Taxation of Nonresident Athletes and Entertainers
Caplin & Drysdale
Taxation of Nonresident Athletes and Entertainers

Fore! The U.S. Internal Revenue Service recently released a Memorandum (July 2, 2009, AM2009-005), which draws a bead on nonresident golf and tennis professionals and their income from endorsement activities. The agency now proposes to tax all the net endorsement income at graduated tax rates, because it is mainly from performing "personal services". (The top rate is currently 35%, but it is set to go to 39.6% after 2010.) This means the IRS will challenge athletes that report these fees as royalty income at lower withholding tax rates. The notional withholding rate is 30%, but tax treaties typically eliminate or reduce it to between 0% and 15%. 

These conclusions are based upon the agency's interpretation of tax laws about on-course and on-court endorsement contracts, common in the golf and tennis business. The IRS Chief Counsel comes to these key conclusions on two types of endorsement income based on the typical endorsement contract: 

Athlete Retainer Fees. The sponsor is retaining the golfer predominately to perform personal services. The incremental value to the athlete for granting the right to use the name or likeness on a stand-alone basis apart from the services is viewed by the IRS as "de minimis". Further, Articles 16 (Entertainers and Sportsmen) and 7 (Business Profits) of the Model Income Tax Convention will apply to on-course and off-course contracts making the personal service income taxable at graduated rates rather than as royalties. 

Ranking and Replacement Bonuses. These bonuses will be characterized by the IRS as income from personal services. They are bonuses paid for personal activities and will fall under Article 16 of the Model Tax Convention as income derived by a sportsman.

Though Chief Counsel's opinion is not the final legal word on the matter, these conclusions represent published IRS policy and it is prudent to assume the tax agency will aggressively assert them in an audit and, if necessary, in court.

Prepare for an Audit. Speaking of audits, the IRS in October 2007 announced a Compliance Initiative to improve tax reporting and compliance by nonresident athletes and entertainers performing in the U.S. The initiative first focuses on high income golf, tennis and music performers. This means the IRS has –

  • Earmarked more compliance and enforcement resources to these groups;
  • Agents attending golf and tennis events to gather endorsement activity data; and
  • Already launched large-scale audits of nonresident active and retired tennis players assessing millions of dollars in back taxes, interest and penalties.

Bottom line: For those in the three targeted groups, it's best to plan and prepare for an audit.

Staying Out of the Rough. Some tax practitioners are already predicting nonresident athletes will test the IRS's conclusions and vigorously litigate them. But why not consider some new thinking to avoid confrontation and controversy? Note that the IRS legal memorandum addresses typical industry contracts, leaving room for skillful golfers to sink a backdoor putt against the Taxman.

Outlined below are a few planning ideas that might help keep you in the fairway:

  • Allocate part of the contract payments to the athlete's name and likeness;
  • Separate endorsement contracts for each country where the athlete performs;
  • Use contract language that de-emphasizes the term "personal services" and accentuates the sponsors' use and value of the athlete's name and likeness;
  • Link some of the fees and bonuses to the sales of sponsors' products; and
  • Creative use and structuring of offshore entities, including minimization of the impact of anti- "loan-out" rules in some of the tax treaties.

Customized Tax Advice. Caplin & Drysdale is well-equipped to provide sophisticated tax counsel to nonresident athletes and entertainers. The information here is general in nature and is not meant to provide definitive tax advice. Since each athlete's situation is unique, sound tax advice will always be tailored to the client's factual circumstances and the applicable tax laws (tax treaties often differ among countries).

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