Taxation of Athletes, Artists, and Entertainers

Presented by: Jeffrey Schneider

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. Income Specific to Athletes, Entertainers and Artists . Deductions – Some general, some specific to Athletes, Entertainers and Artists . TCJA Issues . Loan Out Corporations . US Taxation on Non-Residents . Royalty Income Presented on Behalf of . Sale of Artworks . Foreign Taxation of US Resident Artists, Clear Law Institute Entertainers and Athletes . Multi- State Tax Issues and the Jock Tax By Jeffrey A. Schneider, EA, CTRS, NTPI . More TCJA Considerations

. Compensation for Services Rendered “Income means all . Fees . Contingent Compensation income from . Profit Participations . Residuals whatever source . Royalties . Bonuses derived” . Self-Created Works/Copyrights . Prizes

Agreements in the Entertainment Industry . Certain “A Listers” get a percentage of the . Actors receive compensation for personal gross / net / profits services . Paid only when something happens . Directors, as “consideration for services”, . Profits in profit participation clauses are receive compensation not the same as profits for accounting or

tax §61(a)(1) – specifically mentions compensation for services and fees . Profits, if any, are specifically outlined in the agreements

. Unlike profit participation, these are written in the . Not specifically mentioned in §61(a)(1) Collective Bargaining Agreements between the . Congress gave the US Treasury broad studios, the unions, Screen Actors Guild (SAG- AFTRA) and Directors Guild of America (DGA) powers to enact regulations . What is it? . Treasury Regulation 1.361-2(a)(1) – . Payments over & above compensation “Compensation on the basis of a . “Due” after initial release of show/movie percentage of the profits ... is income to . Not based on profits (see DGA website) the recipients. . Ex: 60% of gross receipts that covers fees BUT ONLY WHEN RECEIVED and other expenses)

. Athletes do not have profit participation (most sports teams claim that they are not Visual Artists, Authors, Recording profitable), but they get bonuses Artists & Songwriters .Paid when their works are sold . To make sure that there is no confusion, or used with §61(a)(1), Reg §1.61-2 includes “bonuses” ... “including Christmas .Not for personal services bonuses”

Book Author Agreements Recording Artists’ Agreements

Generally, based on US hardback sales* Generally, based on a percentage of units 1) 10% of suggested retail on 1st 5,000 sold or licensing fees the record company * 2) 12.5% on next 5,000 receives for the use of the record 3) 15% on next 10,000 4) Digital, paperbacks, international paid at different percentages

* Author Publisher Hardcover Trade Book Contract **Exclusive Recording Artist Agreement Entertainment Industry Contract 41-1 Entertainment Industry Contract 159-1

Songwriters’ Agreements Bonuses vs. Royalties

Generally, 50% of the amount that the Bonuses are specific in what is being paid publisher receives for those songs that are (i.e., actors, directors, pro athletes, etc.).

* recorded used in a movie or TV Show Royalties do not specify amounts, just how Also receives royalties for public the royalty is based performances directly from “performance rights organizations (ASCAP, BMI, SESAC) §61(a)(6) specifically mentions Royalties

** Single Song Agreement Enertainment Industry Contract 169-1

Not Royalties per §61(a)(6) §61(a)(2) – Gross Income Derived Though it is income per §61(a)(1) from Business

§61(a)(2) – Gross Income Derived from Business Requires that the ENTIRE sales §61(a)(3) – Gains derived from the dealings in price is included, then deducts Property (not in the business) expenses as Cost of Goods (Schedule C)

. Tournament Competitors receive prizes §61(a)(3) – Gains derived from the versus compensation, royalties, etc. dealings in Property . Tennis players and golfers receive Requires GAINS is included prizes as their main source of income

Not in the business (Hobby)? . Authors (Nobel Award) or other team athletes receive prizes (i.e., car for MVP Deductions may be limited award), but it is not their main source of income

• the prizewinner didn’t do anything to General Rule - §74(a) – All prizes enter the contest • the prizewinner doesn’t have to provide and awards are income unless any services in the future exempt • the prizewinner designates a charity or government to receive the prize • the prize is given to that organization or government.

