Tax Cut and Jobs Act to Cause Significant Financial Disruption to Sports and Entertainment Businesses
On Friday, December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (the Act). While the emphasis of the Act focused on the reduction of corporate rates, and the repeal of the Affordable Care Act's individual mandate, other less publicized aspects of the bill will undoubtedly cause significant marketplace disruption. In particular, it is widely expected that the sports and entertainment marketplace will experience increased cost and tax risk.
Excise Tax Against Major Colleges and Universities
The Act creates a new provision codified under 42 U.S.C. § 4960. Under that provision, applicable tax-exempt organizations are expected to pay an excise tax of 21 percent for covered employees, when those covered employees receive remuneration in excess of $1 million. Section 4960 limits the tax consequences to the top five (5) highest paid employees once those salaries top $1 million.1 The excise tax also applies to any excess “parachute payments” paid to such employees.2
In practical terms, this tax specifically targets and affects NCAA Division I collegiate coaches and athletic directors who are often the highest paid state officials. For example, the head coach of the University of Minnesota Golden Gopher football team, P.J. Fleck, currently earns approximately $3.5 million per year in base compensation. Under Section 4960, the University of Minnesota will now incur an additional $735,000 in excise tax per year because of this contract. As a starker example, Texas A&M University recently paid Jimbo Fisher a prince's ransom for a 10 year contract worth $75 million dollars. As a result, it is estimated that Texas A&M will be paying close to $90 million dollars over the course of the deal as a result of the new excise tax.
As a result of this change, applicable universities will be tasked with determining how to account for this new excise tax. Coaching salaries may go down below the $1 million threshold and/or will bonus provisions in coaching contracts be decreased or removed entirely which may in turn create some financial parity and competitive balance for schools not otherwise able to pay high coaching salaries. Universities may renegotiate vendor sponsorship or required third parties to directly contract with the coaches to supplement university pay. Revenue sharing for game contracts and production rights may also be redistributed to provide additional financial incentives to coaches.
Another option that may gain popularity would be insurance based alternatives, such as split dollar arrangements. For example, in 2016, the University of Michigan made a series of split dollar loan advances to football head coach Jim Harbaugh, in the amount of $2 million per year. Coach Harbaugh was then able to procure a substantial life insurance policy that during his lifetime he would be permitted to recognize the cash value of the policy by taking out one or more loans from the policy. At his death, the proceeds of the policy would then be used to repay the initial loan made by the university to Harbaugh with the remaining amount flowing to Harbaugh’s estate, tax-free. Since this would be considered a loan, the amount is not taxable to the employee and would therefore not be considered compensation subject to excise tax.3 This may also be much ado about nothing if in fact the individual states and not the tax-exempt universities and colleges themselves pay the coaching salaries as the excise tax would not apply.
Charitable Deduction For College Season Tickets No Longer Deductible
The Act also repeals the tax code provisions related to "college athletic event seating rights” - more commonly referred to a personal seat licenses. Many colleges and universities require donors to provide an annual gift in connection with the right to purchase seat licenses. For example, at Notre Dame Stadium, many donors contribute anywhere between $750 and $2,700 annually per seat. As a result of the donation, the individual is guaranteed certain perks including special access to game tickets and stadium clubs. In connection with this donation, the tax code allowed donors to deduct up to eighty percent (80 percent) of the contributed value against their personal income taxes per Section 13705 of the Code. The Act now repeals any deduction for personal seat licenses.
Across all colleges and universities, it is expected that the loss of this deduction will cost hundreds of millions (if not billions) of dollars on a per year basis.4 By way of example, the University of Texas athletic department generated $32.5 million from suite and seat license contributions during the 2015–16 athletic year, which is in addition to the $37.3 million generated in actual ticket sales.5 Previous estimates during the Obama administration determined that $2.5 to $2.9 billion was spent on college seat licenses over a 10-year period. As a result, many donors are seeing increased activity from their respective colleges and universities, requesting that they prepay their personal seat licenses in order to use the deduction prior to the law going into effect. For example, Syracuse University is asking donors to prepay for two years, and other major institutions, such as the University of Oklahoma, University of Florida, and Southern Methodist University, have asked their donors to prepay for multiple years.
The loss of this “charitable” deduction has significant trickle down effects on the respective universities. Many of these donations are used to improve higher education facilities and provide scholarships to deserving students. By way of example, LSU athletics gave nearly $50 million to its academic programs over the past five years. And without these contributions, enrollment and retention rates would most likely go down due to the inevitable need to balance those financial losses – typically, an increase in tuition fees and costs.
Tax Changes Affecting Professional Athletes
Athletes living in high tax states have long been aware of explicit costs of residing there. For example, those athletes and entertainers residing in California can expect to pay a state income tax in excess of 9 percent. For those that live in Minnesota, high-income earners will also expect to pay close to 10 percent. Traditionally, the state and local taxes incurred by individuals were allowable as a deduction. However, under the Act, Section 11042 is amended to limit state and local tax deductions in excess of $10,000. This could prove problematic for athletes who may decide it is not worth the additional cost to reside in a state where the state and local income tax deduction is no higher than $10,000. States with no personal income tax, such as Florida, Tennessee, Texas, Nevada and Washington, are more attractive residences.
The Act also eliminates the ability to deduct unreimbursed employee business expenses starting in 2018. Professional athletes typically apply this deduction to their agent fees, union dues, and payments made to trainers in the offseason. However, considering that for players in major professional sports leagues, most of their income falls in the top income tax bracket, the reduction from 39.6% to 37% may more than make up for the lost deductions noted above.
Despite the unfavorable tax implications for the sports and entertainment industry noted above, some proposed sports-related tax regulations did not make the final bill. For example, the Republican majority eliminated sports stadiums from being eligible to take advantage of any tax-exempt bond financing for stadium development. Instead, under the Act, interest on any bond issued in connection with stadium development would be taxable.6
1. See, e.g. https://deadspin.com/infographic-is-your-states-highest-paid-employee-a-co-489635228 There are at least 240 coaches and athletic directors across the FBS that receive compensation in excess of $1 million (bonuses and forfeitures affect this total) – most employed by institutions in the Major 5 conferences (ACC, Big 10, Big 12, SEC, Pac-12).
2. Parachute payments are compensation paid upon the termination of the employee’s employment if the aggregate present value of such payment equals or exceeds three times the employee’s base compensation (generally, the employee’s average annual compensation over the five year period preceding termination).
3. If the loan interest is forgiven or below market rate, the employee would recognize income on that amount.
4. Donations to college athletic departments and related booster clubs totaled $1.2 billion in 2015.
5. There is no tax deduction on the purchase of actual game tickets.
6. Many presume that elimination of the tax related to bond financing of stadiums was due to increased lobbying from developers and sports leagues, such as MLB and the NFL. Many investors choose the tax free bonds because of the lower risk associated with the bond. In turn, municipalities are able to generate more funds for stadium development.