On December 11, 2023, the largest professional sports contract in history was announced: Shohei Ohtani signed a ten-year, $700 million contract to play baseball for Major League Baseball’s Los Angeles Dodgers.[i] Ohtani has earned his status as an international superstar and was destined to sign a lucrative contract when he entered free agency after the 2023 season. However, $700 million is still astounding even when record-setting contracts have become the norm across professional sports leagues in the United States and abroad.
Coinciding with the $700 million sticker shock, was the news that Ohtani had personally chosen to defer 97% of his annual salary, which amounts to $68 million of the $70 million he will earn per season. Major League Baseball reports that Ohtani personally made this decision to allow the Los Angeles Dodgers to retain enough capital to pay other players so that the team has a higher likelihood of remaining competitive. Therefore, Ohtani will be paid $2 million per season from 2024 – 2033, and then he will be paid ten equal installments of $68 million annually from 2034 – 2043.[ii]
Benefits of Deferring
Deferring income is a good savings strategy for earners of any level. While most Americans do not have to defer income to help their employer pay other employees, Ohtani’s choice to defer income carries a couple important considerations that apply to most workers: reducing the amount of taxable income and mitigating state income taxes.
Although Shohei Ohtani is deferring 97% of his annual playing income, he is still earning $2 million. On top of his $2 million salary, Ohtani earns around $40 million per year from endorsement deals.[iii] Therefore, Ohtani’s projected earned income for 2024 is $42 million. The decision to defer $68 million in 2024 reduces his potential earned income from $110 million to $42 million; a 62% reduction which will greatly reduce his taxable income for 2024 throughout the term of his contract.
Disregarding the extraordinary numbers, the concept of deferring payment to reduce an annual tax burden is commonly used. The clearest example of deferring one payment while receiving another can be seen in the choice to accept an annual salary while deferring a bonus. In this type of scenario, an individual receives regularly scheduled salary payments while choosing to defer their annual bonus income, which is usually paid one time annually. In doing so, the person will only pay taxes on the salary received and will not have to pay annual income tax until they receive their deferred bonus income in the future. Further, the individual may have the opportunity to defer the bonus income into an investment account so they could earn a return on their deferred income.
In the United States, workers are taxed at the federal, state and (in some cases) local levels. The Los Angeles Dodgers are domiciled in California, which, beginning in 2024, will have a graduated state individual income tax that tops out at 14.4%.[iv] 14.4% is among the highest state income tax rates across all states. By deferring 97% of his income until after his Dodgers’ playing contract expires, Ohtani can avoid paying, what might be, the highest state income tax in the country by moving out of California before he takes his deferred compensation. Pursuant to the Pension Source Tax Act – 4 U.S.C. 114, states cannot tax deferred compensation payments to former residents if the payments are substantially equal and paid over a period of at least 10 years. If Ohtani, who is Japanese, chooses to move back to Japan or to move to a different state in the United States in 2034, he could save up to $98 million (i.e., 14.4% of $680 million) because he will no longer be a California resident when he collects his $68 million annual payment in each of the ten subsequent years. The States with no income tax are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
Relocating to a municipality with favorable tax treatment is common for many retirees. The warmer climates of Florida, Texas or Nevada can also be enticing. Regardless of a retiree’s motivation for moving, the benefits of paying lower or no state income tax cannot be understated when saving for or enjoying retirement.
How’s this possible?
The most well-known deferred compensation vehicles, 401(k) plans and Roth IRAs, have limits imposed by the Internal Revenue Service (IRS). The 2024 401(k) contribution limit is $23,000 and $30,500 for those 50 years and older; the 2024 Roth IRA limit is $7,000 or $8,000 for those 50 years and older. Acknowledging that these limits are far below the $68 million figure Ohtani is deferring is an understatement. However, these limits are set annually by the IRS to promote fairness amongst workers.
To avoid the limits imposed by the IRS, many organizations offer nonqualified deferred compensation plans (NQDCPs) to allow highly compensated workers, which are those earning over $155,000, to save above the limits of the 401(k) or Roth IRA regardless of their age.[v] NQDCPs are deferral vehicles companies use to allow employees to save as much as the company deems acceptable. In doing so, the deferred income is retained by the employer and becomes a liability of the organization and the employee who made the deferral becomes an unsecured creditor. Additionally, some NQDCPs offer access to investment accounts within the plan.
The rule governing Major League Baseball’s deferred compensation is clear. According to the Major League Baseball Players Collective Bargaining Agreement, there are “no limitations on either the amount of deferred compensation or the percentage of total compensation attributable to deferred compensation for which a Uniform Player’s Contract may provide.”[vi]
Although the amount of compensation Shohei Ohtani is deferring is almost beyond comprehension, the way it is being done is straightforward. Deferring 97% of compensation throughout his contract term, Ohtani will be able to reduce his tax burden during the term and then have the ability to avoid a high state tax rate in the future if he chooses. These concepts can be utilized by many employees at companies big or small. To learn more about implementing a NQDCP in your business, please visit KBAdmin.com or contact Karr Barth Administrators at 800-549-1989 or planadmin@kbadmin.com.
[i] Wexler, Sarah. $700M stunner: Ohtani to Dodgers on biggest deal in sports history. December 11, 2023. Major League Baseball. Retrieved from: https://www.mlb.com/news/shohei-ohtani-contract-with-dodgers.
[ii] Feinsand, Mark. Explaining the unprecedented deferrals in Ohtani's Dodgers deal. December 11, 2023. Major League Baseball. Retrieved from: https://www.mlb.com/news/shohei-ohtani-dodgers-deal-deferrals-explained.
[iii] Tracy, Jeff. Baseball's top earners: Ohtani leads the way. Axios. March 30, 2023. Retrieved from: https://www.axios.com/2023/03/30/mlb-baseball-highest-paid-ohtani-leads-the-way.
[iv] Walczak, Jared. California Can’t Give Up Tax Increases. Tax Foundation. October 17, 2022. Retrieved from: https://taxfoundation.org/blog/california-tax-increases//.
[v] Internal Revenue Service. Notice 2023-75: 2024 Limitations Adjusted as Provided in Section 415(d), etc. 2023. Retrieved from: https://www.irs.gov/pub/irs-drop/n-23-75.pdf.
[vi] 30 Major League Clubs and Major League Baseball Players Association. 2022-2026 Basic Agreement. March 10, 2022. Retrieved from: https://www.mlbplayers.com/_files/ugd/4d23dc_d6dfc2344d2042de973e37de62484da5.pdf.