7 Ways for Professional Athletes to Reduce Their Tax Bill
Professional athletes are blessed with large incomes in short windows. The downside of that large income is a large tax bill. One that often becomes the single largest expense for any professional athlete. These tax strategies for professional athletes can help to reduce them.
Strategies Professional Athletes Should Consider For Tax Savings:
1. Know Your Income Types
To understand taxes, we must start at the beginning, with income. Professional athletes earn two types of income, W2 and 1099. One is a result of work you do on the field and the other is the result of work you do off the field. The type of income will drive the rules, strategies, and placement of income as it comes in for an athlete.
W2 income is the money you make as an employee of the team. This is the salary for the work you perform on the field. With that, many of your strategies and deductions under the current tax law are limited. While limited there are still several ways to reduce your W2 income
- Charitable Contributions
- SALT Deduction – State, City, and Local Income Taxes
- Mortgage Interest
- Tax Deferred Retirement Accounts – 401(k) and in some cases IRA contributions
1099 income is the money you make as your enterprise off the field. This is treated as if you’re a business owner which opens the door to further tax strategies. All costs related to earning this income are deemed tax-deductible expenses.
- Agent Fees – In Negotiation of Off-Field Income
- Travel Costs – Ones Incurred in Fulfilling Contract Obligations
- Self Employed Retirement Accounts – Solo 401(k) and/or SEP IRA contributions
2. State Residency
Income is generally taxed at two levels, the federal level, and the state level. While the federal level applies to all US citizens, the state level varies depending on your state of residence. These range from 13.3% for California residents down to states with zero income tax such as Florida and Texas.
Establishing residency in a low or zero-income tax state can save athletes hundreds of thousands to millions of dollars in lifetime taxes. So, how can you establish state residency in a low-income tax state? State residency is determined by a series of facts and circumstances.
The following is a good starting point for athletes considering a change in state residency:
- Establish A Full-Time Address – Lease or Purchase
- Obtain a State Driver’s License
- Change the Mailing Address for All Bills
- Register Any Vehicles with The State – Includes Insuring Vehicles in the New State
- Register To Vote
- Live There
State residency is not a black-and-white issue. As an athlete, you should consult with a financial advisor and CPA with specific knowledge of multistate and athlete taxation.
3. Quarterly Estimates
It pays to be up to date on your projected tax bill. Remember, athletes have two types of income, on-field and off-field. It is your responsibility as an athlete to make sure the government gets its share on time. While the team will withhold taxes from your salary, this does not mean it is the correct amount. In addition, off-field income is generally the athlete’s responsibility to report to the IRS.
This is where quarterly estimates come into play.
A quarterly estimate is a payment of projected taxes each quarter by an individual. This is something that your financial team (Financial Advisor & CPA) should be working together on each quarter. To ensure a penalty-free year you must reach the Safe Harbor Rule. For high-earning athletes this means paying:
- 90% of Current Year Income Tax Liability
- 110% of the Previous Year’s Income Tax Liability
This is where a qualified team of advisors can save athletes thousands of dollars in penalties and fees. Pay what you owe on time and save money.
4. Order of Operations
If earning money is step one then investing money is step two. The foundation of investing is to understand what accounts benefit you the most as an athlete. Contribute to the correct accounts and save money on taxes every year.
*NOTE – Every athlete situation is unique and the below will not apply to each situation.
A good baseline is understanding what account contributions save you the most in taxes in the current year and future years. A proposed order of operations for an athlete earning 5,000,000 dollars with access to a team-sponsored 401(k) plan.
- 401(k) Contribution – Tax Deductible Contribution of $22,500 in 2023
- SEP IRA Contribution – 25% of Off-Field Income Up To $66,000
- Taxable Brokerage Account – Unlimited Contribution
This order of operations would save this athlete tens of thousands of dollars in current-year taxes while deferring investment gains on the 401(k) and SEP IRA contributions. The advantage athletes have is the time to compound. Money invested at 25 has a far higher expected future value than money invested at 45.
Proper order of operations allows for current-year tax savings and future deferred growth.
5. Invest Tax Efficiently
The two best times to pay taxes are never or later. A tax strategy for professional athletes is to ensure your decades of compounding happen tax efficiently. As an athlete, you will have 40+ years of compounding for your investment portfolio.
The thing that matters far more than your rate of return is your AFTER-TAX rate of return. Said more simply, what you KEEP matters more than what you MAKE. As an athlete builds their investment portfolio, the focus should be on AFTER-TAX return. We do this for athletes by focusing on the following investments:
Every investment you make has a tax consequence. Professional athletes should be educated on the best ways to invest.
As an athlete, you certainly have not reached the pinnacle of your sport on your own. There have been countless resources poured into your journey. One way to give back AND reduce your tax bill is through strategic gifting.
The key term here is “strategic”. An athlete’s earning lifecycle is condensed into roughly one decade or less. The benefit is money today and the downside is increased taxes. One way to significantly reduce your lifetime tax bill is to consider a Donor Advised Fund.
What is it?
A Donor Advised Fund is an account that allows you to donate money, take a current-year tax deduction, keep the money invested, and give it out over future years.
Example: An athlete making $5,000,000 wants to give away $10,000 each year over the next twenty years. To maximize his tax benefits, we might recommend he gives $100,000 or more in the current year to a Donor Advised Fund. This money is in turn invested and given away in $10,000 chunks over the next two decades. The athlete saves more money in taxes due to his current high tax rate and achieves the desired charitable outcome.
Done correctly, a properly timed and executed Donor Advised Fund can save athletes tens of thousands of dollars or more.
7. Estate Taxes
Estate planning is for old people and athletes are young, right? Wrong.
Estate planning is simply deciding where your assets go, when they go there, and how they get there. It is a financial roadmap for when you are no longer able to articulate the plan.
Estate planning is even more critical for high-earning athletes due to something referred to as a Death Tax. Did you know there is a tax for dying? If your estate (everything you own added up) is more than 12.92 million in 2023 the government taxes you at 40% over that amount.
The good news? You can plan now to avoid it in the future.
A properly executed estate plan can help to mitigate, reduce or fully eliminate the estate tax liability. The best time to start planning for this as an athlete is today. You set yourself up for future flexibility and a lowered lifetime tax bill.
Taxes will almost certainly be the largest lifetime expense for a professional athlete. These tax strategies for professional athletes are things to consider to reduce that lifetime tax bill. To learn more about how our advisors coordinate athletes’ financial lives and reduce their tax bill, learn more about my own experience navigating this.
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*The tax and estate planning information offered by JL Strategic Wealth is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.