The International Athlete and Entertainer: A Summary of Important U.S. Tax Considerations
Justin Bieber, Manu Ginobili, Roger Federer, Shakira, the Beatles, just to name a few, are some of the most famous athletes and entertainers born outside of the U.S., but who have earned a substantial amount of income within the U.S. Athletes and entertainers face many of the same issues common to most nonresident aliens that either remain nonresident alien individuals or those who choose to relocate to the U.S. and become citizens or U.S. income tax residents. However, they differ from most of these individuals because of the types of income they earn, their extensive travel schedules, and the activities they conduct.
From a U.S. tax perspective, one of the key questions for international athletes and entertainers is whether to become a U.S. income tax resident, and, thus, subject to U.S. federal taxation on their worldwide income. In some cases, such classification is unavoidable. Each circumstance is unique, but as a general matter, avoiding U.S. tax residency status combined with competent international tax planning can save such individuals tens of millions of dollars over the course of a career.
This article discusses the U.S. federal tax implications of nonresident aliens who merely earn a portion of their income from U.S. sources and the implications of an individual who becomes a U.S. income tax resident and some of the methods to minimize U.S. federal tax exposure in such case. In either case, it is clear that international tax planning at the beginning of one’s career is critical.
U.S. Taxation of Athletes and Entertainers Who Remain Nonresident Aliens
In the context of U.S. federal income taxation, the distinction between an individual’s status as a U.S. person1 versus a nonresident alien is significant. The term “U.S. person” is a U.S. federal income tax concept and not a U.S. gift or estate tax concept. U.S. persons include both U.S. citizens (born or naturalized) and U.S. income tax residents.2 A non-U.S. citizen individual will be treated as a U.S. income tax resident during a calendar year if he or she meets one of the following requirements: 1) the individual is a green card holder; or 2) the individual meets the substantial presence test.3 I n contrast, an individual is a nonresident alien if he or she is neither a U.S. citizen nor a U.S. income tax resident.4
A U.S. person is subject to U.S. federal income tax on his or her worldwide income. Generally, this includes salaries, endorsement income, royalties, bonuses, dividends from U.S. and foreign companies, capital gains, and other forms of income. These types of income can be subject to federal income tax at rates up to 43.4 percent, which includes the recently enacted Net Investment Income Tax. For example, an actor who has recently become a U.S. person would be subject to U.S. federal taxation on income earned from acting work conducted in the U.S. and acting work conducted wholly outside the U.S. In contrast, a nonresident alien is subject to U.S. federal income tax only on certain types of U.S.-source income. For these purposes, U.S.-source income generally includes 1) income effectively connected to a U.S. trade or business, including gains from the sale of U.S. real property (ECI)5; and 2) certain types of passive income from U.S. sources that are not derived from a U.S. trade or business, such as dividends, rents, and interest (FDAP income).6
Most relevant to nonresident athletes and entertainers is ECI income, which could include U.S.-source service income and prize money. Nonresident aliens generally are not subject to U.S. tax on foreign earned prize money and endorsement income. ECI is generally taxed at graduated rates (currently a top marginal rate of 39.6 percent) for U.S. persons, and allowable deductions may be taken against such income. FDAP income is generally taxed at a flat rate of 30 percent (or a lower rate when the terms of a U.S. income tax treaty apply) and no deductions are allowed.7
U.S. Federal Taxation of Endorsement Income
Many, if not all, of the world’s top professional athletes and entertainers derive a substantial percentage of their annual income from endorsement contracts. For athletes, endorsement contracts come in two principal forms, some requiring the athlete to wear the sponsor’s apparel and use its products during performance (on-court or on-course contract); and others simply requiring the athlete to endorse a brand or product by allowing the sponsor to use the athlete’s name, image, fame, or likeness in its advertising (an off-court or off-course contract).
