“There is no fair market value of a baseball player.”
— Daniel R. Halem, Chief Legal Officer for Major League Baseball
“Baseball is like a poker game. Nobody wants to quit when he’s losing; nobody wants you to quit when you’re ahead.”
— Jackie Robinson
We’re now less than a week from opening day in Major League Baseball. And when we hit that day, everyone has hope, everyone is in first place, and everyone has dreams of playing in October. I’m a huge baseball fan, for reasons best stated by James Earl Jones in “Field of Dreams”: “The one constant through all the years has been baseball. America has rolled by like an army of steamrollers. It has been erased like a blackboard, rebuilt and erased again. But baseball has marked the time.”
If your team is lucky enough to still be in the hunt come July, you might find that they make a move before the trade deadline to better their roster and improve their chances of success in the postseason. Last year, the Cleveland Indians picked up outfielder Jay Bruce and pitcher Joe Smith.
There’s an inherent cost to doing that. Most of the players who a team trades for are established veterans with high dollar contracts. Making those trades means that teams are taking on extra payroll. But a (likely) unintended consequence of the new tax law (the “Tax Cuts and Jobs Act”) has arisen from a little-known change in the taxation of what is known as a “like kind exchange.”
In the business world, Section 1031 of the IRS code used to mean that you could trade “like” assets and not have to pay any tax on the swap. Perhaps it was mechanical supplies, farm equipment, or even real estate. The new tax bill made changes to that section. Now, the only property that qualifies as a “like kind exchange” is real property.
So, how does that affect your favorite baseball team? Recent pieces on the websites Fangraphs, Bleacher Report, and in The New York Times, used the world champion Houston Astros as an example. Last fall, the Astros acquired Detroit Tigers ace Justin Verlander, who was in the middle of a six-year, $162 million contract. They took on the massive responsibility of paying the rest of that contract, but because they gave up three players in return, they had a “like kind exchange” exemption from taxation.
Now, Major League Baseball is saying teams will be taxed on the asset they gain. But how is that asset valued? It’s not contract value, the league says, because the value rests in the player’s future performance. How do you value that to pay capital gains tax on it? The league says they’ve asked the IRS for guidance, but they have no idea.
Tax experts say the effect on professional sports was almost certainly inadvertent, and the league says that they will lobby for corrective legislation. Congress was intending to generate additional income, and the Joint Committee on Taxation says the “like kind exchange” provision will generate $31 billion over the next decade.
Another change in the tax bill will also have major impacts for millionaire athletes in free agency. Under pre-existing law, you could deduct state income taxes from your federal taxes. Under the new law, that deduction is capped at $10,000. That’s not likely a problem for you or me, but if you’re Clayton Kershaw of the Los Angeles Dodgers, who makes $203,704 for every one of his team’s 162 games, that’s a big deal. And it make be a huge free agency boon to teams in states like Texas and Washington, that have no state income tax. A player like Kershaw could be losing more than two million dollars by playing in California instead of Texas.
It’s immensely unlikely that the impact of these provisions on professional sports ever occurred to members of Congress. But intentional or not, it will be interesting to see the effect they have when the non-waiver trade deadline comes around in July.
And really, as long as Cleveland finally wins a World Series, it’ll all be ok.