What Does Tax Free Mean?
We often hear agents use the term ‘tax free income’ when they discuss the opportunity to play in Europe or Asia, but what do they really mean and what are the tax implications?
First of all: There’s no such thing as ‘tax free.’ However, the way your income is reported and distributed may make it appear to be without tax. Here’s an example: In Canada and the United States, contracts and income are reported in gross dollars, while in Europe and Asia a player’s salary is reported in net dollars. So a contract in North America for $500,000 is not what ends up in your pocket after federal, state, social security, and Medicare taxes are deducted. But in Europe and Asia, a contract for $500,000 is what you receive after your team has paid all taxes, pensions, and even agent fees.
Be forewarned: even if you earn your money outside of North America, you still have to report your income. Although the U.S.’s personal income tax system is based on citizenship and Canada’s policy is based on residency, both countries require you to report all worldwide income on your income tax return.
The bad news: if you played in Europe or Asia, you’ll need to claim your full income. The good news: you’ll be able to deduct the portion of your income that went towards taxes, pension, and agent fees—and in many cases that deduction will offset your federal tax obligation.
What’s your tax liability?
If you’re a North American athlete, your tax liability on foreign income will be at the provincial and state level. If you’re from Canada (except Quebec), you report your provincial taxes with your federal return–and the two tax rates combined can be nearly 50%. Although Canada allows a foreign tax credit for the taxes your foreign employer paid on our behalf, the reality is that the taxes will rarely cover your federal and provincial tax obligation and you will likely end up owing taxes.
Three concerns for American athletes who play in other countries
If you live in the U.S., you should be concerned about three things:
Your resident state income tax liability. Unlike on your federal tax return, you can’t take a foreign tax credit on your state tax return. And with some state income tax rates being as high as 11%, you could be left with a substantial tax liability.
Many athletes earn an income that bumps them into the alternative minimum tax, which limits your ability to fully claim all of your foreign tax credits and could create a tax liability.
The US government may attempt to subject your foreign income to a 15.3% self employment tax because your foreign employer does not withhold US Social Security and Medicare taxes.
How to limit your tax liability Here are a few things you can do to limit your potential tax liability:
If you’re Canadian, try to establish residency in your team’s country. The Canadian system is based on residency, so if you live in a different country, you don’t have to claim your world-wide income in Canada. The country has rules on who is and is not a resident of Canada, so be sure you understand the criteria to be sure to avoid having to report foreign income on your Canadian income tax return.
If you’re a U.S. citizen, you’re not as lucky. In the U.S., taxation is based on citizenship rather than residency, so establishing residency in a foreign land creates potential issues of double taxation. But in most cases—except for those who are affected by the alternative minimum tax–the foreign tax credit will eliminate your foreign tax liability and filing a return is nothing more than documenting your income and subtracting the foreign tax credit from the potential tax.
Something else to consider: establish your residency in one of the nine states in America that don’t tax income.
The United States has Totalization Agreements with 24 foreign countries. If you work in one of these countries, you may avoid US self employment tax if you establish an exemption under the country’s system. To do so, you’ll need your foreign employer to request a certificate of coverage from the government in your team’s region.
I know this is all pretty complicated stuff. But knowledge can save you money at tax time. So if you would like more information about foreign income tax issues, or clarification of the information presented here, please contact me at 585-705-3405.
ALAN POGROSZEWSKI is an Assistant Professor of Sports Studies at St. John Fisher College and the President of his own tax consulting business whose clientele include professional athletes performing services on three separate continents. Prior to accepting his position at St. John Fisher College, Mr. Pogroszewski was the Vice President of Business Operations for Sports Consulting Group, a firm that specializes in the representation of professional hockey players. Mr. Pogroszewski received his M.B.A. from Rochester Institute of Technology in 1996 and his M.S. in Taxation from St. John Fisher in 2003
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