Nobel winners MVP Winners Automatically qualifies under the first Even if they designate a charity and that two exceptions charity receives the award – the award is But have to designate a charity and that income to the winner. Does not pass the charity has to directly receive the award first two criteria

As such, not income to the Hornung v. Commissioner winner 47 T.C. 428 (1967)

Hornung v. Commissioner Hornung v. Commissioner 47 T.C. 428 (1967) USTC Ruling

“We feel confident that Congress has no Paul Hornung Football Hall of Famer – Green Bay Packers of the 60’s intention of allowing professional football to An educational event because football was constitute a type of activity for which proficiency taught in college could be recognized with an exempt award An artistic achievement because being a under section 74(b). Professional football cannot football star calls for “degree in artistry” be viewed as an “educational”, “artistic,” a scientific achievement as there is “some “scientific,” or “civic” field or endeavor as those degree of science” in what they do terms are used in the statute no matter how A civic achievement because he needed a fond of the sport we may be. The crucial leave from the army and the President expressed interest he get it (he did) question for qualification under section 74(b) is the nature of the activity awarded.”

Wills vs Commissioner – 9th Circuit 1969 Maury Wills, LA Dodger Infielder of the 60’s Starting with the 2018 Summer Olympics, Same result with Judicial reservations Olympic Awards will not If Congress wants to tax awards, “the next step would be for the Internal Revenue Service to be taxable* tax the gold and silver medals awarded to Olympic Games’ winners.” *If they earn <$1million annually BUT THEY DO!

True Gifts – Elizabeth Taylor Jewelry from Not Income prior to 2006 Richard Burton Disguised Income – In audit settlement, IRS and Academy of James Cameron gave eleven Motion Picture Arts and Sciences agreed $30,000 Priuses to Cast of Avatar. that for 2006 forward, 1099s will be Adam Sandler gave four $200,000 issued for value of awards. However, the Maseratis to cast of Grown-Ups Academy stopped giving baskets to Oprah now pays the tax presenters. Why is it income? It is a thank (more income) so the audience is you for presenting. Presenting is a made whole service, thus income under IRC §61(a).

Is it income to the donor? Treasury Regulation §1.61-2(c) in applying the ruling in Lucas vs. Earl

Lucas vs. Earl – US SC (1930) – the right to Where, however, pursuant to an receive income for personal services cannot agreement or understanding, services are rendered to a person for the be assigned, not even before its earned. benefit of a charitable organization Thus it is income even if assigned. and an amount for such is paid to such organization by the person to whom the services are rendered, the amount so paid constitutes income performing the services.

. If income, is their donation a Caveat – EMPLOYEES, not ICs corresponding Schedule A deduction? Commonly reimbursed in the entertainment . RR 65-503 says that entertainer did not industry as employer requires them to do so participate in the planning, promoting SAG CBA requires producers to pay actors a or scheduling of an event he “worked”, per diem allowance for meal & overnight did not have to include the admission fees lodging & commercial travel into income st . This is the big distinction whether or not DGA CBA requires to pay for 1 class travel, inclusion meals and accommodations

NFL CBA requires teams to IRC §119 – Not taxable, IF 1) provide room and board during meals and lodging are furnished for the training camp employers convenience, AND 2) reimburse players for travel to and they are furnished on the business from and meals during training camp premises of the employer , AND 3) Even if cut or traded when lodging is provided, the employee is required to accept that Are all of these income lodging as a condition of employment under §61(a)?

Regulation §1.62-2 – Not taxable, IF in connection with the employer’s business the payment is made pursuant to an accountable plan with any access paid to be returned to the employer

Presented in my Substantiating If the business is deemed a hobby, Deductions Course expenses are LIMITED to your gross income (i.e., net sales or revenues)

AND Need to know the 9 factors looked at are itemized deductions by the various courts

1. The manner in which the taxpayer carries on the 4. The expectation that the assets used in the activity activity. Do they have complete and accurate may appreciate in value. Is the plan to generate books? Were records used to improve profits through asset appreciation? performance? 5. The success of the taxpayer in carrying on similar 2. The expertise of the taxpayer or his advisers. Did or dissimilar activities. Have they had success in the taxpayer study the activities’ business converting them from unprofitable to profitable? practices? Did they consult with experts? 6. The taxpayers history of income or losses with 3. The time and effort expended by the taxpayer in respect to the activity. Has the taxpayer carrying on the activity. Do they devote become profitable in a reasonable amount much of their personal time and effort? of time?

7. The amount of occasional profits. Even a single year of profits can be a strong indication that an activity is not a hobby. §162 – Reasonable and Necessary

8. The financial status of the taxpayer. Does the taxpayer have other income sources that are being §262 Except as otherwise provided, offset by the losses of the activity? no deduction shall be allowed for personal, living or family expenses 9. Does the activity lack elements of personal pleasure or recreation? If the activity has large personal elements (MLMs), it is indicative of a hobby.