Most on-court endorsement contracts, either explicitly or implicitly, contain both a services component and a royalty component. Under the services component, the athlete is compensated for performing service days for the sponsor that might include testing new products or entertaining corporate executives. The royalty component consists of compensation for the sponsor’s right to use the athlete’s intellectual property, including his name, fame, image, and likeness in the sponsor’s advertising. The U.S. federal income tax of these two components can vary, in some cases drastically, depending on whether the taxpayer qualifies for the benefits of a U.S. income tax treaty.
For example, the U.S. generally taxes nonresident aliens on their services income to the extent such services are performed in the U.S. In contrast, if a U.S. income tax treaty applies, depending on the exact type of services performed, the taxpayer may not be subject to U.S. income tax, notwithstanding the fact such services are performed in the U.S. Similarly, nonresidents generally are taxable on their U.S.-source royalty income and, assuming such royalty income is not ECI, must pay withholding tax at a 30 percent rate. Whereas, if a U.S. income tax treaty applies, such withholding tax may be reduced, or in some cases, fully eliminated. The Goosen v. Commissioner, 136 T.C. 547 (2011), and Garcia v. Commissioner, 140 T.C. 141 (2013), cases, as discussed below, illustrate these points. Flushing out the components of an endorsement contract for U.S. federal tax purposes is an extremely important exercise before the contract is executed.
• U.S. Income Tax Treaty Benefits — To be entitled to the benefits of a U.S. income tax treaty, a taxpayer generally must meet a residency test and a limitation on benefits test (to the extent such treaty includes one). Assuming the taxpayer qualifies for benefits of the U.S. income tax treaty, U.S.-source endorsement income earned by the nonresident athlete or entertainer that is not attributable to a U.S. fixed base or permanent establishment is generally classified as royalties (in some treaties, art. 13), independent or dependent personal services income (in some treaties, art. 15 or 16), artistes and sportsman income (in some treaties, art. 18), or other income (in some treaties, art. 21).
For purposes of this article, we will refer to the U.S.-Netherlands Income Tax Treaty8 to provide a general overview of these articles, which are common in most U.S. income tax treaties. Art. 13 of the U.S.-Netherlands Treaty provides that royalties derived and beneficially owned by a resident of a foreign treaty country shall be taxable only in that treaty country. Therefore, if the taxpayer is a resident of the Netherlands and qualifies for benefits of the U.S.-Netherlands Treaty, the royalties may only be taxable in the Netherlands, absent the individual having a permanent establishment or fixed base in the U.S.
Art.15, which applies to independent personal services, provides that income derived by a resident of a treaty country partner in respect of the performance of personal services in an independent capacity shall be taxable only in the residence treaty country unless the individual has a fixed base regularly available to him in the source country for the purpose of performing his or her activities. If the individual has such a fixed base, then the portion of income attributable to that fixed base, which relates to such services performed, may be taxed in the other country.
To illustrate, if a Dutch resident tennis player qualifies for the benefits of the U.S.-Netherlands Treaty and has no fixed base in the U.S., money earned from signing autographs on his own account would likely not be taxable to him in the U.S. under art. 15. Art. 18, however, which is specifically applicable to athletes and entertainers, may also apply to income derived by the athlete or entertainer that relates to his or her personal activities as an athlete or entertainer. If art. 18 applies, then the income in question will be subject to tax in the source jurisdiction to the extent derived from his or her personal activities as an athlete or entertainer in that country.
In determining whether the income is subject to art. 18 or another article, such as art. 13, the controlling factor is whether the income in question is predominantly attributable to the performance itself or other activities or property rights. For example, income from awards or prize money from playing tennis would typically be covered by art. 18. In contrast, income that is not earned from playing tennis or not predominantly attributable to playing tennis should not be covered by art. 18.9
Any given endorsement contract may generate more than one category of income for treaty purposes. In allocating income from a single endorsement contract among the various categories of treaty income, the parties to the endorsement contract may consider comparable third-party contracts or other relevant valuation evidence to determine the appropriate value to assign to a particular component. Determining which article the income falls under is significant as it can affect whether the nonresident athlete or entertainer is taxable in the U.S. on such income and whether the sponsor is required to withhold on payments.
