Canada: Dishing Dimes And Not Turning Over Too Much (In Taxes)

Last Updated: April 10 2015
Article by Adam Scherer, BA, CPA, CA

"Why hasn't Toronto been a place that's attractive for free agents? Because you have to pay Uncle Sam and Queen Elizabeth in taxes."

- Jalen Rose, former Toronto Raptor, current NBA broadcaster.

We don't teach enough American history in school, we don't have ESPN on our televisions, and our taxes make it crippling for anyone to play here. These are just some of the excuses I have heard in my twenty years as a diehard Toronto Raptors fan, for what prevents us from fielding a competitive team.

While I can't comment on our education system or television broadcast regulations, I can weigh-in on the tax situation. In this article I will debunk some of the tax myths that are crippling enough to prevent Toronto's own NBA franchise from being competitive. (The 2014-2015 season notwithstanding!)

It is very easy for sports pundits like Mr. Rose to simply compare federal, provincial and state tax rates and sensationalize the differences. Those differences do make for great headlines. For example, in Ontario, the top combined federal and provincial tax rate is 49.53 per cent. By contrast, the U.S. federal tax rate is only 39.6 per cent. Coupled with the fact that some states, most notably Florida and Texas, have no state tax, that's a whopping 9.93 per cent difference in some instances.

So, when a certain point guard faced a decision last summer to re-sign with Toronto, or move to Miami or Houston to play for $12 million a season, did he have 1.2 million reasons per year to leave Toronto for greener pastures?

That's how it looks to a lot of people, but looks can be deceiving. Let's take a closer look at how basketball players are actually taxed in Canada.

To illustrate, assume that the point guard remains a non-resident of Canada and a resident of his home state, Pennsylvania. (Most players leave their families and belongings behind in the U.S. and come to Toronto only long enough to play out the basketball season. They then return home to the U.S. for the off-season.)

Canadian tax rules state that a non-resident is taxable in Canada if he is employed here - specifically, if he performs any of his duties in Canada. That means that any team player that plays games in Canada is subject to Canadian taxation, whether he is a member of the Cleveland Cavaliers or Toronto Raptors. Does that mean that Lebron and every NBA player that comes to the Air Canada Centre for one or two nights a year have tax bills to pay to the Canadian government? Happily for them, this is not the case. A tax treaty between Canada and the U.S. exempts players of U.S. teams from paying taxes on those games.

By the same token, a U.S. resident on a Canadian team who performs a portion of his duties outside of Canada would not be subject to Canadian taxation on those days. Therefore, a Raptors player does not pay any Canadian taxes on income he earns for games he plays outside of Canada - effectively, his road games.

The team carefully calculates duty days and monitors where all players perform their service. In the 2014 calendar year, Raptors players spent roughly 70 per cent of their time in Canada. Therefore, a U.S.-resident Raptor pays tax to Ontario and Canada on only 70 per cent of his total employment income.

The player receives credit for the taxes he paid to Canada when he files his U.S. return - so he avoids double taxation. Effectively, a Raptor player ends up paying the higher of the two tax rates between Canada and the United States (factoring in his U.S. state of residence) on his income.

The comparison of a player's tax burden between Canada and the United States does not stop with simple rates. Other significant factors come into play. Employees in Canada are also very restricted on the expenses they can claim against their income. This is not the case for athletes in the U.S., who can claim agent fees and training expenses as deductions against their income. Agent fees generally run at least three per cent of a player's income - potentially a big number! This further inflates the Canadian tax burden as compared to that of the United States.

But countering this effect is the United States' rising income tax rates. It was not long ago that the top federal tax rate was only 35 per cent. The U.S. now has a top federal rate of 39.6 per cent and a Medicare tax rate of 2.35 per cent. While Canada's social security costs (Canada Pension Plan and Employment Insurance premiums) are marginal and less than their corresponding taxes in the United States (Federal Insurance Contributions Act), there is no meaningful Canadian equivalent to the Medicare tax that exists in the United States. Further, an employee of a U.S. organization pays this Medicare tax on his entire income (including the other 30 per cent of his income). In addition, many U.S. states have their own tax regime. California, for example, has a top state tax of 13.3 per cent!

Ignoring contract restructuring and using all the variables described above, we computed the tax bill for the point guard on a $12 million per year contract. If you believe the rumours, the point guard had options to play for the Houston Rockets, the Miami Heat and the Los Angeles Lakers. We also analyzed what would have happened had he been traded to the New York Knicks.

To start off, no team in the NBA can compete with the tax advantages teams have in states where there are no personal taxes. The Raptors are no different. Our point guard is going to pay approximately $5.92 million in taxes and social security payments per year on his contract. For comparative purposes, had that player signed with the Rockets or Heat, he would have only paid $5.12 million in taxes and social security. That's a significant $800,000 difference in taxes alone. Fortunately for the Raptors, league rules allow teams to sign their current players for more money than any other team. Therefore, while the point guard may have been able to save some tax dollars by signing with a Florida or Texas based team, he may have had to take less money to do so.

However, what if that same point guard signed with the Lakers? In our example, he would have been slightly worse off financially. In that case, he would pay an additional $70,000 per year in taxes. What about that trade to New York that never happened? That trade would have resulted in a $5.86 million tax bill - a scant $63,000 savings compared to what he pays as a Raptor.

Jalen Rose isn't entirely wrong in his assessment; Florida, Texas and other states without state taxes are examples where large discrepancies still do exist. However, as illustrated above, these added tax costs for a player on the Raptors would be no different than if he played for the Lakers, Clippers, Kings, Warriors, Knicks or Nets.

Rising U.S. tax rates and steep Medicare costs have significantly narrowed the gap between Canadian and U.S. taxes for professional athletes. There may also be other ways for athletes to reduce their Canadian tax bills even further. This may involve restructuring their contracts to receive a signing bonus. Signing bonuses get significant preferential tax treatment under the tax treaty and can be taxed at a maximum 15 per cent Canadian tax rate. A simple signing bonus can drastically affect the overall taxes a Toronto Raptors player pays. Can we now begin to attract future free agents with the right tax advice and marketing? Can we structure our contracts to lower our tax rates to compare with, say, that of Oklahoma City and thereby attract new talent? Time will tell.

It is time to eliminate taxes as a potential reason for athletes to stay away from Canada. Current and future Toronto Raptors players should be able to focus on factors other than taxes when deciding to play here. We have a winning franchise, with a rabid #WeTheNorth fan base packing the Air Canada Centre all winter long; not to mention a beautiful city with a cultural and culinary scene that easily rivals that of any major American centre.

About the Author

Adam Scherer is a Partner in Crowe Soberman's Tax group.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Adam Scherer, BA, CPA, CA
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