio, or Wisconsin performs in Michigan, they do not pay Michigan income tax.
Ohio: Residents may exclude wages, salaries, tips, or commissions earned in Indiana, Kentucky, West Virginia, Michigan, or Pennsylvania.
An athlete should contact a tax advisor to ensure they obtain the maximum resident state tax credit, include or exclude the correct income, and meet the resident and/or nonresident filing requirements for states in which they reside and/or perform.
Deductibility of expenses
There are many expenses unique to athletes. Athletes who are part of a team are generally considered employees, and expenses will likely be treated as itemized deductions. Individual athletes, on the other hand, are generally classified as independent contractors or self-employed persons, and may be able to deduct athletic expenses as business or hobby expenses. Expenses that are unique to athletes include agent’s fees and certain sports equipment. As we have mentioned, athletes typically maintain multiple residences and may incur larger travel expenses than most taxpayers. Athletes should consult a tax advisor to ensure they are maximizing the deductions permitted by the tax code.
Tax compliance and enforcement
State tax authorities are able to easily enforce these taxes due to the visible nature of professional athletes. Team schedules and player salaries are public information. For example, if Ohio wants to monitor the tax to which NFL athletes visiting Ohio are subject, the tax commissioner can simply pull the schedules of the Cincinnati Bengals and Cleveland Browns, and then obtain a roster of the visiting players who played in Ohio or were part of the team that day. Many states, including Ohio, have revenue agents who deal exclusively with enforcing taxes amongst athletes. Ohio’s “athlete tax team” regularly obtains rosters and tax records to verify withholding. Ohio’s tax enforcers are able to quickly spot discrepancies, and generate letters to resolve the matter. Thus, an athlete’s returns are subject to a heightened scrutiny, and there is greater importance that their returns are prepared accurately.
Tax compliance can be extremely burdensome on athletes, especially if the athlete is not highly compensated. Each state maintains its own unique tax rules, and an athlete may end up filing in 10 or more states. An athlete must first determine whether they are a resident or nonresident. For each nonresident state the athlete plays or performs in, they must determine the correct method to apportion their income, whether to use the “Duty Days” or “Games Played” method and how to apply each method, and then determine which income to include in the calculation. Income from bonuses and endorsements presents a variety of tax issues. Finally, the athlete must determine how to limit their tax exposure from earning income in multiple tax jurisdictions. When it comes to multistate taxes, athletes are best leaving it to the pros.
New York: Investors beware! You may be personally liable for unpaid taxes in a business venture
When investing in a business venture, one may often hope to profit off the venture without having to play an active role in its business affairs. This line of thinking may be too good to be true. Investors must determine whether circumstances dictate that more than just a contribution of their capital is required.
Investors whose business arrangements require more than just contributions of capital must be wary of the affairs of the corporation and be diligent in the pursuit of their interests. Otherwise, the oblivious business investor may find themselves the investor of a failing business arrangement and personally liable for the unpaid taxes of the business. This was the situation In the Matter of the Petitions of Peter Pappas for Revision of Determinations or for Refund of Sales and Use Taxes under Articles 28 and 29 of the Tax Law for the Periods from March 1, 2004…through November 30, 2005, Dkt. Nos. 822124; 822125, New York Division of Tax Appeals, Administrative Law Judge Determination (Aug. 21, 2014).
Peter Pappas (the Petitioner), was issued 11 notices of determination assessing sales and use taxes due, plus interest and penalties from the New York Division of Taxation dated for various periods from March 1, 2004 through Nov. 30, 2005. According to the notices, the Petitioner was the person responsible to collect and remit sales and use tax as a shareholder and officer of two corporate entities. For the periods at issue a sales tax return was not even filed and for others the tax stated due on the returns was not paid.
The Petitioner invested in two donut shop franchises in the Bronx with another investor, Mr. Papamichael. In commenting on Mr. Papamichael’s interest in investing in the franchises with him, the petitioner stated that Mr. Papamichael was “a Wall Street guy and…I don’t know what happened…but he came out of being a Wall Street guy” and asked the Petitioner if he wanted to invest with him. Mr. Papamichael formed two corporations, Double Papas, Inc. and W. Pappas, Inc., for the franchises and the Petitioner obtained a 45 percent ownership interest in each corporation.
