5 Strategies to Help Lower Your Tax Exposure
Shohei Ohtani, a pitcher and designated hitter, recently signed a contract with the Los Angeles Dodgers that made national headlines. Surprisingly, the media buzz had less to do with the staggering $700 million the team agreed to pay Ohtani and more to do with the player’s decision to defer most of that salary until a decade from now.
Under the arrangement, Ohtani will receive an annual salary of $2 million for the next 10 years, his contract term with the team. Then from 2034 through 2043, Ohtani will receive $68 million per year to round out the $700 million.1
Why would Ohtani do such a thing? For two reasons:
- It allows the Dodgers to lower their luxury-tax salary from $70 million to $46 million per year, which lowers the team’s current payroll obligations, providing financial flexibility to sign additional players and bolster their chances of winning.
- It potentially saves Ohtani from paying excess state taxes. As a resident of California, the player’s income is subject to a 13.3% tax rate in 2023, which jumps to 14.4% in 2024. By deferring a significant portion of his salary until after he’s done playing baseball, Ohtani could potentially move to a more tax-friendly state and save millions in state income taxes.
In case you’re worried about how Shohei Ohtani will survive on just $2 million per year for the next 10 years, keep in mind that the baseball superstar also earns approximately $40 million a year in endorsements.2 I think he’ll be able to pay the electric bill.
Ohtani’s decision to defer such a large portion of his salary offers a great segue into the importance of tax planning for professional athletes. And you don’t have to have a $700 million contract to implement smart tax planning strategies.
Following are five important tax moves for professional athletes.
#1 – Maximize your deductions.
Professional athletes are eligible for multiple tax deductions, which have the potential to significantly lower your tax liabilities. You can likely deduct expenses that contribute to your health and ability to compete. Be sure to track and claim the following.
- Travel expenses, including airfare, car rentals and lodging expenses for work-related trips
- Gym and health club dues and fees
- League fees
- Massage therapy
- Training equipment
- Agent and management fees
- Coaching and training fees
#2 – Contribute to tax-deferred retirement accounts.
Making contributions to tax-deferred retirement accounts, such as a 401k or traditional IRA, can be an effective way to lower your tax exposure in the current year while also accumulating tax-advantaged assets for the future. Assets within these accounts grow tax-deferred and are taxed as ordinary income when withdrawn.
In 2024, you can contribute up to $23,000 per year to a qualified retirement plan (plus an additional $7,500 catch-up contribution for those age 50 and older). It may make sense to max out your tax-deferred retirement plan contributions during your athletic career, when your income may put you in a higher tax bracket. Not only can you defer taxes in the current year but you may save on taxes in the future by withdrawing from the accounts when your income is lower and you fall into a lower tax bracket.
#3 – Be strategic in structuring contracts and endorsement deals.
You don’t have to defer hundreds of millions of dollars like Shohei Ohtani to realize the tax benefits of a strategically structured compensation arrangement. Your wealth manager and tax advisor can help you consider your options, such as deferring a portion of your income, negotiating signing bonuses and analyzing the potential tax impact of various contract clauses.
#4 – Develop a charitable giving strategy.
Not only are charitable donations a great way to give back to causes that matter to you but they can also help lower your tax exposure. Giving cash is a great way to support charities, but there may be added tax benefits for both you and the charity if you consider other ways to donate. Following are two giving strategies that often make sense for professional athletes.
Making an in-kind donation of appreciated securities, such as stocks, bonds or mutual funds, can have tax benefits for both you and the charitable organization you wish to support.
For example, let’s say you decide to donate $5,000 in appreciated stock to your favorite charity. Your cost basis on the stock is $1,000. If you sell the stock for $5,000 and donate the proceeds, you will owe capital gains taxes on $4,000 (the difference between the stock’s current market value and its cost basis). At a 20% capital gains tax rate, you would owe $800 in taxes following the sale, and $4,200 would be left to donate to the charity. Assuming you itemize your taxes, you would then be able to deduct $4,200 in charitable donations from your tax return.
On the other hand, if you were to make an in-kind transfer of the appreciated stock directly to the organization, you would avoid triggering a taxable event and the charity would receive the entire $5,000 value of the stock (because charitable organizations are tax-exempt, the charity could sell the stock without paying taxes on the transaction). Plus you could claim a charitable deduction of $5,000 on your itemized tax return. Clearly, that’s a win-win for both you and the cause you wish to support!
Donor-advised fund (DAF)
Whether you wish to donate cash or appreciated assets, a DAF can be an effective way to lower your taxes and optimize your charitable impact. A DAF is a 501c3 charitable fund that holds irrevocable charitable gifts. As the donor, you retain control over the timing of charitable distributions as well as the organizations to which donations are made.
As a professional athlete, one of the main benefits of establishing a DAF is that you can make a single large contribution of cash, stocks or other assets during a year in which your income is higher than normal, then distribute assets to charities over several years. By doing so, you can take a charitable deduction from your itemized tax return in the year you made the donation while supporting charities over time. This practice can be an especially effective way to lower your taxable income during high-income years, such when you’re playing professional sports.
By front-loading a DAF during your high-earning years, you can lower your taxable income while setting aside funds for charitable giving once you retire from sports.
Another benefit is that the assets within the DAF can be invested and grow tax-exempt within the account. This provides you with an opportunity to establish a charitable legacy for future generations of family members, as your children and grandchildren can have a say in how assets are donated to various organizations.
#5 – Maintain a tax-efficient investment portfolio.
Not only do you face tax liabilities on the income you earn but you may also be subject to taxes on your investment gains. That’s why it’s vital to take steps toward a more tax-efficient investment portfolio. Work with your wealth manager to implement the following strategies.
Asset location refers to the strategy of dividing assets among taxable and non-taxable accounts according to each asset’s tax characteristics. Essentially, asset location allocates tax-efficient investments to taxable accounts and tax-inefficient investments to tax-advantaged accounts. When implemented correctly, this strategy can help minimize portfolio taxes and enhance returns.
Investment returns play an important role in asset location because, typically, the higher an investment’s return, the more taxes you’ll need to pay. That’s why it’s wise to place high-return investments in tax-advantaged accounts. Investments with lower return potential, such as U.S. government bonds and cash, can be placed in taxable accounts without adding significantly to your tax exposure.
Within an investment portfolio, investors are only taxed on net capital gains, which equals gains minus losses. This means any realized losses can be used to reduce your tax liability. Tax-loss harvesting is the process of looking for opportunities to realize losses in order to offset gains.
Tax-loss harvesting works by selling an investment that has declined in value in the short term — a common occurrence in a heavily weighted equity portfolio — and replacing the investment with a highly correlated alternative. If done correctly, your risk profile and rate of return remain unchanged, but the temporary tax losses are extracted in the transaction.
By realizing the investment loss, a tax deduction is generated that can lower your taxes. You can then reinvest your tax savings to further grow the value of your portfolio.
Could you use some help with your tax planning strategies? Creative Planning is here for you. We are fiduciary advisors who specialize in helping professional athletes navigate the unique financial challenges of their careers. As a specialty practice of Creative Planning, our experienced team members include CERTIFIED FINANCIAL PLANNERTM professionals, certified public accountants, attorneys, insurance specialists and more. We help you navigate today’s challenges while preparing for a financially smart future. To learn more, schedule a call.