How Are MLB Draft Signing Bonuses Taxed? The Athlete’s Guide for 2022
Talk to the author about your MLB Draft questions:
How are MLB Draft signing bonuses taxed?
As an athlete, you should consider that question long before draft day.
There are many factors to consider when deciding if you will remain an amateur player or start your professional career.
For most players, it comes down to money.
Yet, players and their families are rarely proactive in understanding how to maximize the after-tax amount of a MLB Draft signing bonus. Before you sign your first contract, you have a unique opportunity to take ownership of your wealth from day one.
This is a financial decision. Seek out the expertise of a financial team, preferably a family office that works with professional athletes, to avoid costly mistakes that new players often make in negotiating a signing bonus.
Sure, taxes may seem like a boring subject. But if discussing this topic puts more money in your pocket, that’s time well spent.
That’s why we created this guide, just for you.
Don’t Rely on Your Agent for Tax Planning
What traditionally happens is that a player will hire a sports agent, who is a critical member of your advisory team. Your agent exists to make sure that you receive the money that you are due.
Step 1: Through your performance, you create value for which a team is willing to pay.
Step 2: Your agent negotiates with the team to get you paid for your full value.
Which results in what? Money.
Your agent’s main priority is getting you the biggest possible gross (before-tax) signing bonus.
But they are only focused on the sticker price -- not how much you’ll have left after taxes.
A good rule of thumb in determining a professional's main role is to follow the money. How are they compensated?
Your agent has specialized expertise and has accomplished their goal once they secure your contract. An agent is paid a percentage based on the gross (before tax) value of your contract.
This motivates your agent to negotiate the highest possible bonus and salary. In this instance, both of your interests are aligned, which is a win-win situation for both parties.
However, once the gross amount has been negotiated, an agent’s vested financial interest disappears. What you choose to do with your money has no financial effect on your agent.
This is NOT a criticism against agents. Rather, it emphasizes the importance of hiring financial experts to perform jobs where their interests align with yours.
As a player, your ultimate goal is not the gross (before-tax) amount you earn; it is the net (after-tax) amount. Therefore, it is critical for a player to leverage the expertise of not only an agent but also a Certified Public Accountant (CPA) and a Certified Financial Planner (CFP®), all of whom must specialize in working with professional athletes.
In fact, the best agents consult with athlete wealth management firms like ours all the time to make sure their clients have qualified advisors in place.
In the 2021 MLB Draft, we worked with an agent to negotiate the structure of a player’s signing bonus that resulted in the player receiving an extra $700,000 after-tax. But that doesn’t always happen.
Ultimately, it’s your responsibility to make sure the after-tax planning for your signing bonus has been considered.
One of the best ways to do that is to be proactive. Don’t wait until draft day, then ask your agent, "What are we going to do about the taxes?"
Next thing you know, the agent responds, “Oh, I've asked, but the club won't negotiate.”
Bad move.
Please make sure you hire a qualified financial team. Do this well in advance of the draft.
Make sure everyone is on the same page, and they understand their roles.
Set up a phone conversation between your agent and your financial team. Monitor it. Guide it.
Remember, you are the CEO of your life and your career.
What Conversations Should I Have with My Agents Through This Process?
Your agent should have no issue working with an independent financial team.
You’re paying them a significant portion of your signing bonus (typically $50,000 per every $1 million you will earn), and they work for you.
But for tax planning, you need specialized expertise. Your agent can only do so much. That’s why I keep reiterating the importance of having a team of experts.
We love the saying, “Trust, but always verify.”
What’s the best way to verify?
Ask your agent and your financial team this question:
"Can I please see a copy of a contract from last year's draft where you negotiated the signing bonus and structured it in the most tax-efficient way?"
If your agent or your financial team gives you a blank stare, consider that a red flag. Either they don’t know how to help you, or they don’t care enough about your long-term financial health.
What Does the Contract Say About Your Bonus?
Once you sign, you’re contractually bound by every single word on your contract.
You’ll be facing pressure to sign and close a deal quickly, but it’s essential to review every detail on that contract carefully.
Many assume that the fine print within a contract is just throwaway text, as if it’s just the extra wrapping on a birthday present. But the fine print may have crucial information. Not just about your signing bonus, but also other vital details that could affect your career and personal life.