• Goosen and Garcia cases — As discussed above, Goosen10 and Garcia11 involved disputes between professional golfers Retief Goosen and Sergio Garcia, respectively, and the IRS on the characterization and apportionment of endorsement income between royalty and personal services income. In Garcia, the IRS further contended that the royalty income component was subject to the artistes and sportsmen article of the U.S.-Switzerland tax treaty, instead of the royalties article of the treaty. Unlike Garcia, a U.S. income tax treaty was not applicable in Goosen.
In both cases, the IRS asserted that the income received from worldwide endorsement agreements should be characterized as solely personal services income or predominantly all personal services income. In both cases, the taxpayers argued that the income received was primarily for the right to use their name and likeness. In Goosen, the Tax Court held, based on the record before it, that Goosen’s compensation for on-course endorsement contracts was 50 percent personal services income and 50 percent royalty income. Further, the Tax Court held that royalty income received from the on-course endorsement contracts was 50 percent U.S.-source income effectively connected with a U.S. trade or business and that he was not insulated from this result by the U.S.-U.K. Income Tax Treaty, which the court noted was inapplicable. Thus, the U.S.-sourced portion of Goosen’s endorsement income was subject to U.S. federal tax. This was a largely unfavorable tax result for Goosen.
In Garcia, TaylorMade Golf Co. held the right to use Sergio Garcia’s name, image, and voice in its advertising and marketing campaigns worldwide. Garcia also agreed to perform certain personal services for TaylorMade, including using the company’s products in his professional golf play, making personal appearances, and posing for TaylorMade. The parties to the endorsement agreed to allocate 85 percent of compensation from the endorsement agreement to royalties and 15 percent to personal service.
Rejecting the IRS’ contention that all of the TaylorMade endorsement income should be treated as service income, the Tax Court ruled that the payments for the use of the Garcia’s image rights in marketing and advertising campaigns and performance of personal services for using the sponsor’s golf products were allocable 65 percent to royalties and 35 percent to personal services. In reaching its decision, the Tax Court compared Goosen to Garcia, as golfers, and noted that Garcia was TaylorMade’s only global icon during the years at issue, and he was the centerpiece of TaylorMade’s marketing efforts, and the golfer whom TaylorMade used to build its brand. The Tax Court reasoned that Garcia’s status as a TaylorMade global icon, particularly to the extent TaylorMade used his image rights to sell its products, was strong evidence that his TaylorMade endorsement agreement was more heavily weighted toward image rights than Goosen’s. Further, because Garcia had a head-to-toe deal and was not required to complete additional service and personal appearance days, it appeared that Goosen was required to provide more personal services than Garcia. As such, the Tax Court ruled that Garcia’s endorsement agreement was more proportionally weighted to royalties than personal services.
After determining that 65 percent of the payment was attributable to royalties, the Tax Court analyzed whether the royalty income was subject to the royalties article or the artistes and sportsmen article of the U.S.-Swiss Tax Treaty. The Tax Court focused its determination on whether the income was predominantly attributable to Garcia’s performances or other activities or property rights. Disagreeing with the IRS’ view that the artistes and sportsmen article applied to the income, the Tax Court ruled that although Garcia’s golf play and personal services performed in the U.S. had some connection to his U.S.-image rights, the income from the use of such rights was not predominantly attributable to his performance as a golfer in the U.S. Instead, the image rights were a separate intangible that generated royalties described in paragraph 2 of the royalties article of the U.S.-Swiss Tax Treaty. Therefore, the U.S.-Swiss Tax Treaty fully eliminated the withholding tax that otherwise would have applied to the U.S.-source royalty component of the payment and, under the royalties article, such royalties were taxable only in Switzerland. Unlike Goosen, because Garcia qualified for the benefits of a U.S. income tax treaty, the royalty component of his endorsement income from TaylorMade was fully exempt from U.S. federal income tax.
