The Billion-Dollar Question: Are Deferred Compensation Contracts In The MLB Legal, Or Have The Dodgers Broken Baseball?

The Los Angeles Dodgers leveraged deferred compensation contracts to gain $241.44 million in player value for 2026 while paying half that amount. With two World Series in the last four years and another bid this year, this strategy seems to be paying off. But then why aren't more teams using it? This article breaks down the risks and benefits for players and teams using deferred compensation.

No MLB team has used deferred compensation contracts more than the Dodgers, with the next closest team being over $800 million behind. In recent years, the Dodgers have garnered the most headlines for this type of compensation structure. But nothing the Dodgers are doing is improper or unusual—in fact, it is regularly used in the corporate employment world. And it has a history in the MLB.

It has been reported that Ted Williams accepted a deferred compensation contract back in the 1950s. Bobby Bonilla is famously getting paid $1.19 million by the Mets every July 1 until 2035. The Dodgers, however, have used the practice on a bigger scale in recent years. Here is a rough breakdown of current deferred compensation contracts for rostered Dodgers players, not accounting for variants like opt-outs and signing bonuses:

Sports contracts are ultimately just performance employment contracts. While the numbers are eye-popping compared to normal employment agreements, professional athletes' contractual negotiations with their employer, the MLB team, face the same regulations, risks and benefits as any employment contract.

Employment contracts in general are governed by state contract law, and federal and state labor, employment, and tax law. In the MLB context, another consideration is the collective bargaining agreement (CBA) between the 30 MLB clubs and the MLB Players Association—the governing "law" of the MLB.

How does deferred compensation work?

At the federal level, compensation generally is governed by the Internal Revenue Code, (also called the Code). Compensation is generally taxed in the year it is constructively received. Code 404, however, "creates a special set of tax rules to govern deferred compensation."

Deferred compensation, under these regulations, falls under two categories: qualified deferred compensation plans and non-qualified plans. Both carry varying degrees of legal requirements and tax benefits.

Qualified deferred compensation plans include 401(k) and 403(b) retirement plans and pensions. These plans are controlled by both the Code and the Employee Retirement Income Security Act (ERISA). Under ERISA, employers are required to run the plan solely in the best interests of plan participants and beneficiaries. Under the Code, money put into the plan (contributions) and money taken out of the plan (distributions) are subject to certain restrictions.

The Dodgers use nonqualified plans, which are far less regulated. This grants more freedom to the parties but comes with more risks. These plans are essentially written agreements made between an employer and an employee wherein the employer withholds the employee's pay until a later date.

Though generally not subject to ERISA and the Code's strict contribution and distribution limitations, nonqualified deferred compensation plans must meet the requirements in Code Section 409A. And they must be subject to the risk of company creditors and employer bankruptcy.

Section 409A doesn't have many limitations, but if the few it does have aren't met, it carries a heavy tax penalty. The main limitations in Section 409A are two-fold:

1. "you cannot speed up the time or form of the payment of your deferred compensation."
2. "you cannot slow down, or delay, the time or form of the payment of your deferred compensation."

Payment is only permitted upon certain events: death, disability, an unforeseeable emergency, separation from service and change in control, or at a specified time or pursuant to a fixed schedule.

Failure to comply with Section 409A can lead to deferred compensation being counted as income in the current year. That increased gross income will then be taxed at 20%, plus interest. For reference, if Ohtani breaches Section 409A after five years with the Dodgers, then Ohtani would be immediately responsible for 20% of his $340 million current contract value ($68 million/year). That's $68 million in tax penalties, plus interest.

There are a few exceptions to Section 409A restrictions, including what is known as a short-term deferral.

To qualify for the short-term deferral exception, the payment must be required and actually made "on or before the 15th day of the third month following the end of the employee's tax year or the employer's tax year, whichever is later, in which the right to the payment vests." Put another way, the payment must be made when there is no longer "a substantial risk of forfeiture."

In sports contracts, non-guaranteed compensation contracts often qualify as short-term deferrals. For example, if the Dodgers agree to pay a player $500,000 if he plays for the Dodgers until 2030, then the right to the payment vests at the end of 2030. The deferred compensation is considered subject to a substantial risk of forfeiture until 2030, because the player will not get any of the $500,000 if he leaves the Dodgers before 2030. Under the short-term deferral exception, if the Dodgers pay all the $500,000 before March 15, 2031, the compensation will not be subject to 409A. Another example would be compensation tied to meeting a performance metric, like hitting a predetermined amount of home runs or pitching a no-hitter.