It’s always a good idea to have a sports attorney review your contract.
However, it’s equally important to consult with wealth advisors who understand the tax implications of the payment structure, including a CFP® and CPA.
There are a few key details in your contract that affect how your signing bonus is taxed. Check to see if it has any clauses that will affect the timing, structure, conditions, and amount of your payments.
For example, the standard Minor League Uniform Contract has a “Recoupment Special Covenant Clause” that can dramatically impact how much tax you pay on the bonus.
According to the IRS, a bonus can’t be conditional on playing games for the team, and it can’t be refundable.
Under this clause, the player forfeits the bonus if there’s an unexcused absence lasting two weeks or more during any required training or during the season (regular season or post-season). The player also has to refund the bonus to the club if certain conditions are not met.
That means the IRS taxes the payments as regular wages, subject to state taxes where you played through the season. This is known as the allocation of wages according to duty days.
A true signing bonus would be subject to state taxes where you reside.
Depending on your state of residence and where you play, this distinction could mean the difference between paying no state income tax -- and paying hundreds of thousands of dollars.
This standard clause is proof that it’s essential to read every single word of your contract. And that definitely includes the fine print. Even if you have to hold a magnifying glass to it.
How Much Are Signing Bonuses Taxed?
A signing bonus may seem fantastic at face value. But when you consider its worth after taxes, it may amount to significantly less money.
Your taxes can vary greatly depending on several factors:
The language of your contract
The timing of payment
Your residency (state taxes)
All of these factors come into play when determining your tax liability. No two cases are the same, and it’s essential to get individualized advice for your situation.
Let’s discuss each factor.
Language of Your Contract
Unfortunately, the Standard Minor League Uniform Contract contains an “Abandonment Clause” which makes income apportioned under this clause part of your regular wages. In simple terms, your signing bonus is taxed in the state(s) in which you play.
The Abandonment Clause States:
“If player fails to report for, or abandons Club without permission and is absent from Club for a material portion, or for at least two weeks, of any playing season (which includes the championship season, any training required by Club in preparation for such championship season and any post-season that the team or affiliate to which Player is assigned participates) during the term of this Minor League Uniform Player Contract (“UPC”),
Player shall relinquish and forfeit any right to, and Club shall not be obligated to pay, any portion of the amount not yet paid pursuant to the payment schedule set forth in this signing provision and
Player shall immediately return and refund to the Club, and relinquish and forfeit any right to, that portion of the signing bonus already paid to Player by Club, regardless of the year of payment, that exceeds the amount of signing bonus already paid to Player by Club (i) multiplied by the number of championship seasons Player reported to, and did not subsequently abandon without permission, Club and (ii) divided by the number of championship seasons covered by the team of this UPC.”
The addition of this language to the contract violates the following two conditions of a true “signing” bonus, resulting in the income being apportioned as part of regular wages:
the bonus is not conditional on playing any games for the team; and
is not refundable.
As a simple illustration, take the following two scenarios:
| True Bonus | Regular Wages | |
|
Signing Bonus |
$1,000,000 |
$1,000,000 |
|
Team |
Miami Marlins |
Miami Marlins |
|
Resident State |
Texas |
Texas |
|
Team Assignment |
NY |
NY |
|
Team State Tax |
8.5% |
8.5% |
|
State Tax |
$ 0 |
$ 85,000 |
As you can see, the impact of whether a player’s signing bonus is considered a true “signing bonus” versus regular wages carries significant tax consequences. This is one of the many factors you must take into account when negotiating your signing bonus. However, this is also the most difficult to change.
Timing of Payments
As a result of COVID-19, the typical bonus payment structure of two installments over two calendar years was eliminated for the 2020 & 2021 MLB Draft.
Under the new agreement, drafted players received no more than $100,000 of their signing bonuses within 30 days of the approval of the contract by the Commissioner’s office. The player receives 50 percent of the remainder by July of the following calendar year, and the remaining 50 percent by July of the third year.
Unfortunately, the new structure eliminated a player’s ability to maximize their after-tax signing bonus through uneven payment splits. However, new tax planning opportunities were made possible, given the signing bonus is paid over the course of three calendar years.
It is yet to be seen if the current rules will become permanent or will return to the pre-COVID-19 rules.
