When Jeff Fried, the agent for former University of Maryland basketball star Steve Francis, sat down to begin contract negotiations with the Vancouver Grizzlies last week, the sides quickly resolved the salary issue. Francis, the No. 2 overall pick in last month's NBA draft, will receive $9.741 million over three years. Then Fried and General Manager Stu Jackson tackled the thorniest issue: structuring the deal in order to neutralize Canada's higher rate of personal income taxes.
Since the Reagan administration slashed the top rate for federal personal income tax from 50 percent to 39.6 percent in 1983, pro athletes in major league baseball, the NBA and the NHL have balked at playing for Canadian teams because of the higher tax rate and lesser value of the Canadian dollar. But helped by provisions of a U.S.-Canada tax treaty targeted at equalizing the tax impact for U.S. athletes who play in Canada, NBA rookies such as Francis and free agents signing new contracts can reduce the difference in tax liability to virtually nothing with good tax planning.
"It really doesn't affect American players that much if they have the right people making proper arrangements and doing their taxes," Francis said recently.
Players for Canadian NHL and major league baseball teams also can equalize their taxes like NBA players. But baseball, unlike the NBA, operates without a salary cap, and does not always structure contracts specifically to equalize Canadian taxes, said players' union executive Gene Orza.
"They negotiate salaries that take into account the additional taxes [their clients] would pay," he said.
Hockey and baseball players virtually always receive their paychecks in U.S. dollars, although unlike the NBA, their labor agreements do not mandate it.
When Fried, a lawyer and accountant, started researching the tax issue after the draft, he thought that playing for a Canadian team could cost Francis 8 percent of his salary, or about $780,000 over three years. Homework done, he now says: "We're feeling more and more confident that the effective tax rate Steve will be paying will be the same as if he were playing" for a U.S. team.
Fried said he expects to have the deal finished in a few weeks, with Francis receiving some of his money on an accelerated basis and some of it on a deferred basis.
U.S. citizens are required to pay taxes on income they earn anywhere in the world. But they also are allowed to receive a credit up to the top U.S. rate for any taxes they pay to a foreign government. The effective rate of income taxes--provincial and national--in British Columbia is about 53 percent, compared with the top U.S. federal rate of 39.6. State tax rates vary in the United States, with California the highest and New York next; seven states--including Florida, Texas and Washington--have no personal income taxes.
As part of a U.S.-Canada tax treaty, money earned in Canada by U.S. residents is taxed in the country in which the work is performed. About 65 percent of Francis's salary will be taxed at Canadian rates, the rest at U.S. rates, based on a formula that uses days spent in Canada either playing games or practicing. (It does Francis no good to reduce his Canadian tax liability below the top U.S. rate, because he would owe the difference to the Internal Revenue Service.)
Here's how Fried can average down his client's effective Canadian personal income tax rate to reach the U.S. rate, according to NBA team executives in Canada and tax experts in both countries:
Defer about $750,000 of Francis's salary annually into a Retirement Compensation Arrangement, known as an RCA, according to Noah Croom, the Grizzlies' general counsel and assistant general manager. Under this seldom-used device--it has no tax advantage for Canadians--the money, after taxes are withheld, is placed into a trust account. After Francis leaves Canada as a player, the withheld taxes are refunded to him, and the entire sum is subject only to U.S. taxes.
Negotiate for Francis to receive his annual salary in one or two lump-sum payments, giving him use of the money for a longer period of time and allowing him to earn additional income through conservative, tax-free investments in the United States. Croom said the Grizzlies would be amenable to an accelerated payment schedule. Tax-free interest income effectively could help offset the impact of the Canadian taxes by at least two percentage points. Under the standard player contract, NBA salaries are paid every 15 days during the season or in 26 equal installments, depending on the player's wishes.
As part of the NBA's new labor agreement, the Grizzlies have an option to keep Francis for a fourth year, at a salary of $4.385 million. Then they have the right either to match any offer Francis receives when he becomes a free agent or sign him to an extension during the fourth season. At that time, Francis would be eligible to negotiate a signing bonus as a free agent. Signing bonuses are rare among U.S.-based NBA teams because, unlike the NFL, long-term contracts are almost always guaranteed. But, in a 1984 provision of the U.S.-Canada treaty, Canada taxes signing bonuses at only 15 percent.
George Mavrikis, Chevy Chase-based agent for Vancouver forward Michael Smith, said a signing bonus between 20 and 25 percent of a player's salary and paid over six seasons would negate the Canadian tax bite.
There was some early confusion on the Canadian tax issue when the NBA's first Canadian teams began play in 1995. Now, Raptors General Manager Glen Grunwald said "people are becoming educated" through the efforts of the two teams to publicize efforts by the league, the players' union, the two teams and the two governments to overcome the tax disadvantages related to Americans playing for Canadian teams.
"It's not like we have a tax haven here," Grunwald said. "But it's no worse than playing for a U.S. team."
That, however, is not totally true for an NBA player who is traded from a U.S. team to either Toronto or Vancouver. Such a player is stuck with the existing terms of his contract. The rookie-friendly RCA and the signing bonus for free agents are available only before a contract is signed.
One NBA player in that predicament is center-forward Kevin Willis, traded to the Raptors by the Houston Rockets prior to last season. Willis was particularly impacted because he was playing in a state without a personal income tax. His agent, Steven Woods, has been quoted as saying that Willis will pay nearly $300,000 more taxes in Canada this season on his $2.76 million salary. His contract expires after this season.
Even living in Maryland, a state that collects personal income taxes, Vancouver's Michael Smith and Tony Massenburg, both of whom were obtained by the Grizzlies in trades with U.S. teams, will lose substantial portions of their salaries to Canadian taxes.
Dick Davies, a financial services expert at McLean-based Advantage International, said the firm's only Canadian client (which the players association lists as Massenburg) would lose $80,000 to $100,000 of a million-dollar salary this season. Massenburg, a former University of Maryland player who lives in Prince George's County during the offseason, declined through Davies to be interviewed.
When asked how the difference in tax affects Smith's take-home pay, Mavrikis said, "Greatly." His salary for the 1999-2000 season, the final year of a contract signed before Sacramento traded the former Dunbar High All-Met to the Grizzlies in early 1998, is listed in union data as $2.44 million. Based on an example given by Mavrikis for a player making $2 million in base salary, Smith's tax bite--in addition to what he would pay were he playing for a U.S. team--this season should be $120,000 to $150,000.
The higher taxes are somewhat offset by a lower cost of living. Smith, whose permanent home is in Greenbelt, lives during the season in an 18th floor, two-bedroom luxury apartment overlooking the Vancouver inlet. He pays the equivalent of about $2,000 U.S. a month for it, Mavrikis said.
"The only bad thing to me about Canada is the taxes," Smith said. "It's a good thing they can't [double] tax you in both places. If they could, I'd be broke."