Ohtani’s Tax Play: Unpacking Shohei’s Historic Contract

In the realm of Major League Baseball, a new era of contract negotiations has dawned, courtesy of Shohei Ohtani, the two-way sensation. Last week, Ohtani inked an unprecedented $700 million deal with the Los Angeles Dodgers, marking the largest contract in baseball history. This 10-year agreement not only shatters records but also introduces a groundbreaking financial structure that could redefine the landscape of sports contracts. Ohtani’s deal, intricately crafted to navigate through potential salary cap constraints and tax considerations, raises intriguing questions about its implications for the athlete, the team, and the state of California.

The uniqueness of Ohtani’s contract lies in its payment structure. From 2024 through 2033, Ohtani will receive a modest $2 million per year, a stark contrast to the usual hefty annual payouts in such mega deals. However, the plot thickens post-2033, where he will receive $68 million annually for the following decade, totaling the mammoth $700 million commitment.

Representatives from both Ohtani’s camp and the Dodgers have cited salary cap considerations as the primary reason for this unconventional structuring. However, some speculate an additional motive: a strategic move to sidestep California’s hefty income tax. The idea is that Ohtani, after playing a decade in California, could relocate to a state like Florida, which boasts no income tax, and enjoy the bulk of his earnings tax-free. However, the reality of tax laws paints a different picture.

Understanding Athlete Taxation

To appreciate the tax implications of Ohtani’s contract, it’s crucial to grasp how athletes are taxed. Professional athletes’ incomes are typically divided among states they play in, based on a ‘duty days’ system. These duty days encompass all days spent on team-related activities, from the beginning of the season to the end of the regular season or post-season, depending on playoff appearance. The income is then allocated proportionally to the states where these team-related activities occur (games, practice, team meetings, etc.).

For instance, consider a Philadelphia Eagles player with a game in Denver. His week’s income would be split between Pennsylvania (Monday through Friday) and Colorado (Saturday and Sunday) based on the number of duty days spent in each state. Such allocation applies to all away games.

The California Challenge

In the fascinating case of Shohei Ohtani, the bulk of his duty days for the next decade will be predominantly in California, due to his commitments with the Dodgers. This is where the intricacies of California’s tax laws come into play. According to the state’s regulations, compensation received by a nonresident for services performed in California is subject to state income tax (FTB Pub. 1100 “Taxation of Nonresidents and Individuals Who Change Residency”). This means that Ohtani’s earnings, accrued while he is a resident of California, are likely to be taxed by the state, irrespective of his future residency status.

The heart of the matter lies in the $680 million that Ohtani is set to earn after his initial ten years with the Dodgers. The theory that Ohtani could move to a state with no income tax, like Florida, and evade California’s tax on these earnings is overly simplistic. California has a strong stance on taxing income earned within its borders, particularly for high-earning individuals. Therefore, the notion that Ohtani could avoid paying state income tax to California on the bulk of his contract is not as straightforward as it might seem.

California’s individual income tax rate, which is the highest in the nation at 13.3%, would apply to nearly all of Ohtani’s contract amount of $680 million if it’s considered earned while he is a California resident. The state is unlikely to forgo such a significant tax revenue, especially from high-profile contracts like Ohtani’s. Even if Ohtani manages to attribute a portion of the $680 million to other states based on duty days during away games, California will still assert its right to tax the remainder. This means that the potential tax bill could be in excess of $90 million to the state of California, a hefty sum that highlights the state’s motivation to enforce its tax laws stringently.

In summary, while Shohei Ohtani’s contract structure is innovative and helpful to the Dodgers’ salary cap, it does not necessarily provide a clear path to avoid California’s high tax rates. The state’s approach to taxing income earned within its jurisdiction suggests that a significant portion of Ohtani’s earnings, if not the entirety, will likely be subject to California state income tax, regardless of his residency status post-retirement.

Broader Implications

Shohei Ohtani’s groundbreaking contract with the Dodgers does more than just rewrite the record books; it potentially alters the landscape of sports contract negotiations and state tax policies. This section explores the wider implications of such innovative contract structures in professional sports and their ripple effects on state tax revenues, athlete financial planning, and the sports industry as a whole.

Ohtani’s contract structure could inspire a new wave of creative financial strategies in sports contracts. Athletes and their agents might start to explore similar models, especially those playing in states with high income tax rates like California. This trend could lead to more deferred payment plans or complex contract structures aimed at maximizing post-retirement earnings and minimizing tax liabilities.

The potential shift toward deferred compensation models poses significant implications for states with professional sports teams, especially those relying on income tax from high-earning athletes. States like California could see a decrease in immediate tax revenues from athlete contracts, prompting a reevaluation of tax strategies and policies. This could lead to legislative changes or more aggressive tax collection efforts to safeguard state tax interests.

For athletes, such contract structures introduce new dimensions in financial planning and wealth management. Athletes would need to navigate not only the complexities of multi-year contracts but also consider the long-term tax implications and residency planning. This approach requires a more strategic and forward-looking financial management, possibly involving a team of tax advisors, financial planners, and legal experts.

The sports industry, encompassing teams, leagues, and related businesses, may also feel the impact. Teams might face new challenges in managing salary caps and long-term financial commitments. Leagues could witness changes in how teams structure contracts, possibly leading to revisions in rules and regulations governing player contracts and compensation.

Public perception plays a crucial role in the realm of professional sports. Innovative contract structures like Ohtani’s might raise questions about the ethics of tax avoidance strategies. While legally permissible, these tactics could be viewed critically by fans and the media, especially in a socio-economic climate where income inequality and tax fairness are hot topics.

The ripple effect of such contracts could extend beyond U.S. borders. International sports leagues and athletes might take cues from the MLB’s example, leading to changes in contract negotiations and financial strategies in global sports.

Conclusion

Shohei Ohtani’s groundbreaking contract with the Dodgers isn’t just a landmark in sports history; it’s a case study in the intricate interplay between sports finance and state taxation. As this deal sets a new bar in athlete contracts, it also invites us to consider the complexities of tax laws and their implications for both the athletes and the states involved. While Ohtani’s contract strategy may seem like a clever workaround, it underscores the importance of understanding the nuances of tax regulations in the world of professional sports.