Yes, RG3, There is a Tax Man

As many of you are aware, the deadline for filing your 2011 U.S. federal and state tax returns is this Monday, April 16th.  Although this can be a painful time for us Americans, it may give you comfort to remember that this annual torture is also borne by professional athletes, including players in the NFL.  Whatever your occupation or income level, April 15th (or the occasional 16th) is a date to be dreaded.

What sets professional athletes apart, however, are certain tax issues that the rest of us are unlikely to face, at least on the same scale.  Today we’ll take a look at two of these taxing matters:  whether NFL fines are deductible and city wage taxes.

Are NFL Fines Tax Deductible?

What I wouldn't give for a whole season off...

If you’ve been following the latest NFL news, you’ve probably heard more than you want to about the New Orleans Saints and their “bounty” system, which paid cash bonuses for hits that caused injury to opposing players.  The fallout from the scandal was swift, and the punishment harsh:  an indefinite suspension for defensive coordinator Gregg Williams, who is now with the St. Louis Rams; head coach Sean Payton is suspended without pay for the entire 2012 season; general manager Mickey Loomis is also suspended without pay for the first eight regular season games; and the team must pay a $500,000 fine. 

The league has not yet imposed fines on the players who were involved.  However, this is only because Commissioner Roger Goodell wants to investigate further the extent of each player’s involvement.  He wants to make sure each actor’s fine is commensurate with his level of culpability.  Since the bounties were primarily player-funded, you should not expect Goodell to go lightly on anyone.

In the meantime, maybe the players involved should contact their CPAs (the NFL Players Association has already hired lawyers for them) and ask them the question I’m sure is burning in their brains:  “Will my fines be tax deductible?”*

Your first reaction might be a resounding “No.”  These acts, and most actions resulting in NFL fines, were violent, broke the rules and were just plain wrong.  The IRS, however, doesn’t always care about where items on the balance sheet fall on the morality scale.  Instead, we have to take a look at the tax code’s requirements for business expense deductions:

‘  The expense must be both “ordinary and necessary.”  To be “ordinary,” it has to be common and accepted in the trade or business.  An expense is “necessary” if it is “helpful and appropriate” for your trade or business.  The IRS emphasizes in Publication 535 that the expense doesn’t have to be indispensable to your business to be eligible for deduction.

‘  Despite its generally amoral nature, the U.S. tax code does have a kind of moral compass.  Penalties and fines that result from any violation of law are not deductible.  This can include penalties for violent crimes, as well as for nonviolent crimes, like a parking ticket.  Instead of being based in morality, though, the reason for this is that allowing such a deduction would essentially result in the government giving back the money that it took from you for the violation of law.

Now that we have the standard for a business expense deduction, let’s apply it to the case at hand.  Was the bounty system “ordinary”?  We would like to think that this was an isolated incident, but revelations from multiple sources since the story first broke would indicate otherwise.  For one thing, it appears that Gregg Williams had such a system at each of his various stops around the league—including the Washington Redskins and Buffalo Bills.  While many players have come forward condemning Williams and the Saints’ players, others have just shrugged their shoulders.  Some, like Pittsburgh Steelers linebacker LaMarr Woodley have come out and said that incentives in player contracts are much like player-sponsored bounty systems.

Now we have to ask whether the fine is necessary, meaning “helpful and appropriate.”  Certainly the players would argue that the bounty system was “helpful and appropriate” as an incentive to play with more aggression, which better positions the team for victory (this is Woodley’s basis for his comparison).  As for the payment of the fine itself, it would probably even rise to the level of “indispensable” (again, not required), since a player has to pay his fine to be able to continue playing in the league.

OK, what about the restriction on fines and penalties?  The recent Saints’ bounty system resulted in violence fueled by greed.  Morally reprehensible.  However, though bounties are prohibited by NFL rules, they are not a violation of U.S. or state law, for now.  There’s a chance this could change, though.  United States Senator Dick Durbin is putting together a Judiciary Committee hearing about the use of bounty systems in the NFL and the other professional sports leagues.  For the most part, hearings like these are little more than a good show for politicians’ constituents.  However, you never know in this town, especially if there are many more revelations of other bounty systems in the weeks and months to come.

"But Coach Williams, what if we get caught?"
"Don't worry, Vilma.  Your fines will be tax deductible!"

So, it looks like NFL fines (and fines imposed by a player's team) are deductible as business expenses.  It is important to note, finally, that business expenses must exceed two percent of an employee’s adjusted gross income to be deductible.  With the exorbitant salaries for many players, the fines levied by the NFL might not meet this standard—though in this case, the league will probably try their hardest to make it so.

City Wage Taxes (“We just lost to the Eagles and now this?!?”)

It may be news to some of you, but not others, that there are some cities and counties that impose a tax on wages earned within their boundaries.  Most jurisdictions only impose this so-called “wage tax” on residents.  However, there are some notable exceptions, cities that also impose this tax on non-residents, at an equal or lower tax rate.

What does this mean for an NFL player?  Well, for those who are residents of these cities, it means an extra ding on every paycheck.  Remarkably, it also applies to a player’s game check when that player is in a wage tax city for an away game.  In other words, a player is taxed even though he is on the visiting team.  The amount of the tax is based on the number of days you were in the city.  As you’ll see from the list below, this tax is not going to be insignificant when you consider how much an NFL player makes for playing in just one game.

The following are NFL cities that apply a wage tax, with the tax rates of each (as of August 2011): 

‘  San Francisco, CA  (1.5% for both residents and non-residents, imposed on employer)

‘  Denver, CO  (for both, $5.25 on income over $500)

‘  Indianapolis, IN  (1.62% for residents; 0.405% for non-residents)

‘  Baltimore, MD (3.05% for residents; actually a state tax for non-residents, 1.25%)

‘  Detroit, MI (2.50% for residents; 0.013% for non-residents)

‘  Kansas City, MO  (1.0% for both)

‘  St. Louis, MO (1.0% for both)

‘  New York City, NY  (between 2.9% and 3.876% for residents only)

‘  Cincinnati, OH  (2.10% for both)

‘  Cleveland, OH, (2.00% for both)

‘  Philadelphia, PA  (3.928% for residents; 3.4985% for non-residents)

‘  Pittsburgh, PA  (3.0% + $52 per year for residents; 1.0% for non-residents)

The city offered an amnesty period back in 2010

As you can see, Philadelphia, PA boasts the highest city wage tax.  Gotta feel sorry for players in the NFC East…

Well, I hope this has made you feel a little bit better about your own tax return.  If not, and you’re thinking about filing late, or perhaps contemplating an alternative to filing altogether, tune in for our next post, when we’ll look at the fates of some NFL players who tried to buck the system.

*Another question should be whether payments a player received from the bounty system need to be reported as income.  From the articles I’ve read, the answer is yes—even if they were “under the table” and in violation of league rules, income is income and should have been reported.