Issues for Athletes and Entertainers Who Become U.S. Income Tax Residents
• Implications of Obtaining Visa, Green Card, or Citizenship — In contrast to nonresident individuals, U.S. persons are subject to U.S. federal income tax on their worldwide income.12 Because of the significant U.S. federal income tax savings that may be available to nonresident aliens, strong consideration should be made as to whether an individual should become a U.S. person.
• Substantial Presence Test (183-Day Test) — A U.S. person includes a U.S. citizen, a green card holder, and an individual who meets the substantial presence test. Subject to various exceptions, an individual meets the substantial presence test with respect to any calendar year the individual is present in the U.S. for at least 31 days and the number of days he or she is present in the U.S. for the current and prior two calendar years, pursuant to a formula equals or exceeds 183 days.13
An exception applies when a person who otherwise meets the substantial presence test may instead be treated as a nonresident alien if he or she has a closer connection to a foreign country. In general, to qualify for the closer connection exception, a person must be present in the U.S. for less than 183 days in the current year and can demonstrate that he or she has both a tax home in a foreign country and a closer connection to such foreign country than to the U.S. for the relevant year ( i.e. , has more significant contacts with the foreign country than with the U.S.).14
• Tax Treaty Residency — When a person is treated as a U.S. income tax resident and a tax resident of a foreign country, a treaty override to the substantial presence test may be available under an applicable income tax treaty negotiated by the U.S. with the foreign country, which would allow such person to be treated as an income tax resident of the foreign treaty partner country and a nonresident alien for U.S. federal income tax purposes.15 This exception, known as the treaty tie breaker rule, is generally only available for non-U.S. citizen individuals who are treated as U.S. income tax residents.16
An individual that qualifies as a tax resident of the foreign country under the treaty tie-breaker provision will be treated nonetheless as a U.S. income tax resident for all purposes of the Internal Revenue Code other than the computation of the taxpayer’s U.S. income tax liability. Generally, this means that other tax and information filing requirements of a U.S. income tax resident must be met ( e.g. , Form 5471, FBARs, etc.).
• Pre-immigration Planning — Certain actions should be considered prior to becoming a U.S. person to avoid unnecessary U.S. taxation on appreciated assets and previously earned but unpaid income.
• Increase Adjusted Basis in Appreciated Assets — If a nonresident alien owns valuable assets that have low historic cost bases, the sale of those appreciated assets after the individual becomes a U.S. income tax resident or U.S. citizen will be subject to U.S. federal income tax on the built-in gains, even though most or even all of the appreciation arose prior to the individual becoming a U.S. income tax resident or U.S. citizen. As such, the individual should consider certain transactions that will cause the individual’s adjusted tax basis to be increased to the fair market value of the appreciated assets immediately prior to becoming a U.S. income tax resident or U.S. citizen. When properly implemented, only the future appreciation in the value of the assets from the time of the basis step-up should be subject to U.S. federal income tax.
• Income Acceleration and Expense Deferral — It is often beneficial for nonresident aliens to maximize their amounts of gain recognition and income realization, prior to becoming a U.S. person. For instance, if the individual contemplates selling a particular appreciated asset in the near future, then he or she may want the sale to occur prior to becoming a U.S. person to ensure the built-in gains will not be subject to U.S. federal income tax. Similarly, if there is future income that the individual expects to receive and the individual can control the timing of its receipt, the individual should strive to accelerate the receipt of such income prior to becoming a U.S. person. Additionally, if the nonresident alien has otherwise deductible business expenses that he must incur (e.g., agent commissions), but the individual can delay the payment, it generally would be preferable to defer making payment until after the individual becomes a U.S. person so as to obtain the benefit of a U.S. income tax deduction with respect to that expense.
