How Athletes Should Account For Taxes
Why Taxes For Athletes Are Complex
One of the biggest missteps an athlete can make when they receive their first contract is to not account for the taxes that are going to be taken out of their paycheck. Whatever the number is that you see on the contract, that is not the number that you are going to end up seeing in your bank account. In fact, the more you make the more taxes are going to be taken out. Understanding what taxes are, how much are going to be taken out, and how to plan correctly for your potential tax liability are important steps that must be taken in order to ensure your financial wellbeing. We have seen some examples of some high profile sports stars such as Lionel Messi and Cristiano Ronaldo get hit with potential prison sentences and huge fines or mismanagement of their taxes.
Types of Taxes
Income Tax - a percentage of individual earnings filed to the federal or state government. Everyone must pay some sort of federal income tax, however there are seven states that do not have a state level income tax. They are: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Tennessee and New Hampshire both do not tax personal income but do have taxes on investment income. The United States has recently changed its federal income tax code, and these are the current federal income tax rates for 2022
Sales Tax - Taxes levied on certain goods and services. 45 states and the District of Columbia collect statewide sales taxes, and local sales taxes are collected in 38 states. The five states with the highest average combined state and local sales tax rates are Louisiana (9.98%), Tennessee (9.46%), Arkansas (9.30%), Alabama (9.01%), and Washington (8.92%).
Property Tax – Tax based on the value of land and property assets. Once again, these taxes vary from state to state.
Tariff - Taxes on imported goods imposed in the aim of strengthening internal businesses. Tariffs are used to restrict imports of goods and services purchased from overseas by making them more expensive, and therefore making them less attractive to domestic consumers.
Estate tax - A tax levied on the net value of the estate of a deceased person before distribution to the heirs. Most relatively simple estates (cash, publicly traded securities, small amounts of other easily valued assets, and no special deductions or elections, or jointly held property) do not require the filing of an estate tax return. A filing is required for estates with combined gross assets and prior taxable gifts exceeding $12,060,000 in 2022.
Gift Tax - A gift tax is a federal tax applied to an individual giving anything of value to another person. Something is considered a gift if the receiver does not pay the full value of the gift. The giver of the gift is the one who is on the hook for the gift tax liability, but the receiver may pay all or part of the gift tax depending on if the giver has met their gift tax deduction limit.
The annual gift exclusion amount is $16,000 for 2022, these exclusion for non-taxable gifts include:
1. Gifts that are not more than the annual exclusion for the calendar year.
2. Tuition or medical expenses you pay for someone (the educational and medical exclusions).
3. Gifts to your spouse.
4. Gifts to a political organization for its use.
In addition to this, gifts to qualifying charities are deductible from the value of the gift(s) made.
Taxes on Investments- As with money that you earn from working, money earned from investments is also subject to taxation. However, there are certain caveats depending on the type of investment account, type of investment, and the length of time that you hold certain securities.
Short term capital gains- Are gains made on investments that you have owned less than 1 year and are taxed at your ordinary income tax rate.
Long term capital gains- are gains on investments you have owned for more than 1 year. They're subject to a 0%, 15%, or 20% tax rate, depending on your level of taxable income.
Taxes on dividend income- Qualified dividends are subject to a 0%, 15%, or 20% tax rate, depending on your level of taxable income. Dividends that are nonqualified are taxed at your usual income tax rate. Most payments from the common stock of U.S. corporations are qualified as long as you hold the investment for more than 60 days.
Taxes on interest income- Interest paid from fixed income such as bonds, CD’s, money market securities, and even savings accounts. Interest income is subject to the same tax rate as your usual income tax rate.
Tax-deferred investment vehicles- There are certain types of accounts where the tax treatment of the money you earn is different than that of taxable brokerage accounts. In some cases, you won’t have to pay taxes on earnings until you take money out of the account, or in some cases, ever. The number one way to reduce taxes is to reduce your income. And the best way to reduce your income is to contribute money to a 401(k) or similar retirement plan at work. Your contribution reduces your wages and lowers your tax bill.
401(k) Plans- A 401(k) is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Most employers that sponsor 401 (k) plans match a percentage of deferred savings up to a certain point, the most popular being a 3% match of your salary. Taxes aren’t paid on pre-tax 401(k) contributions until the money is withdrawn from the account.
IRA- Contributions to your Individual Retirement Account (IRA). If you are under the age of 50 you can contribute up to $6,000 per year to an IRA and that contribution will be deducted from your taxable income. If you are 50 or older you can contribute up to $7,000 per year. Once again, similar to a pre-tax 401(k) plan; you are taxed once you withdraw money out of the account.
Roth IRA- Roth IRA’s are different than traditional IRA’s because contributions are not tax-deductible, but eligible distributions are tax-free. This means you contribute to a Roth IRA with after-tax dollars, but as the account grows, you do not face any taxes on capital gains. When you decide to retire, you can withdraw from the account without incurring any income taxes on your withdrawals.
529 College Savings Plans- A 529 plan is an investment account that you can use for education savings. The plans are usually sponsored by states and offer great tax benefits. Most states let you deduct your 529 plan contributions on your state income tax return, up to your state's limit, earnings will be deferred from federal and usually state taxes, and you will not be taxed on the money you withdraw for qualified education expenses.
Effective tax planning is a big key to keeping more money in your bank account versus paying it to the government. It is important to have an understanding what your potential tax liabilities are based on your level of income. Using different vehicles for lowering your potential taxable income, as well as being able to grow your savings tax free over time can have huge impacts on your wealth. This is especially important for athletes who are at peak earnings during a short career, and whose paychecks are only coming for a part of the year. Once again, this a reminder that the salary number that you agree to on your contract is not the number that will end up being paid out to you, and to plan your lifestyle habits accordingly. Secondly, not paying taxes, or paying your taxes incorrectly can lead to huge problems down the road. Professionals that can help with tax planning are: Certified Public Accountants (CPA), enrolled agents, or an attorney. Using these professional services can help you to properly file and manage your taxes and avoid being hit with an audit, fines, or worse.
Jonathan Perrin is a former professional baseball player turned financial advisor. Jonathan was selected in the 2015 Major League Baseball Draft by the Milwaukee Brewers after graduating from Oklahoma State University. His professional career spanned five seasons, including stops in both Mexico and the Dominican Republic. Jonathan became a licensed investment advisor while still an active professional baseball player, with his first clients being his teammates. Post-playing career; Jonathan earned a Masters in Personal Financial Planning from the University of Missouri, and has continued to work as a financial advisor at helping professional athletes and other young professionals manage and invest their money to create long-term wealth.
Disclaimer: This material has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading or distribution strategy. Past performance does not guarantee future results. The accuracy and completeness of this information is not guaranteed and is subject to change. Waterfront Wealth Inc. is currently registered as an investment adviser with the Securities and Exchange Commission.
