Facts:

In December $2023,$ major league baseball player Shohei Ohtani signed a record $$700$ million ten year contract with the Los Angeles Dodgers. Remarkably, rather than taking the payments evenly split over a ten year period $($a common compensation structure for professional athletes$),$ he structured the deal to receive $$2$ million per year for the first $10$ years and then $$68$ million per year over the second $10$ years starting in $2034,$ supposedly to allow him to avoid state taxes in California on a majority of the contract if he moves out of California after the initial $10$ years.

Calculations:

Calculate the after$-$tax NPV of Ohtani$$s total expected compensation under several different scenarios below.

Hints and assumptions:

You can assume that his federal tax rate is $37\%$ and don$$t forget state income taxes $($CA state tax rate is $14\mathrm{.}4\%).$ You can ignore the progressive tax rates and just do calculations using the top marginal rates I have given you.

You can ignore itemized or standard deductions for tax purposes.

Use a discount rate of $5\%.$ Remember your formula for the present value of a lump sum:

Annual pmt$/(1+$discount rate$)^$years in the future

And excel formula for the present value of annual annuity payments.

$=$ Pv$($discount rate,years,$-$Annual pmt$,0,0).$ You can use the google sheet for PV calcs.

Also remember that when figuring NPV$,$ you should use the after$-$tax amount as the starting point to discount back to present time.

You can ignore the $$jock$$ tax, which is tax that he will have to pay to other states as a result of playing games outside of his home state.

Scenario $1-$ standard contract for professional athletes

Calculate the after$-$tax NPV of his total expected compensation of $$700$ million if he had structured the payments evenly over a $10$ year period $($$$70$ million per year$).$

Scenario $2-$ Ohtani$$s actual contract structure

Calculate the after$-$tax NPV of his total expected compensation of $$700$ million using the actual payment structure. He receives $$2$M per year for the first $10$ years and then receives $$68$M per year over the subsequent $10$ years $($years $11$ through $20).$ From an NPV standpoint, how does the ATCF of this contract compare to what you calculated in the standard contract?

Scenario $3-$ State tax planning

News outlets speculated that the deal was done to save money on state taxes. If he moves outside of California to a zero$-$tax state after the initial $10$ year period, the bulk of his compensation $($$$680$M$)$ might escape California$$s state tax.

Calculate the after$-$tax NPV of his compensation assuming he receives $$2$M per year for the first $10$ years that is taxed in California and then receives $$68$M per year over the subsequent $10$ years $($years $11$ through $20)$ that is not taxed by California $($you can assume a $0\%$ tax rate$).$

What is the NPV of the tax savings compared to scenario $2?$

Is he better off in Scenario $3$ compared to scenario $1($the standard $10$ year contract$)$ as a result of the state tax savings?

Scenario $4-$ comparable contracts

Ohtani$$s contract is by far the highest contract in major league baseball history. The contracts of the next most highly paid players in recent years were in the $$400-500$M range. Calculate the after$-$tax NPV of his total compensation assuming he had instead received $$460$ million paid evenly over a $10$ year period.

Discuss as a class:

What insights can you gain from this case as far as:

What are the benefits of deferred compensation for sports teams or companies in general? What are the costs and risks to the employee?

If a taxpayer receives income from more than one state, how can we use jurisdictional tax planning to reduce overall taxes?

What should an employee think about as far as negotiating compensation levels if they are taking more deferred compensation?