• Estate and Gift Tax Planning — Before analyzing pre-immigration U.S. estate and gift tax planning opportunities, it is important to understand certain implications of an individual’s citizenship or domicile. Unlike U.S. federal income tax, U.S. federal estate and gift tax is applied on the basis of an individual’s citizenship or domicile (instead of residence). On the one hand, a U.S. citizen or U.S. domiciliary17 is subject to the U.S. federal estate and gift tax, which is currently subject to a maximum federal rate of 40 percent, on the fair market value of his or her worldwide assets (wherever located throughout the world) that he transfers during life or at death. 18 On the other hand, individuals who are not considered domiciled in the U.S. are only subject to U.S. federal estate or gift tax on the value of their ownership interest in certain U.S. situs assets transferred during lifetime or upon death. U.S. citizens and U.S. domiciliaries are currently entitled to a $5,430,000 lifetime exemption;19 however, a non-U.S. domiciliary is only permitted to exclude the first $60,000 of his taxable U.S. situs property from the calculation of his or her U.S. federal estate tax. No similar exemption from U.S. federal gift tax exists for non-U.S. domiciliaries. Based on the foregoing, an individual with a large accumulation of wealth outside of the U.S. is incentivized to avoid becoming a U.S. citizen or U.S. domiciliary.
Once an individual becomes a U.S. domiciliary or U.S. citizen, the individual will become subject to the U.S. federal estate, gift, and/or generation-skipping transfer taxes.20 As such, it typically is in the individual’s best interest to complete as many gifts or irrevocable transfers into trusts (pursuant to an estate plan) prior to the individual becoming a U.S. domiciliary or U.S. citizen to ensure that such transfers will not be subject to the U.S. federal gift tax. Provided such gifts are made at the time the individual is not a U.S. domiciliary or citizen and are not of U.S. real property interests or tangible property located in the U.S. (e.g., certain artwork), such gifts will be outside the scope of the U.S. federal gift taxing jurisdiction and later avoid U.S. federal estate tax.
• Expatriation — Frequently, athletes and entertainers obtain U.S. citizenship or a green card but, later decide to return to their country of origin. In general, if an individual relinquishes his U.S. citizenship, or holds a green card for a certain number of years and then relinquishes the green card, he or she could be subject to a U.S. exit tax.21 S pecifically, the exit tax applies to an individual who either relinquishes his or her U.S. citizenship or green card after holding it in eight of the last 15 years,22 and who satisfies an average annual net income tax liability test, a net worth test, or is unable to certify that he or she has been compliant with U.S. federal tax laws for the previous five years (covered expatriate).23 A covered expatriate is treated as selling his or her assets for fair market value on the day before he or she expatriates and must recognize any gain on the deemed sale to the extent it exceeds $690,000 (as adjusted for inflation in 2015).24 The exit tax generally does not apply to individuals who were treated as U.S. persons solely by reason of meeting the substantial presence test.
U.S. federal income tax should be considered by professional athletes and entertainers as early in the individual’s career as possible, as the stakes are high and the careers often span 10 to 20 or more years. Regardless of whether the athlete or entertainer intends to remain a nonresident indefinitely or is considering becoming a U.S. income tax resident, discussing the issues raised in this article with qualified counsel is incredibly important. With proper planning, most non-U.S. athletes and entertainers can avoid unnecessarily large U.S. tax bills on endorsement income. Finally, for those athletes considering becoming U.S. income tax residents, it’s equally important to understand fully and appreciate the gravity of the U.S. federal tax consequences applicable to such change in residency status, even if for only a single year. Bottom line: seek qualified counsel and plan before you serve or tee-off, as foot-faults and bogeys are harder to overcome after the match is in full swing.