Promotions Physical . Deducted (tix to their shows) Conditioning 1) $178k in physical conditioning 2) $12k for NBA imposed fines Self-Defense Classes Gifts (in full) 3) Thousands for Laker Game Tickets (he was a Personal Grooming Fan Mail Responses Laker at the time) that he distributed for “promotional” purposes Legal Fees Make-up

Clothing Contacts Actually settled, so not published, but lawyer Newspapers & Mags Phones says that the IRS caved on first two & settled on #3 Cable & Internet Entertaining Fans

Why would the IRS give in? . There is case law allowing for certain . NBA Uniform Player contract specifically states entertainment that players are to be in good physical condition and it gives the NBA the right to suspend players (without pay) if they are not fit . Next few screens will discuss

. Paying the fines is also defined in the contract . Then we will review how the TCJA changes under Players Conduct clauses. things – “MAYBE”

Tony Award winning Actor wanted to sustain He won “entertainment and publicity expenses.” Court ruled that “the purpose of the Theatre tickets and M&E he gave to newspaper entertainment was to enhance his men (remember this is 1930’s), playwrights, photographers, voice teachers, dramatists, backers reputation as an actor and to secure of plays, actresses, actors, agents, directors, school theatrical engagements for easily.” chums, fliers, pugilists (boxers were called that then), army & navy men, hotel manager, foreign How much did he save? princess, a senator and his family, but not family or close friends. $50.61

. Related IRC Sections . §274(e)(1) – All provisions are exceptions to . §162 – Ordinary and Necessary §274(a) . §212 – Expenses for the production of . Deductible if “conducive to a business income discussion” . §274 – Disallowance/Limitation provision . Under pre-TCJA law – if 274(e) applies, expense . §274(a) – enacted under the Revenue Act of 1962 does not need to meet §274(a) requirements . President Kennedy wanted to deny these . Hence, the success of taxpayers in court even expenses when there was no proof of a business . Rev Ruling 63-144 (Q&A #7) – any expense for discussion meals purchased for a business customer . Meals are a part of entertainment . Steel, 437 F.2d 40 (2d Cir 1971 . Thus non-deductible . Howard, TC Memo 1981-250

. Regs. §1.274-2(f)(2)(vi) – “Any expenditure . What does the new law say or does not say by a taxpayer for entertainment which is . Removed “directly related to” directly related to bona fide business . Removed “associated with” meetings of the taxpayer’s employees”... . Says “No deduction otherwise allowable “held principally for discussion of trade or under this chapter shall be allowed for any business in not subject to the limitations on item – with respect to any activity which is of allowability of deductions provided by a type generally considered to constitute paragraphs (a) through (e) of this section.” entertainment, amusement or recreation.”

Even for individuals in these industries, they However, meals are not specifically mentioned; must follow the same rules as everyone else Deductibility is not so clearly determined. Aneitra Hamper, a TV news anchor wanted May or may not – TREAD LIGHTLY to deduct everything, including her under One on Ones? garments Denied – “Inherently Personal” Occasional business meal on site (studio lot)? Meal accompanying business meeting Hamper v Commissioner of employees? TC Summary Opinion 2011-17

§263A(a)(1)(A) – Include in inventory costs . Used in connection with the Costs incurred for the production of production of property is to be deducted when sold, as  Recordings part of the finished product  Motion Pictures  Videotapes §263A(a)(1)(B) – depreciable/amortizable  Books Equipment, etc., is handled for property  Copyrights producers the same as servicers.  Patents

* Mathematical mechanics are not specifically spelled out in the code

Each year’s depreciation deduction is equal to the cost of the property multiplied by a fraction. Depreciable costs of $1,000 to produce a CD The numerator is the current year’s net Expects to have net profits of $10,000 over next income from the property. 10 years, not equally

The denominator is the total income anticipated through the end of the 10th Year 1 - $4000 Year 2 - $3000 taxable year following the year the Year 3 - $1000 Years 4 & 5 - $500 each property was placed in service. Years 6-10 - $200 each year

YEAR TOTAL EXECTED EARNINGS AMOUNT OF AMOUNT FOR YEAR / TOTAL DEPRECIAITON FOR THE SPEENT EXPECTED EARNINGS YEAR 1 $1000 X $4000 / 10000 = 400

2 $1000 X $3000 / 10000 = 300

3 $1000 X $1000 / 10000 = 100

4-5 each $1000 X $500 / 10000 = 50

6-10 each $1000 X $200 / 10000 = 20

Total $1,000

. Concept of Residency

. Pay to Play – Non-Resident Income Allocation Issues

. Tax Credits, Withholdings and Other Stuff

. Importance of Residency Status

. Basic Residency Tests . Residency Based on Domicile . Residency Based on Days

. Burden of Proof in Tax Cases . Jeter vs. NYS . State claimed that Jeter’s domicile is NY when he signed with the club Jeter claims he lives in Florida, works in NYS