Why does it matter?
Under the historical structure, players could negotiate uneven payments. Players were able to maximize their after-tax dollars through optimizing the graduated Federal Tax Brackets and allocation of wages to states with smaller tax liabilities.
To make this concept tangible, here’s an example of just how much a draftee can save in taxes by timing payments correctly.
In both scenarios, the draftee received a $4,500,000 signing bonus.
Scenario A: Common Approach
$4,500,000 signing bonus = $2,597,100 net after tax
This is a fictional scenario, but it’s the most common approach. The player receives half of the bonus money upfront, and the other half the following year.
In this scenario, the player would have received a gross amount of $2,250,000 in year one, then the second payment for $2,250,000 in year two.
This would have resulted in an after-tax amount of $2,597,100.
Unfortunately, that’s the arrangement that the player allowed his agent and team to structure.
If he had consulted with a qualified CPA before agreeing to the standard timing of payments, he could have saved more than $100,000 in taxes.
Scenario B: Tax Planning Approach:
$4,500,000 signing bonus = $2,712,900 net after tax
This scenario is based on a real draftee, who worked closely with our group and his agent before signing the contract. Together, we structured the signing bonus in the most tax-efficient way possible.
The result?
$115,800 in after-tax savings
Here’s how we did it.
An efficient payment structure for this draftee consisted of two uneven payments:
$4,000,000 in year one and $500,000 in year two.
Combined with three additional tax planning strategies, the result was a total net compensation of $2,712,900.
Compared to the draftee from Scenario A, our client had a tax savings of $115,800.
That’s why working with an experienced financial team is so crucial.
Residency and State Taxes
Where you live can have a dramatic effect on your signing bonus tax rate. Income tax rates vary by state, with a handful of states currently having no income tax. There are also many localities and cities that have also implemented income taxes.
Professional athletes are subject to taxation in each jurisdiction in which they perform services (play games), which can make the selection of residency an important planning tool.
According to TurboTax, only eight states are free of personal income tax:
Alaska
Nevada
Florida
Texas
Tennessee
Washington
South Dakota
Wyoming
So, as a professional athlete, if you live in one of these states, you’ll save a lot of money on taxes.
On the other end of the spectrum is California, the state with the highest personal income tax rate at 13.3%.
The team will typically withhold state taxes in the state where the player is assigned. In cases where the team state is a “no income tax” state, the team will not withhold any state tax, which could result in a surprise and lost deductions when the resident return is filed.
State taxes need to be considered, not only for your resident state but also in the states you play in during the season. Both need to be planned to maximize the benefit and reduce your overall tax liability.
State residency is one of the hottest topics among professional athletes, but it’s also one of the most misunderstood. The days are over of simply using someone else’s address and getting a new driver’s license as a way to “claim” residency. States have become savvier and are proactive in securing what they believe is their rightful claim of an athlete’s income.
These are all things you should consider as you select your place of residence. And remember, language in your contract can impact state taxes too. If it’s not a true bonus according to the IRS, you’ll pay income tax in the state where you play -- not where you reside.
By the way, click here if you’re interested in using a signing bonus tax calculator.
How Do I Pay the Least Amount of Taxes on a Bonus?
To pay the least amount of taxes on any type of income, work with a professional in advanced tax planning.
Don’t just file your taxes. Plan for your taxes. Consider what tax deductions for professional athletes apply to your case and maximize those write offs.
As a high-earning professional athlete, you need individualized advice -- it’s not a simple answer and rarely a short-term strategy.
Be wary of those who tell you otherwise.
The ideal scenario is working with an integrated financial team experienced in saving professional athletes money on taxes, and helping them build lasting wealth.
Capture Every Dollar Owed
Now you have the answers on how signing bonuses are taxed.
That’s great. Because the last thing you want to do is leave thousands of dollars on the table.
The bottom line is you need a plan in place to lower your taxes long before you receive your signing bonus, when you have a chance to negotiate and plan for the best possible contract.
You can dive further into making that happen in this podcast episode.
And just as important, make sure you work with an experienced financial team. A team with tremendous success helping athletes structure their signing bonus—in the athlete’s favor.
If you have any questions about planning for financial success as a professional athlete, don’t hesitate to contact us.
