United States: Did Sergio Garcia Lose In Match Play With The IRS?

One of the most recognizable names in professional golf—although not the most winning name, having never won a major golf tournament—is Sergio Garcia. He is especially known for his tree shots, the latest of which was a one-handed backward shot from a tree that he climbed to get to his ball in the Arnold Palmer Invitational. More recently, Garcia made news in losing his match play with the IRS. But did he lose?


On his 2003 and 2004 Forms 1040NR, U.S. Nonresident Alien Income Tax Return, Garcia, a U.S. nonresident (he resides in Switzerland), reported 15% of his income from a TaylorMade Golf Co. endorsement agreement as U.S.-source personal service income and the remaining 85% as royalty income for the use of his name, image, and likeness, which is not subject to U.S. taxation under the Switzerland-U.S. tax treaty. When it audited Garcia's returns, the IRS treated 100% of the income as personal service income in accordance with its published position that all endorsement income of a professional athlete is from personal services (see ITA 199938031 and AM2009-005). In turn, deficiency notices in the amounts of $930,248 and $789,518, respectively, were issued, and Garcia filed a Tax Court petition contesting the deficiencies.

On March 14, 2013, the Tax Court held that 35% of the income paid under the TaylorMade endorsement agreement should be characterized as personal service income and the remaining 65% should be treated as royalty income, not subject to U.S. taxation under the Switzerland-U.S. tax treaty (Garcia, 140 T.C. No. 6 (2013)). This is the second time in two years that the Tax Court in very similar cases involving nonresident professional golfers has rejected the IRS position that all income under an endorsement agreement is personal service income (see Goosen, 136 T.C. 547 (2011)).

In 2002, Garcia signed a seven-year endorsement agreement with TaylorMade, under which he became a TaylorMade Global Icon. Under the endorsement agreement, Garcia was required to use, on and off the course, TaylorMade products such as clothing, shoes, gloves, golf clubs, bags, and golf balls. In addition, TaylorMade was given the right to use Garcia's image, likeness, signature, and voice to promote its products. Further, Garcia was required to play in at least 20 professional golf events each year, provide at least 12 personal service and appearance days for the company, and act in a courteous and professional manner.

The initial endorsement agreement did not allocate the compensation between personal service and royalty income, but upon a subsequent amendment a year later, TaylorMade and Garcia agreed that 15% of the compensation was for Garcia's personal services and 85% was for Garcia's image and likeness.

U.S. taxation of nonresident athletes

The delineation between personal service compensation and royalty income is important because of the difference in treatment under the Switzerland-U.S. tax treaty. Generally, nonresident aliens are taxed by the United States only if they are engaged in a U.S. trade or business. For these purposes, the performance of personal services within the United States by a nonresident alien is considered the conduct of a trade or business in the United States. Consequently, income that a nonresident athlete receives as salary, fees, compensation, bonuses, and prize money for performances in the United States is subject to U.S. taxation as income from a U.S. trade or business. The personal service income is taxed at the same graduated rates that apply to U.S. citizens. In addition, if the nonresident athlete receives royalty income connected with the performance of services in the United States, the royalty income is subject to U.S. taxation the same as personal service income.

Only U.S.-source income is subject to U.S. taxation. It is important to determine the character of the income that a foreign athlete is paid since personal service income and royalty income are sourced differently. Personal service income is sourced where the services are performed. Royalty income, on the other hand, is sourced where the property is used or where the privilege of being used is granted.

Royalty income received by a foreign athlete that is not effectively connected with the athlete's performance of personal services in the United States is subject to a flat 30% withholding tax or a lower treaty rate. Under the Switzerland-U.S. tax treaty, only the foreign athlete's country of residence is entitled to tax royalty income. This is what Garcia was relying on to avoid U.S. taxation on the TaylorMade royalty income.