So under relevant federal tax law, absent some unforeseen breach of 409A, the Dodgers' practice of deferred compensation contracts is entirely legal.

Does the MLB's collective bargaining agreement regulate how teams pay players?

The CBA controls terms and requirements for the MLB's deferred compensation contracts. Article XVI of the CBA specifically provides for deferred compensation, notably with no limits. The CBA requires the club to fully fund "the present value of the total deferred compensation obligation," but it gives clubs a two-year grace period before having to front the funds. Fully funded means "the current present value of the then outstanding deferred payments, discounted by 5% annually." That 5% discount rate can be negotiated later by the player and club based on the stock market fluctuations. The discount is based on the assumption that the club will invest 95% of the amount, and that it will grow by at least 5% to equal the full deferred amount by the final distribution date.

The CBA gives clubs freedom to invest the 95% as they see fit, provided that the amount is earmarked for the player and remains rather liquid. A player's agreement may provide otherwise or require with more specificity how that money is put aside. Unless a player's contract provides otherwise, a club may fully fund the deferred compensation amount "in such manner as it elects." The funds are also "subject to the claims of the club's general creditors." The CBA outlines various compliance measures for the Player's Association to monitor the club's funding obligations.

Use Ohtani again as a general example. He deferred about $68 million annually, which means that the Dodgers need only put up 95% of that amount: roughly $64,600,000. Using these estimates, Ohtani's contract alone frees up $3.4 million in cash for the Dodgers to move around, on top of the two-year grace period the Dodgers can take into account. Likewise, there is no restriction in the CBA saying the Dodgers cannot make more than 5% return on the invested $64,600,000, as long as Ohtani gets his annual valuation of $68 million at the end of the term.

It's worth emphasizing what a club can do with an extra $3.4 million. While it might be dwarfed by Ohtani's record-setting $70 million per year salary, most MLB contracts are nowhere near that high. For example, future hall of famer pitcher Clayton Kershaw resigned last year with the Dodgers for $7.5 million in 2025. Almost half of Kershaw's salary alone can be covered by the money saved on Ohtani's deferred salary. As a further illustration, the $3.4 million saved might seem trivial compared to the Dodgers' total payroll of $303,851,665, composing roughly 1.12%. But when compared to the payroll of the lowest payroll team, the Marlins at $43,630,000, that $3.4 million goes much further (roughly 7.79%).

Ohtani benefits, too. He probably has more control over tax payments. While the specific terms of the contract are not public, Ohtani will have to pay taxes on the deferred compensation based on the payment date provided in his contract. To avoid having to pay tax on the entire $680 million in one year, the contract likely provides that the $680 million is paid in installment or on a fixed schedule (e.g., monthly, quarterly, yearly). All the while, he and the Dodgers can invest and earn interest on that deferred amount. On top of that, with the extra cash in the clubs' hands, Ohtani and any other stars who decide to live on less salary (plus endorsement deals) hope that their teams will be able to structure spending to guarantee more championships.

Given the protections provided by the CBA, it seems like a win-win for clubs and players. The clubs are in better control of immediate finances, and still have to put aside most of the deferred compensation today. The players have assurance that the money is earmarked for their benefit, and barring their team going bankrupt, can access the full fund at the end of the term.

Do the Dodgers have a competitive edge by using deferred compensation contracts?

The Dodgers have been one of the most, if not the most, successful franchises in the last 10 years. How much of that success is due to the use of deferred compensation contracts? Likely none.

First, any club and player can utilize the freedom provided by deferred compensation, not just the extremely wealthy. In fact, smaller market teams might consider it a competitive equalizer to free up immediate cash to pursue bigger stars.

Second, the use of deferred compensation does not have a material effect on the competitive balance tax, also called the luxury tax. The CBA calculates the deferred salary into the total annual amount for luxury tax purposes. A club's luxury tax is levied if the club's "actual club payroll" exceeds the "base tax threshold." The actual club payroll includes deferred compensation costs as part of players' "average annual value."

Therefore, the clubs using deferred compensation contracts do not avoid luxury tax responsibility for the current annual value of that deferred compensation. In other words, the MLB still calculated Ohtani's $68 million deferred value into the Dodgers' actual club payroll when determining its luxury tax under CBA Article XXIII.

What does this mean for other MLB teams?

While the practice of deferred compensation contracts is not new to the sports world or the corporate employment world, the Dodgers have seemingly perfected the tactic, using it to create financial flexibility and increase their competitive ability in baseball. Considering the freedoms provided by the Internal Revenue Code for unqualified deferred compensation contracts, other teams might benefit from emulating the Dodgers' strategy.

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.