Seven tax planning tips for professional athletes and entertainers

What's less glamorous are the many different tax laws that accompany non-traditional incomes that professional athletes and entertainers earn. The complexities of these tax rules can be especially problematic early on in an athlete or entertainer's career before they have even had a chance to hire a team of qualified tax professionals.

"Professional athletes are often quite young," says Mitch Drossman, head of National Wealth Strategies in the Chief Investment Office for Merrill and Bank of America Private Bank. "They come into money quickly, and this can result in a lot of taxes very quickly."

If athletes and entertainers (and others working in those fields, such as coaches, trainers, directors and agents) don't have a sophisticated wealth advisor in place, including tax advisory, there are significant risks, according to Michael Duffy, Managing Director and Strategic Wealth Advisor for Merrill Lynch Wealth Management and Head of Art Planning for Merrill. "They can easily rack up surprise tax bills, incur penalties and interest, create extensive debt, damage their personal brand and wind up in legal jeopardy simply by being unaware of applicable tax laws," Duffy explains.

Early-career individuals are unlikely to have any experience with most state income tax laws, such as the "jock taxes" that can be accrued when working outside of the individual's home state; tracking multiple income streams and understanding the tax rates and tax laws for each; and knowing how to support their favorite causes without running afoul of the laws that govern charitable giving. While the majority of high-net-worth individuals will hire an accountant or tax attorney to prepare their various tax returns, every earner should have a baseline understanding of the tax rules.

At Merrill, we have extensive experience collaborating with high-net-worth athletes and entertainers, as well as their managers, agents, CPAs and tax attorneys, to assist these professionals with tax planning.¹

Here we've compiled a list of the top points for athletes, entertainers and other non-traditional earners to keep in mind, highlighting some important nuances to consider. Tax planning and compliance does not have to be a second job where it consumes an already busy schedule. But it is important and can help one plan and act accordingly.

1 Get organized and pay on time

The number one thing to keep in mind is to make sure to file tax returns and make tax payments on time to avoid penalties and interest. Most athletes' and entertainers' incomes will vary considerably from year to year, which can complicate the task of making estimated quarterly income tax payments. Careful planning and budgeting can help mitigate years where earnings are considerably lower. They will also need to put in place a system to collect and track the information that will enable their CPA to accurately calculate what tax is owed.

2 Understand the jock tax

Many states require athletes and entertainers who perform in their state to file a state income tax return and pay a portion of their earnings, known as a "jock tax," to that state, even though the athlete or entertainer doesn't live there. Rates and filing requirements vary from state to state — a few states don't require income tax at all, and some states only require income tax on athletes who are residents of states that also enforce a jock tax on visiting athletes and entertainers. On top of the state income tax, some cities may charge a municipal tax (in addition to state income tax) on athletes for games played in certain venues.

One popular history attributes the origin of the jock tax to 1991, when the Los Angeles Lakers lost the NBA finals to the Chicago Bulls. In what some interpreted as a desire for retribution, California charged the visiting Chicago Bulls' athletes income tax, and in response Illinois began enforcing income tax on visiting California athletes.²

Frequent complaints about the jock tax are that these taxes unfairly target athletes and entertainers because they place an undue compliance burden on them. For instance, it's not uncommon for a National Football League player to file up to a dozen non-resident state income tax returns.

Careful tax planning can help athletes and entertainers avoid surprise tax bills from places they've traveled to for work and keep them in compliance with the various taxing authorities.

3 Clearly establish your domicile

A domicile is the place one treats as their permanent home. Many athletes and entertainers can save millions in taxes by choosing to reside in a state that does not have an income tax, such as Florida, Texas or Washington. Living in a low or no income tax state can also reduce taxes because signing bonuses are not subject to the jock tax and are only taxed in the state where the athlete or entertainer resides. However, proving that the athlete or entertainer resides in that state can be complicated if they travel frequently for work or spend time in multiple homes they own in different states. Proving official domicile often means being clear about where one's primary residence is — where they vote, where they are registered to vote, the state where a driver’s license is issued, how many days are spent in the state, where one goes to maintain religious or secular community-based social affiliations and where their children attend school. A knowledgeable advisor can help athletes and entertainers navigate the more complicated aspects of the domicile equation.

