What do pro golfers and racing teams have in common? For one thing, the arena in which they work is extremely competitive. For another, both professions depend on endorsement and sponsorship money as a major source of funds
A Tax Court case[1] settled in June of this year demonstrates the ability of the IRS and the Federal Courts to specify the type of income that a taxpayer receives. And the type of income (or the way it’s “characterized,” in tax lingo) can have a major difference in how it’s taxed.
Let’s begin at the beginning. Retief Goosen is a professional golfer from South Africa and has played on the European tour for a number of years. In 2001, he won the U.S. Open tournament and played in the PGA. During the years 2002 and 2003, he was on the pro tour and received endorsement fees as well as bonuses, prize money, etc.
He signed agreements with various sponsors, including a watch company, clothing and golf equipment firms, and a video game producer. Some of these agreements required him to wear the sponsor’s clothing or use the golf equipment. The agreements also required him to make himself available for a certain number of days for photo shootings and public relations activities. Some of the agreements contained a clause that permitted the sponsors to void the agreement should he commit any action that violated public morality or decency. This seems to be part of a standard contract for sports figures.
His earnings were deposited in bank accounts at the direction of IMG, his representative. (IMG also has a major presence in motor sports.) His financial affairs were arranged in such a way as to minimize taxation, especially British taxation.
When the IRS audited Goosen’s tax return for 2002 and 2003, it raised the issue of what portion of his income was due to personal services and what part consisted of royalties. In his case, the tax treatment resulted in different tax liabilities.
One of the problems Goosen faced was that some of the endorsement agreements failed to allocate between personal services and royalties. There was also the matter of allocating a portion of his endorsement income to the United States.
Although he had some international tax issues that the average racing team doesn’t normally face, there are some similarities between Goosen’s tax problems and the tax problems of a racer or racing team when it comes to endorsements and royalties.
First, the IRS and the courts have the power to determine the type, or “character,” of income if either the endorsement agreement doesn’t specify the amount attributable to personal services, endorsements, royalties, etc., or if the allocation is unreasonable. The take-away for racers and racing teams is simple: make certain that any agreements of this type specify the amounts or percentages to be allocated to each type of income. If not, you could be taking your chances with the IRS.
Second, the allocation between US and non-US endorsement income was an important issue in the Goosen case. Although his specific issue is probably of little interest to the average racer or racing team (unless they compete internationally), the principle still holds on a smaller scale for motor sports.
If a racing team competes in different states or cities, it should be aware of the “jock tax.” If personal services, such as participated in a sporting event, e.g., a race, are performed in a particular taxing jurisdiction (state, county or city), that taxing locality can, and oftentimes will, have its hand out for its share of tax dollars.
Of course, if a racing team is going to be taxed on its revenue attributable to a specific locality, it should also be able to deduct a portion of its expenses attributable to that locality. Local law will govern and should be consulted.
Major League Baseball, the NFL, the NBA and the NHL are all very much aware of this. Many years ago, I helped prepare a tax return for a sports coach who, in one year coached in Minnesota, several cities in Michigan and in Pennsylvania. On top of it all, he was a Canadian citizen. At least eight tax returns were prepared for that particular year.
Third, another tax aspect of the Goosen case dealt with royalties. There’s a line of court cases holding that payments for the right to use the name or likeness of a person are considered royalties. Royalties are subject to income taxation, and may also be subject to self-employment tax if:
- The taxpayer is pursuing his or her trade or business in an unincorporated manner, and
- The taxpayer is “regularly engaged” in his or her trade or business.
So, if you’re “regularly engaged” in racing, not incorporated, and you receive royalties, you are probably subject to self-employment tax on the royalties.
(Self-employment tax is the social security and Medicare tax paid by taxpayers who conduct business without incorporation. For 2010 the rate is 15.3 percent of self-employment income. In 2011, the rate decreased to 13.3%. This tax is in addition to the income tax liability.)
What does “regularly engaged in a trade or business” mean? In 1968, the IRS issued a ruling[2] that gave an example:
If an individual writes only one book as a sideline and never revises it, he would not be considered to be “regularly engaged in an occupation or profession,” and his royalties would not be considered net earnings from self-employment. However, where an individual prepares new editions of the book from time to time, and writes other books and materials, such activities reflect the conduct of a trade or business, the earnings of which would be subject to self-employment tax.
The bottom lines for racers:
- If you receive endorsements, royalties and prize money, make sure the agreements are specific and the source of the income is well documented.
- Be mindful that the various cities and states in which you compete may also be interested in the revenues you earn.
- Be mindful of the self-employment tax.
There were quite a few issues involved in the Goosen care. In the final decision by the court, he won a few and lost a few.
Just like racing….
Contact me an email at phil.schurrer.racingprof@gmail.com if you or your group would be interested in a detailed presentation about this topic or other tax and financial aspects of motor sports. I'd also be interested in any comments you have about the blog or suggestions for future topics
Until next time …
Phil Schurrer, CPA
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