Shohei Ohtani’s Deferred Salary Triggers Massive California Tax Break
When news broke that Shohei Ohtani had signed with the Dodgers for 10 years and $700 million, I was aghast at the price tag. Thus, while I was disappointed that Ohtani would not be a Cub, I was at peace with the outcome. The Dodgers had simply outbid the field. Then news broke that Ohtani was deferring $680 million and that the Cubs had been willing to go up to $500 million over 10 years. After accounting for the difference between current and deferred money, the total value appeared to match or exceed the Dodger’s offer.
Even worse, the massive difference between Illinois and California income tax rates, meant the Cubs’ offer was higher. That irritated me, until my research showed the deferrals may save Ohtani over $70 million in taxes.
California has the highest state income tax in the country and the Dodgers are taxed around $106,000 per $1 million in salary. That number will rise, as California’s top rate increases from 13.3% to 14.4% next year. So Ohtani was looking at a $70-80 million tax bill. But many tax experts believe Ohtani’s deferrals will instead eliminate most of that tax hit.
Calculating state taxes for baseball players is complicated because they are taxed based on the state their team plays in as well as the states in which they play games. But there are ways to avoid some of these taxes. For example, signing bonuses are taxed in a player’s state of permanent residence, not the team’s state. This loophole saved Manny Machado $2 million when he signed with the Padres, and now Ohtani may have uncovered another loophole.
Federal law 4 USC 114 prohibits California from taxing specific types of retirement income paid to non-residents. The law states that this includes deferred compensation packages that pay equal yearly sums for at least 10 years. By happenstance or clever intent, Ohtani’s contract pays him $68 million per year for 10 years starting in 2034. So if Ohtani leaves California after his playing days, California likely cannot tax his $680 million in deferred income. And there you have that $70 million savings.
The average annual value (AAV) of Ohtani’s contract comes out to roughly $46 million after factoring in the value lost by deferring compensation. That was lower than the Cubs’ $50 million AAV offer in terms of net present value, but Illinois taxes of $3-4 million per year bring it back down a bit. The Dodgers deal avoids any real tax hit since the actual salary is so low, relatively speaking, and a huge bulk of the deal will be paid out later. So in the end, the Cubs really didn’t outbid the Dodgers in terms of either perceived or total value.
Ohtani could have asked the Cubs for the same type of deferrals, but it seems clear — for the second time — that he was never going to choose the Cubs. Ohtani wanted an AL team back in 2017 so he could DH and he was always going to choose the Dodgers this year because he wants to stay in LA. I can’t blame him for either of those choices, I just wish the charade that gave us hope had not been necessary.