In exchange for his ownership interest, the Petitioner invested $250,000 in the businesses and contributed a lease for one of the shops. The Petitioner’s business partner, Mr. Papamichael did not acquire an ownership interest in the businesses. Mr. Papamichael’s wife held another 45 percent and the remaining 10 percent of the stock was sold to a minority business owner. The Petitioner stated that Mr. Papamichael “couldn’t sign his name on things, I guess, so he put his wife instead.” The Petitioner signed the franchise agreements along with a personal guarantee of liability. The Petitioner was not alerted to anything troubling by the facts that Mr. Papamichael was no longer a “Wall Street guy” and couldn’t sign his name to documents.
The Petitioner did not participate in the day-to-day operations of the two donut shops, but was listed on several of the corporations’ documents as the president and did have signature authority over the corporation's bank accounts. Mr. Papamichael assumed control of the franchises and the daily operations of the businesses. The Petitioner devoted his time to his own business, and his only involvement with the donut shops was the occasional signing of checks and tax returns...or stopping in for a coffee or donut.
The Petitioner received returns on his investment for the first four or five months, but after that payments ceased. The Petitioner was told that “there was no money,” but failed to inquire of the book or records of the corporations or step in to turn the business around. The Petitioner left those responsibilities to his business partner.
In the middle of 2004, the Petitioner and Mr. Papamichael had a falling out and no longer spoke to each other. Mr. Papamichael took various measures to exclude the Petitioner from the business, and litigation ensued more than a year later.
New York division of tax appeals determination
§ 1133 (a) of the New York Tax Law “imposes upon any person required to collect the tax imposed by Article 28 of the Tax Law personal liability for the tax imposed, collected or required to be collected.” Corporate officers under a duty to act for a corporation in complying with New York’s tax laws pursuant to Article 28 are persons required to collect tax. NY Tax Law § 1133. Whether an officer can be held personally liable for tax is determined on a case-by-case basis.
The court stated that the inquiry of the case was whether the petitioner, Mr. Pappas, possessed sufficient authority and control over the affairs of the corporations to be considered a person under a duty to collect and remit the unpaid sales and use taxes. One who is responsible for collecting taxes cannot escape their obligation by delegating this responsibility to others. Mr. Pappas’s defense is that he was merely an investor in the corporations and was not involved in the day-to-day operations.
The court found, based on the following factors, that the Petitioner maintained a level of responsibility to the businesses exceeding that of mere outside investor. The Petitioner invested a significant amount of money, contributed a leasehold as a storefront for one of the franchises, signed the franchise agreements along with a guarantee of personal liability to the franchisors, held the title of president, was one of two majority stockholders, had signature authority over the corporations’ bank accounts, and had authority to sign documents, such as checks and tax returns.
The court stated that the Petitioner had made a decision to rely on others in running the daily operations of the businesses, and this decision did not relieve him of personal liability for unpaid taxes. The court noted that the Petitioner could have exercised sufficient authority and control over the corporations' affairs to ensure that the taxes were paid, but failed to do so. For example, the Petitioner never asked to see the corporations' financial documents, or inquired as to why Mr. Papamichael couldn’t sign documents or hold stock in the corporations. The court explained that the Petitioner’s failure to make further inquiries, assume any responsibility for the management of the corporations' operational and financial concerns, and reliance on others to pay taxes does not excuse him from personal liability for unpaid taxes.
Advice for business investors
When investing in a business:
Determine the level of involvement required: Know the difference between being a mere investor and an active participant in the business, and take the appropriate action to protect your interests. A mere investor may only lose their investment, but an active participant in the business may be held personally liable for obligations of the business, such as unpaid taxes.
Make inquiries: Ask to see business and financial records on a regular basis. If something sounds questionable or raises suspicion, look into it further.
Know when to take action: If the business is failing and taxes aren’t getting paid, seek the advice of tax and legal professionals to determine if there are certain steps you need to take in order to protect yourself from any personal liability of the business. Otherwise, like the Petitioner in this case, you’re the one who could be responsible for unpaid taxes.
Develop an exit strategy: If the business arrangement isn’t working, seek the advice of tax and legal professionals regarding an exit strategy to try to limit your losses and any additional obligations you may have to the business, such as personal liability for unpaid taxes.
For additional information regarding these subjects or any other multistate tax issues, please contact:
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.