4 Multiple revenue streams, endorsements, appearance fees

One of the primary ways that athletes and entertainers differ from other earners in other sectors is that their income almost always comes through a variety of different channels. They may make a base salary, while also enjoying signing and performance bonuses, appearance fees, sponsorship deals, prize money, royalties and back-end compensation. There can potentially be different rules and regulations that govern tax rates and deductible expenses for each of these sources of income. For example, when most people sell property that they create, any gain is taxed as ordinary income. However, when a songwriter sells a song or part or all of their songwriting catalog, proceeds can be taxed under the more favorable capital gains rate if the appropriate election is made. Understanding the tax ramifications of different sources of income is critical to an athlete’s or entertainer’s financial management and well-being.

5 The Tax Cuts and Jobs Act (2017)

Prior to the passage of this law, professional athletes and entertainers were able to make significant deductions for expenses such as agent fees, union dues and payments made to trainers in the offseason. The new tax code eliminated many of these deductions until 2026.

6 Philanthropy

After reaching certain professional goals, athletes and entertainers may want to give back to their community through charitable giving. One popular path is to leverage their public profile and ability to inspire others by setting up a charitable foundation. Another avenue for giving is to donate time and effort to a cause. It's important to note that there are no income deductions allowed for donating time, so this approach does not confer tax benefits.

"Philanthropy often plays a big role in tax planning," notes Dina Friedman, Managing Director and Co-Head of the Strategic Wealth Advisory Group at Merrill Lynch Wealth Management. "When someone considers philanthropy, they may have their specific ideas about how they want to do it, and their approach doesn't always align with their tax goals. It then becomes a question of 'What is it you're trying to accomplish as a philanthropist?' Some clients have a philanthropic goal in mind and are not concerned about achieving tax savings, so we can structure their giving strategy to achieve their stated goals. Whereas, if they say, 'I want to give money to charity, but I also want to make sure I optimize any available tax deductions,' that might lead to a different solution set.”

"While it's common for athletes and entertainers to set up foundations, it's tremendously important that they get the right guidance," Friedman points out.

Additionally, individuals may want to hire family members or friends to work at the foundation. But setting up a charitable foundation is not a simple task, and there are a number of laws and rules that govern how foundations are structured, funded and managed, including rules for paying reasonable compensation and the necessity to avoid conflicts of interests between oneself, family members and the charitable entity. A well-intentioned foundation that doesn't carefully adhere to the rules can attract scrutiny and could end up hurting their image and even the causes that they're trying to benefit.

For these reasons, it's critical to consult knowledgeable advisors when setting up a foundation or other philanthropic entities.

7 Understand estate tax and the role of life insurance in planning for eventual estate tax payments

Athletes and entertainers who've achieved great wealth often want to ensure the next generation of their family will benefit from this wealth. Understanding how gift and estate taxes work and planning for those tax considerations is key to any robust tax planning process. In particular, these individuals may have created valuable intellectual property, such as a singer who owns copyright on their song catalog. If, in their estate plan, they bequeath those songs to a relative the estate may not have the cash needed to pay the estate tax and the estate may be forced to sell. Or, that relative can have those copyrights stripped from them down the road under Federal Copyright laws. "This is where a strategic life insurance policy can be a viable solution. Life insurance benefits are paid out in cash. It provides the beneficiaries of the deceased person with liquidity to pay estate tax bills," offers Friedman.

We understand that just as no two athletes or entertainers are alike, your investment strategy and financial wellness will be unique to you. We will recommend a strategy that is appropriate for you and your life goals. And when your goals change, we will work with you to modify your strategy to fit your new plans.

Merrill offers comprehensive services with an understanding of the unique challenges of professionals in the sports and entertainment industries.