State taxation of professional athletes and entertainers.

States and localities often target nonresident professional athletes and entertainers to pay income taxes. Such celebrities are often highly paid individuals whose whereabouts can easily be tracked from readily available performance schedules and advertisements. Moreover, tax collections from such taxpayers are an efficient revenue generator. For example, in fiscal 2000, California and Wisconsin collected $94 million and over $11 million, respectively, from nonresident athletes; see Walker," A Closer Look at the Jock Tax,'" Milwaukee Journal Sentinel (7/9/02), at www.jsonline.com/sports/ brew/allstar/jul02/57648.asp.

Why should such taxpayers and their tax advisers be concerned? The Tax Foundation, a Washington-based, nonpartisan, nonprofit group that monitors fiscal policy, reported that the taxation of nonresident athletes is poorly targeted, arbitrary and burdensome; see Hoffman, "State and Local Income Taxation of Nonresident Athletes Spreads to Other Professions," at www.taxfoundation.org/sr123.pdf. Such individuals may have to file returns in over 38 states, not including localities. The sourcing rules for such income may vary significantly by jurisdiction and may depend, in part, on the type of income earned, the state's particular sourcing method and the reporting-entity relationship (i.e., employee, independent contractor, etc.). Moreover, athletes and entertainers may even be subject to "double taxation" as explained below.

Often, athletes and entertainers are treated differently from other highly paid workers, such as investment bankers, corporate executives and attorneys. Are these and other more moderately paid individuals next on the states' radar? Following are the general rules, pitfalls and planning recommendations in this area.

General Rules

Typically, a resident individual is subject to state income tax on his or her worldwide income; a nonresident individual is subject to state income tax on his or her income derived from or connected with sources within the taxing state. In addition, a resident taxpayer is generally allowed a resident tax credit, subject to certain limits, for taxes paid to the nonresident jurisdiction. If the taxpayer's resident state does not impose an income tax (e.g., Florida and Texas), no resident credit is available.

Historically, sports-team athletes would file income tax returns in two jurisdictions: (1) their resident state and (2) the state where home games were played. They did not file income tax returns in states where away games were played. Entertainers also need to determine the location(s) to source their income (i.e., where a performance occurs).

Although many states follow traditional rules, others have revised their laws, regulations, guidance and policy to tax athletes and entertainers under alternative methods. Such methods may be a trap and result in unanticipated tax liability and compliance.

Allocation methods: The two most common allocation methods for athletes of professional teams are the (1) "duty days" method and (2) "games played" method. The duty days method allocates income based on a ratio, the numerator of which is the number of duty days the taxpayer is present in the state and the denominator of which is the total number of duty days. "Duty days" are all days the athlete is required to perform services (i.e., from pre-season and training camp through postseason playoffs, including instructional leagues, promotions, appearances, etc.).

In comparison, the games played method allocates income based on a ratio of games played in the taxing state to total games played. Certainly, the athlete's taxation can differ significantly, depending on the state's method of taxation, as well as a particular athlete's residence, sport and location of activities.

Entertainers: Like athletes, states may also tax entertainers on a duty days or "performance days" method (i.e., working days within and without the state). Other states may simply tax an entertainer based on the net income derived from a particular performance within the jurisdiction.

Pitfalls

Athletes and entertainers who do not file a tax return in a jurisdiction can be assessed tax, interest and penalty for all back years, as there is no statute of limitations (SOL) on assessment if a return has not been filed. In addition, if assessed, a resident credit may not be available if the SOL has expired in the taxpayer's resident state (or, as indicated above, if the state does not impose an income tax).

Significantly, a resident credit may not be available in certain jurisdictions if the taxpayer's entire income was deemed earned within the resident state. For example, in a surprising result, Illinois would not allow baseball star Sammy Sosa, an Illinois resident, a credit for taxes he paid to other jurisdictions for games he played in nonresident states. The Illinois Circuit Court agreed with the Illinois Department of Revenue in finding that the taxpayer's income was compensation paid solely in Illinois, because his employer, the Chicago Cubs, was based there. As a result, Sosa was subject to "double taxation" and paid state income tax on more than 100% of his income; see Sosa v. Bower, IL Cir. Ct., Dkt. No. 02 L 50670 (6/26/03).

Sourcing issues: State income tax sourcing issues for athletes may include:

1. Bonuses (for signing, playing or performance);

2. Contract termination payments; and

3. Payments for commercials and endorsements.

The state tax sourcing of an entertainer's income may become more complex, for example, if the entertainer is (1) an employee of a promoter, organizer or production company; (2) an independent contractor; (3) receiving royalty income; or (4) receiving income for television and radio transmissions.

Planning

* Identify the jurisdictions in which the athlete or entertainer provides services.

* Review the jurisdiction's "sourcing" rules.

* Determine the taxpayer's resident state and understand its resident-credit rules.

* Analyze the types and character of the income earned by the athlete or entertainer in sourcing prior, current and prospective revenue.

* Consider amnesty programs and voluntary disclosure arrangements for nonfilers.

* Identify other taxpayers who may be subject to similar state income taxation (i.e., investment bankers, corporate executives, attorneys, etc.).

* Consult a tax adviser with experience in the industry.

FROM DAVID SCHMUTTER, CPA, J.D., LL.M., AND ARI LAZAAR, WEISER, LLP, NEW YORK, NY (NEITHER, AFFILIATED WITH GRANT THORNTON LLP)