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Thursday, July 08, 2010
Lebron James and his Big Decision: Thoughts on Role of Endorsement Income Potential and State Income Taxes
At 9 p.m. tonight we’ll find out where Lebron James – who at age 25 has already made $68 million in NBA salary and around $200 million in endorsement deals – will play for the next five or six years. It seems that he’ll select from one of four teams: the Miami Heat, the New York Knicks, the Chicago Bulls or his current team, the Cleveland Cavaliers.
What factors could be motivating his decision? A supposedly leading reason for James to sign with the Knicks is that he would attract better endorsement opportunities there than if he stayed in Cleveland or signed with Chicago or Miami. Is that true? Even if it is, do differences in state income taxes prove more valuable than differences in potential endorsement income?
As a starting point, it's safe to say that endorsement income is not as geographically contingent as it used to be. In fact, with the bevy of technologically contingent ways that we now follow sports – TV, websites, blogs, PDAs, video games, fantasy sports, etc. – it may not even matter which city one plays in.
James seems to illustrate this point. He earns at least $28 million a year in endorsements while playing in Cleveland, the mere 18th largest media market. Despite what would seem like a geographic disadvantage, James earns more in endorsement income than any other NBA player. Also, his most lucrative deals are with “A List” companies, including Nike, Sprite, McDonald's, State Farm, and Upper Deck.
To be sure, he would have attracted that same caliber of endorsement opportunities had he been playing for the Knicks or Lakers for the last 7 years. You might also argue that he would have had more local endorsement opportunities in New York City or Los Angeles. Fair enough.
Then again, there’s only so many endorsement deals that a player can enter into before the value of his endorsement becomes too non-exclusive or non-special. Besides, it isn’t like we haven’t been able to watch James whenever we want while he’s been in Cleveland; we're not in 1980 anymore with no internet/cable etc.
Geography might matter more in another way: state income taxes, which vary a great deal. Some states, like Florida and Texas, have no state income tax, while others, like New York and California, impose relatively heavy tax burdens, especially on high-earners. Signing with a team that plays in an income-tax free state does not mean the player completely avoids paying state income taxes. Taxes are generally allocated based on where games are played, so when a player plays a road game in a state that has an income tax, he would be obligated to pay a state income tax for income related to that game. Still, he would not pay income taxes for all of his home games or games in other states which lack a state income tax.
While state income tax rates are probably not at the top of the list of deciding factors for James, they are meaningful in a financial sense. In Florida, James would not pay a state income tax for his home games; in Illinois, he would pay a 3.0% state income tax, in New York, he would pay an 8.97% state income tax. Assuming, for the sake of argument, that James earns about $16.8 million in 2010-11 in a max free agent contract, about half of that income – the income for home games – would be subject to state income taxes should he sign with the Knicks or Bulls. More specifically, he would pay $753,480 to the New York state treasury if he signs with the Knicks or $252,000 to the Illinois state treasury if he signs with the Bulls. He would keep his money, at least from the hands of state government, if he instead signs with the Heat.
Or James could decide to stay with the Cavaliers. In that case, he would earn more in a contract (about $20 million in 2010-11) because teams can re-sign their players for more than other teams can sign them. He would, however, be subject to a 6.24% Ohio state income tax on about half of his income, meaning his state income tax burden would be about $624,000.
Actual income tax calculations would of course be much more complicated than depicted above, especially when factoring in playoff games, road games in states without an income tax, deductions and other forms of state and local taxes, which are on the rise in most states, most acutely in New York. And no matter where James plays, he’ll be paying the federal government to the tune of a 35% marginal tax rate.
Nevertheless, the impact of state income taxes is real, and should James take less to sign with the Heat over the Knicks, a reduction in salary may be offset by the lack of Florida state income tax. It's also not clear that going to the biggest media market means better endorsement opportunities, at least not now-a-days. Plus, if James joins Dwayne Wade and Chris Bosh in Miami, and proceeds to win 75 regular season games and an NBA title possibly every year they're together, I'm sure there would be plenty of endorsement opportunities.
My thanks to my Vermont Law School colleague and good friend Jason Czarnezki, with whom I had a fun discussion about this topic the other day and whose comments were very insightful. Jason co-runs a great blog called Czarnezki.com.
Update: Paul Caron at TaxProf Blog has a good post discussing detailed numbers compiled by Kyle Gillis of the Business & Media Institute for the likely tax consequences. The take-away from Professor Caron:
Here are the projected state and local taxes on a five-year, $96 million contract:Interesting stuff, though the numbers don't tell the whole story for a few reasons.
First, James would be able to sign for about $25 million more with the Cavaliers on a 5-year contract because the NBA pay scale provides large financial incentives for free agents to stay with teams.
Second, if James, as expected, signs with the Heat, he'll have to sign for something of a discount in order for he, Wade, and Bosh to have contracts with the Heat that stay under the NBA's salary cap.
And third, the Florida tax break would only enable him to avoid paying taxes for Heat games played in Florida; road games in other states would still be taxed under those states' income taxes. Still, the Heat contract would likely be in the neighborhood of $90 million, and with the Florida tax break still partially benefiting him, he would probably still end up making more with the Heat than if he were to sign with the Knicks.
Update 2: Professor Edward Zelinsky, a tax law expert at Cardozo Law School and contributor to the Oxford University Press blog, lets me know of an added tax wrinkle to Lebron's Choice:
[It's] potentially even more complicated. Suppose that LeBron plays in Miami but maintains his residence in Ohio. In that case, Ohio still taxes his entire income, giving credit for taxes paid to other states. If, however, LeBron becomes a Florida resident, he also benefits from state tax-free treatment of his investment income.If there's a law student out there looking for a law review/journal note topic, the dynamics of an NBA superstar free agent contract might be a good one. Between the coordination of individual free agents (Wade, Bosh, and James seemingly collaborating) and the tax and economic considerations, there would be a lot to write about and it would be new ground for sports law scholarship.