Never litigated, but the issues is who has the Burden of proof? Court has said that the state has the burden since they are asserting the claim of residency

. Ohio – Has a bright line test based on accounting

. Domicile only - no statutory tests . Alabama . South Carolina . Wisconsin . Michigan . New Mexico

. Statutory Residence . Factor Based Tests . PPA = Principle Place of Abode . Home . Business (where they work) . 183 days . Time (quality vs. quantity?) . Near and Dear . PPA Test . Family . Living Quarters . Any type of dwelling . Leave and Land Rule – that . Gaid vs. NY is one day even if it is on . Taxpayer must “use as a residence”, the same day . not just have ownership

US Athletes and Entertainers pay US taxes The History – wherever they play and perform except in Referred to as Michael Jordan’s Revenge those states that do not have an income tax! Started in California in 1991 State was “upset” that the LA Lakers lost to Jordan’s TN used to charge $2500 per game for up to 3 Chicago Bulls in the NBA finals. appearances in the state – ceased in 2016. Decided to levy SIT on the salaries earned in CA. Illinois took revenge on CA and did the same to the Many athletes consider the state tax when CA athletes choosing where to sign a new contract. BUT not all athletes, just those from states that taxed out of state ones (like California)

The History – Do not forget the various city, county & local Although, very true, the jock tax started 30 years tax returns prior in California NYS 1979, then again in 1982 Remember the taxes paid to other jurisdictions WI 1989 as a credit for those similar taxes

How big is the Jock Tax? – What is the true residency of the taxpayer in 2010 California raised $171.7million

from non-resident athletes, alone Formula - Duty Days vs Games Played

Duty Days Duty Days – Formula Takes the total number of number of days spent playing in that location and divides it by the total work days during a season.

Games Played (largely abandoned) Takes the number of games played in that particular state or municipality and divides it by the total number of games played in the season.

. All practice days, game days, travel days from pre-season to end of post season play

. Plus off-season practice days, per contractual obligation . MLB – . AZ Cactus (except in Arizona) . FL Grapefruit league play

. Travel Days – Only if there is activity

Tom Hanks did a play in NYC on Broadway. He lives in California, which he has a PPA. He claims that California is his domicile and should pay NYS/NYC tax only on his earnings Tour Schedule in the play. NYS could possibly claim that he is a NYS/NYC resident due to the amount of ISSUE?? (besides NYC having its own tax) days in the area!

. S-corp versus C corp . Apportionment Factor . Three Factor Formulae . Single Sales Factor

. Sales tax on merchandise sales

. Some states don’t tax signing bonuses

. Tony Bennet vs NY . Paid for recording album – service income in NY . Received residuals from “radio play” . Bennet said that it is royalty income and should be taxed in state of domicile . State says its NYS/NYC income

Result – Service income – derived from Service conduct – recording in NY

. Limitations on SALT to $10,000 . Removal of exemptions . Increase of CTC, but high earners are not eligible anyway . Loss of employee unreimbursed business expenses . §199A – specified business?

. What is it? What is it?

Entertainment industry’s version of a . With the benefits of using them being personal service corporation substantially reduced, what benefits remain? What is a PSC? – It is when the sole shareholder/officer/director provides . What burdens are imposed on those his/her own personal services to other who use them? companies

Loan Limited Liability Agreement Loan Out Entertainment Main Line Pictures sued Kim Basinger & her $

Company company LOC for breach when she quit on her

$ commitment. Contract was with LOC. She $ Employment Personal won, it was Contract US $ Service Treas Just like any other corporation/LLC if the Employee Shareholder Benfit contract is actually between the Providers entertainment company and the LOC

Saving for Retirement If entertainer is an employee (like team athletes), they can contribute to an IRA or 401K. Employer can add pension monies (all professional sports leagues have pensions). However, there are limits. If they are IC, their LOC can create their own 401K and pension. They control the $’s.

Saving for Retirement – Consider This THE ANSWER IS

What happens if the LOC shareholder is covered by an union-employer’s retirement plan? IT DEPENDS!!

If they are permitted to do so, are there limits on the amount that can be contributed, deducted and distributed by the LOCs?

Since entertainers can work as ICs, employees or via LOCs, it is important to understand where the income stream is coming from so that you are not contributing to two different plans from the same income stream.

Though a 1978 PLR came to a different They no longer allow teams to “borrow” conclusion – not precedent at all – many in the industry did just rely on it until 1995 players from loan out companies. They when the unions began asking questions and have to be employees of the teams that limiting their contributions. they play for!

