Athletes find changing rules, tax burdens difficult to assess
Just ask professional golfer Retief Goosen after his battle with the IRS last year over the characterization and source of his endorsement income. His case, which is under appeal, illustrates the tax difficulties facing global athletes. Although the court did not provide strict guidelines for determining the tax treatment of endorsement income, the decision gives some indication as to how the IRS may treat these cases in the future.
It is important to note Goosen was not trying to evade taxes or hide income. This case dealt with the characterization of his endorsement income as royalties or personal-service income and how much of it was earned in the U.S. The IRS assessed a tax deficiency for 2003 and 2004 totaling $164,698 — Sergio Garcia has a similar case pending, for $1.7 million — claiming Goosen excessively classified his income as royalties and sourced too little of it to the U.S. Both parties appealed the tax court’s decision but have since reached a private settlement, and the case was dismissed on Feb. 28.
|Retief Goosen recently settled a U.S. tax dispute stemming from how his income was characterized.
Sponsoring companies sign athletes to obtain certain rights to their name and likeness for promotional use in exchange for agreed-upon compensation. This sounds simple enough, but how much of this compensation is tied to personal services performed by the athlete versus the mere use of the athlete’s name and likeness?
The IRS argued Goosen’s golf endorsements were all personal service and any associated royalties were nominal. The court, looking closely at the contracts, noted there was value to sponsors by associating with Goosen’s image. It eventually split the difference and classified his on-course endorsements (TaylorMade, Acushnet and Izod) as 50 percent royalty and 50 percent personal-services income. His off-course endorsements (Rolex, Upper Deck and Electronic Arts) were ruled 100 percent royalty income.
As for the source of this income, Goosen claimed no more than 9 percent of it as U.S. sourced. The court disagreed, allocating between 50 percent and 92 percent as U.S. sourced, depending on the contract. Furthermore, 50 percent of his on-course royalty income and all the off-course endorsement income sourced to the U.S. was not “effectively connected” to a United States trade or business. As a result, a flat tax of 30 percent applied to this income versus the normal graduated rates.
All this talk of U.S. sourced and effectively connected income is enough to make one’s head spin. It’s important, however, because many professional athletes create sophisticated business structures to address these issues. Goosen, a resident of the United Kingdom, wisely uses business entities created in tax-favorable jurisdictions to reduce his overall tax burden.
Allocating income with great precision is virtually impossible in this case, and the court appeared to classify the on-course endorsements as 50 percent royalty income and 50 percent personal-services income as a matter of convenience. Still, the decision provides some helpful guidance and highlights issues to consider when consulting clients.
1. Understand a client’s endorsement market and where the company whose product is being endorsed plans to use his or her likeness.
Sourcing cannot be determined with real certainty, but a tax consultant should not ignore this issue and leave the entire process to the taxing agency. Without some reasonable justification to the contrary, the IRS will try to source all royalty income to the U.S. Outlining a preliminary understanding of allocation, based on the client’s competition schedule or the sponsoring company’s target markets, will better serve a client when determining the tax implications.
2. Define what the athlete is being paid for.
Is the payment tied directly to athletic performance or merely for use of his or her likeness? Nonresidents typically pay less in taxes on royalty income under tax treaties, which explains Goosen’s aggressive allocation in this case. But the expressed terms of the contracts (e.g., personal appearance days, minimum tournament requirements, etc.) influenced the court’s classification of personal-services income versus royalty income. Therefore, the contract terms negotiated on behalf of the client can have significant tax implications.
3. How do you advise your clients on where to participate in competition?
Although this case involved a foreign athlete in the United States, American athletes face a similar dilemma overseas. The United Kingdom aggressively allocates global endorsements even if the athlete and endorser have no tax presence. Andre Agassi challenged this notion and lost in 2006, leading several high-profile athletes, including Usain Bolt and Roger Federer, to limit their appearances in the U.K.
This policy also created controversy prior to the 2010 Ryder Cup in Wales before a compromise could be worked out. Because the competition does not involve prize money, players would actually lose money as a result of a U.K. tax on their endorsement income. Considering the applicable tax rate is roughly 50 percent, American players would have faced significant tax liabilities on endorsement deals having no connection to the competition.
The global marketplace for athletes continues to expand. Golf is no exception as it looks to increase its presence in the Far East and beyond. In light of this expansion, the Goosen decision is a reminder of the complex financial issues athletes can expect to encounter.
Mark Iacono (email@example.com) is owner and president of Hyperion Sports Management, which focuses on individual athlete representation, and is of counsel at the law firm of Salter McGowan Sylvia & Leonard.