Avoid 'Jordan's revenge' and find slam-dunk savings for athletes

For financial advisors and tax professionals, Michael Jordan's first championship took meaning beyond the beginning of the Chicago Bulls' legendary dynasty. Hoops fans recall the team's 1991 National Basketball Association title over the Los Angeles Lakers as the first of the Bulls' six championships under His Airness and company, a changing of the guard from the dominance of Magic Johnson and his "Showtime" squad.

Among advisors and tax pros working with a coveted client base of professional athletes and entertainers, though, the hardwood history came with dueling state-level duties that California and Illinois levied against each other. California hit the Bulls players and employees with a tax on income they earned in the state, but Illinois came back with its own levies. At the time, the duties earned the monikers, "The Jordan tax" or "Michael Jordan's revenge." But today all 50 states charge what has come to be known as a "jock tax."

The need for planning

Those tax complications, and the significant differences between high- and low-tax states, often require athletes and performers' certified public accountants to fill out dozens of returns. However, there are many strategies that provide opportunities for savings. These approaches include tax planning around the clients' home residencies, charitable deductions or credits, and business entities such as an S corporation. Focusing on these available strategies means that an athlete could live in a high-tax state like California — which has a top rate of 14.4% on income — if they'd rather be there than a place with a rate of zero, said Nisiar Smith, founder of Elkins Park, Pennsylvania-based Courtside Wealth Partners.

Courtside Wealth Partners

"While our goal is to mitigate your tax liability, as your advisor, I'm not going to push you to live in those states, especially if you're not going to have a quality of life," Smith said in an interview. "If that's where you want to live, then by all means, we just have to figure out other ways to mitigate your tax liability. … I don't really advise them on where to live. I start backwards and ask, 'Where do you see yourself?'"

Questions about residency are "very important" to athletes and entertainers, as is the fact that their tenures at the pro level or ability to fill large venues is often limited to "a relatively short period of time, when you compare it to different industries, to optimize their wealth," said Frederick Blue, the head of new business development with Wells Fargo Wealth and Investment Management. A pass-through entity or trust planning could bring savings to, say, college athletes benefitting from "name, image and likeness" deals. In light of federal, state and local taxes, a paycheck of $10 million may begin to look much different, Blue noted.

"Net-net, that could potentially be cut in half, all associated with those three taxes," he said. "So it's important to look for strategies and work with a tax advisor."

READ MORE: Shohei Ohtani's deferred $680M drives home tax and planning lessons

Potential strategies

The so-called jock tax assesses either a pro rata amount tied to the number of games in a given jurisdiction compared to an athletes' salary or the state's duty on a performer's one-time earnings. Living in a zero-income-tax state can be "a huge win," but the residency "must be intentional and well-documented," said Ron Pac, the co-founder and managing partner of Westport, Connecticut-based RIA firm Trivium Point Advisory.

"Residency planning is about more than where you sleep, it's about where your life appears to be anchored. This will require more than just a Florida license," Pac said in an email. "Most income will be taxed where it's earned, so tracking by source is critical. This is where you will see many athletes or entertainers use planning tools such as personal service entities, deferred compensation arrangements or image-right structuring to help address messy tax footprints into a well-managed strategy."

For athletes and entertainers who may not be acquainted with the challenges of sudden wealth, the budgeting and tax planning should start when they begin collecting the large paychecks, Blue said. Their residency, or domicile, could come up in contract negotiations, as well.

"With some contracts in the tens and possibly hundreds of millions of dollars, seven-figure taxation savings can be realized through the right selection of a domicile," according to a white paper released last month by Wells Fargo. "While the money you earn day-to-day playing for a team is likely to be taxed as income in the state in which you play, other payments may not. For example, signing bonuses for athletes are generally taxed by the state of the athlete's residence at the time the bonus is received. So even if you are to play for a team located in a high-tax state, by domiciling in a no- or low-tax state you could save significantly on taxes for the signing bonuses. The language of your contract and the specific state in which you are to play weigh heavily on this analysis and should be overseen by a tax professional."

READ MORE: Student-athletes need an assist with NIL taxes

Taylor's taxes

International events may add further complexity to the equation, noted a guide to tax strategies for athletes and entertainers released earlier this year by professional services firm Armanino. On the other hand, a high-grossing performer like Taylor Swift traveling worldwide could deduct business expenses abroad, and athletes' teams usually pick up other countries' income tax tabs on their games, the guide notes. Of course, the athletes must still pay the IRS, and they could earn other income during their time overseas.

Back home in the U.S., the state and local tax deduction, incentives for energy efficiency and research and development, rules for equipment depreciation and credits for education or film, television and other entertainment could apply.

"The massive success of Taylor Swift's Eras Tour didn't just shatter records for attendance and ticket sales — it showcased the unique tax challenges entertainers and athletes face when working across multiple states and countries," the Armanino guide said. "With most cities and states on her tour demanding their slice of the pie, savvy tax planning, including the strategic use of tax credits, becomes essential for maximizing profitability."

Tax considerations deliver a lot of challenges and openings for sophisticated planning around events like the Olympics or legendary feats that result in a contractual performance bonus, Smith noted. To address these highly specific circumstances that affect his clients who are NBA and WNBA players, Courtside is — like many other wealth management companies — building its tax-related services. An upcoming merger will create a new unit of the registered investment advisory firm called Courtside CPA & Associates.

READ MORE: 12 tips for advisors on working with athletes, actors and entertainers

Tough competition for clients

Compared to some of the biggest wealth management firms, Smith saw a "need to be competitive, in terms of what in-house offerings am I giving them" and a way "to be able to offer those tailor-made services," he said. Those include ensuring that they "plan ahead before signing contracts or booking appearances" for the tax impact and simply keeping track of where the athletes are earning money in the course of their hectic schedules, according to Smith.

"You gotta pay your taxes, period," Smith said. "Second, you have to keep detailed records of where you work and perform, because that can be an Achilles' heel for a lot of athletes."

Advisors seeking to break into work on behalf of athletes or entertainers could consider pursuing the Sports and Entertainment Accredited Wealth Management Advisor, or "SE-AWMA," designation through the College for Financial Planning, a Kaplan Company, Blue noted. That, "in itself, establishes a level of credibility when you are looking to build relationships in that space," he said. Then they could follow that up with outreach to agents, business managers, sports attorneys, trainers and, subsequently, to the athletes themselves.

"Network as best you can. Build and cultivate relationships with what we call 'centers of influence,'" Blue said. "Tell your story. What's your value proposition to these prospective clients?"