Tax Court opinion

The Tax Court rejected both Garcia's 15/85 and the IRS's 100/0 allocations between personal service income and royalty income, since neither reflected the true intent of the TaylorMade agreement. Finding that Garcia and TaylorMade were not adverse parties, the Tax Court first rejected Garcia's argument that the TaylorMade agreement setting forth a 15/85 allocation was controlling. The testimony of TaylorMade's CEO that the allocation was irrelevant undermined Garcia's argument. At the same time, in response to the IRS's 100% personal service income argument, the Tax Court determined that the TaylorMade agreement was not intended to compensate Garcia only for his personal services. Since Garcia's on-course success did not support the level of his endorsement income, the Tax Court found that TaylorMade must be paying Garcia for his image, likeness, etc. rather than his golf game. Finally, the Tax Court disagreed with the conclusions of both the IRS's and Garcia's experts, but did rely on some of their analytical points in arriving at its conclusions.


This left the Tax Court with the two Tax Court cases dealing with the allocation of endorsement income between personal service income and royalty income. In Kramer, 80 T.C. 768 (1983), a retired professional tennis player was entitled to a certain percentage of net income from the sale of tennis equipment with his name. Under those facts, the Tax Court determined that a 30/70 split was appropriate. The Tax Court distinguished Kramer given the age of the case and its different facts. The Kramer court had held that the 70% royalty income was justified on the basis that, since Kramer was retired and not playing competitive tennis, he was being paid mostly for his image.


The Tax Court then turned to the rationale it used in Goosen, 136 T.C. 547 (2011), where it determined that a 50/50 allocation was appropriate. Because Garcia was a bigger star than Goosen, TaylorMade used Garcia's image rights more than Goosen's, TaylorMade selected Garcia as its sole "Global Icon" while Goosen was only a brand ambassador, and Goosen was required to use TaylorMade products more than Garcia was, the Tax Court found that more of Garcia's contract should be allocated to royalty rights than the Goosen contract. In breaking down an endorsement contract between personal services and royalties, the Tax Court weighed the use of endorsed products during professional play very heavily. Since Goosen had to use TaylorMade products more than Garcia did (Goosen was required to use TaylorMade's products in 31 tournaments a year, while Garcia was required to use them in 20 tournaments a year), the Tax Court allocated a lesser percentage to personal service income for Garcia than it did for Goosen.

Switzerland-U.S. tax treaty

Garcia was not home free yet. To avoid U.S. taxation on the royalty income for his image rights, Garcia argued that the Royalties article of the Switzerland-U.S. tax treaty applied. Under that article, royalties received by a resident of a country, here Switzerland, are taxed only in that country, regardless of whether the royalties are attributable to personal services performed in a different country. The IRS argued that the Artistes and Sportsmen article of the treaty overrode the Royalties article. Under the Artistes and Sportsmen article, royalties are taxable in the country in which the personal activities to which they are attributable are performed. Thus, the decisive factor was whether Garcia's income was predominantly attributable to the personal services performed in the United States.

The Tax Court found that, although Garcia's golf play and personal services performed in the United States had some connection to his image and likeness, the income from the sale of his image and likeness was not predominantly attributable to his performance in the United States. Consequently, the Royalties article of the treaty was the applicable article, and the royalty income was not taxable by the United States.


While the Garcia case may look like a defeat for Garcia since he had argued that only 15% of the endorsement income was for personal services, it is a clear victory over the position of the IRS that 100% of the endorsement income of a nonresident professional athlete should be characterized as personal service income. Clearly, the lesson of the Goosen and Garcia cases is the more marketable an athlete's name, the more likely that fees are being paid for the athlete's image rather than the athlete's performance and skill.

Thomas R. Wechter, J.D., LL.M. (Tax), is a partner with Duane Morris LLP in the Chicago office and concentrates his practice in tax planning for individuals, corporations, and partnerships and in tax controversy matters in front of the IRS and before the Tax Court, U.S. Court of Federal Claims, and the district courts.

Previously published in the AICPA Tax Insider

This article is for general information and does not include full legal analysis of the matters presented. It should not be construed or relied upon as legal advice or legal opinion on any specific facts or circumstances. The description of the results of any specific case or transaction contained herein does not mean or suggest that similar results can or could be obtained in any other matter. Each legal matter should be considered to be unique and subject to varying results. The invitation to contact the authors or attorneys in our firm is not a solicitation to provide professional services and should not be construed as a statement as to any availability to perform legal services in any jurisdiction in which such attorney is not permitted to practice.

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