. Minimum State Tax Filings Personal Holding Company . Separate county, municipal or local licenses . Additional tax returns (state, county, city, Additional 15% tax on undistributed personal holding company income! – See handouts for three IRS examples from district) the regulations – 1.543-1(b)(8)(iii) . Must use be an accrual basis taxpayer Definition . Foreign tax credits may be limited (discussed 1. more than 50% of the stock is owned <5 people AND later) 2. 60% of income is from services of a person who owns . Personal Service Company Tax Rate more than 25% of the company’s stock AND 3. the person who will perform those services is . Flat 35% selected someone other than the corporation

LOC MUST: • Earn more than 40% of its income . Taxed Like US Citizens other than providing personal services . Green Card Holders (hard) of a 25% or more shareholder; . Statutory Formula • If person other than shareholder . Substantial Presence Test (formula using 183 days or provides personal services, they have more over the past 3 years) (By accident) to be essential; . Tax Residents – by application (easy) • LOC must have 6 or more S/H, of which 5 cannot own >50%.

. Exceptions to the Statutory Formula . US Source Royalties – paid for using, . Charity Sports Event – playing in charity events in the US, copyrights, trademarks or vs for prize events ”other like property”. . Closer Connection – File form 8840 . Must be in the US <183 days during current year AND . Even non-residents may have to pay . Must establish she or she US tax unless an exception applies . Has a tax home in another country . Has a “closer connection” to that country (i.e., car (i.e., treaty). registrations. bank accounts, homes) . Treaty – an agreement between US & the . Foreign Source Income – NRA will alien’s home country not pay US tax on that income.

Example of US Source Royalties – Mixed Sourced Income Australian author owns copyrights to book in US and Australia. Hired US Same Australian author, but she hired US book company to publish her book in book company to publish her book in US for which she is paid royalties. several countries. She is paid one amount, as a advance. Thus, she has US and foreign source royalties. Assuming no US/Australian treaty related to royalties (though there is one), she would have had to pay US She must allocate the income tax on that income. (Goosen v Commissioner, TC 547 (2011).

. “Effectively Connected” with a US trade of business IRC §865(a) – taxed like regular income at our graduated rates General Rule

. Fixed or determinable amount . Derived from use of copyrights, trademarks, etc. in the  US Source Income if it is sold by a US US resident . Activities of the US trade or business was material factor in the realization of the royalties  Foreign Source income if is sold by a non- . “Not Connected” – 30% flat tax rate with resident mandatory withholdings at the source

General rule does not apply to sale of inventory . Income is taxable in US from whatever (§865(b)), sold in the regular course of a trade source, from wherever derived or business. . Can be eligible for credits or exclusions

If inventory made in US and sold outside . Foreign tax credits if paid tax in other country on same income or made outside and sold in US, the gross income and related expenses are allocated 50% . Can be partially excluded including foreign to the US and 50% foreign. housing costs paid by the employer under IRC §911 Treasury Regulation §1.863-3(b)(1) . Available to all US Citizens and RAs

The exclusions and tax credits available to US . US Bilateral Conventions – taxpayers do not offset 100% of the income earned outside of the US, there may be double . US and some 60 countries (counting all Soviet countries as 1) taxation. . US Totalization Agreements Organization for Economic Co-operation and . Development – 34 country organization, 24 countries, whose purpose is to avoid double taxation on social security income. dedicated to global development

Model developed by OECD is used by most . Does not effect how countries tax their countries own citizens or resident aliens

One must look to the Internal Revenue Common Language – “Resident of Contracting Code as to the taxability of that income. State” who has income in the “Other Contracting State”. One must look to the treaty or convention to see how that income for that non-resident is to be treated. Presumes that income was earned by someone who is a resident of one of the two countries but Code §894 says that treaties are to be given not a resident of the country where income was “DUE REGARD” to any treaty. earned. Code §7852 says neither treaty or the law is to have “PREFERENTIAL TREATMENT”. Must show a closer connection to the other country than they do to the US to be a non- resident.

Closer Connection Too many countries, too many treaties . Where the person’s permanent home is; to do here . Where the person’s family is? . Where their personal belongings are? . Where their social, political, religious or BUT cultural organizations are? . Where they do their personal banking? . Where they vote? Rest assured that all income is taxable . Where they are registered to drive? unless it is not. . What is designated on the government issued documents?

Jeffrey A. Schneider, EA, CTRS, NTPI Fellow 738 Colorado Ave Stuart, FL 34994-3005

Office 772-337-1040 Fax 772-337-1041

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