1 I.R.C. §7701(a)(30).
2 I.R.C. §7701(a)(30(A).
3 I.R.C. §7701(b)(1)(A).
4 I.R.C. §7701(b)(1)(B).
5 I.R.C. §871.
6 This includes interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income. See I.R.C. §871(a)(1)(A). FDAP Income typically is subject to a flat 30 percent withholding tax rate (absent an applicable U.S. income tax treaty), without allocable deductions, depending on the type of U.S.-source income.
7 I.R.C. §§871(a) and 1441.
8 The Convention Between the United States of America and the Kingdom of the Netherlands of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, entered into force on December 31, 1993 (the U.S.-Netherlands Treaty).
9 See Garcia, 140 T.C. 141.
10 Goosen, 136 T.C. 547.
11 Garcia, 140 T.C. 141.
12 I.R.C. §§865(a) and 871(a)(2). As a nonresident alien, capital gains generally are not subject to U.S. federal tax unless the nonresident alien is present in the U.S. for 183 days or more.
13 See I.R.C. §7701(b)(3)(A). The days are calculated as follows: the days present in the current calendar year, plus one-third of the number of days on which he or she was present in the U.S. during the preceding calendar year, plus one-sixth of the number of days on which he was present in the U.S. during the second preceding calendar year.
14 See I.R.C. §7701(b)(3)(B) (emphasis added).
15 See Treas. Reg. §301.7701(b)-7.
16 Although not every treaty is the same, the treaty tie-breaker rules for assigning residence generally provide that if an individual is a resident of both the U.S. and foreign treaty partner, then he or she shall be deemed to be a resident of the country in which he or she has a permanent home available to him or her; if he or she has a permanent home available to him or her in both states, he or she shall be deemed to be a resident of the country with which his or her personal and economic relations are closer ( i.e. , center of vital interests). If such a center of vital interest cannot be determined, or if he or she does not have a permanent home available to him or her in either country, residence is where the individual has a habitual abode. Generally, a habitual abode is the country where the individual spends most of his or her time. See Podd v. Comm’r, 76 T.C.M. 906 (1998). If the individual has a habitual abode in both countries or if he or she does not have a habitual abode available to him or her in either country, then residence is the country in which the individual is a national.
17 A domiciliary for U.S. federal estate and gift tax purposes is an individual who at the time of his death or when a gift is made had or has his domicile in the U.S. U.S. citizens are considered U.S. domiciliaries. U.S. domiciliaries may also include nonresident individuals. The determination of whether a nonresident individual is a domiciliary of the U.S. is subjective in nature, requiring an examination of the surrounding facts and circumstances. Specifically, to be a U.S. domiciliary requires the nonresident individual to be physically present in the U.S. with the intent to remain there indefinitely. See Treas. Reg. §25.2501-1(b); see also Estate of Jack v. U.S., 54 Fed. Cl. 590 (2002), citing Mitchell v. U.S., 88 U.S. 350.
18 See I.R.C. §§2501 (gift tax) and 2001 (estate tax).
19 See Rev. Proc. 2014-61.
20 The U.S. federal generation skipping transfer (GST) tax may also apply. When applicable GST tax would impose a similar tax on death or during life for taxable transfers made to persons who are two generations below the transferor ( e.g., grandchildren). See I.R.C. §2601 et. seq. The GST can also apply to non-U.S. domiciliaries; however, a special $1 million GST exemption may be available as an offset.
21 See I.R.C. §877A.
22 See I.R.C. §§877A(g)(3)(B); 7701(b)(6). A green card holder who has held a green card for the eight-out-of-15-year test above will be treated as expatriating for purposes of the exit tax if he or she makes a treaty tie breaker election.
23 See I.R.C. §§877(a)(2), 877A(g)(1), (2). For year 2015, an individual with average annual net income tax of more than $160,000 for the five taxable years ending before the date of the loss of U.S. citizenship or green card is a covered expatriate. See I.R.C. §877(a)(2)(A), modified by Rev. Proc. 2014-61. An individual with a net worth of $2 million or more is also a covered expatriate.
24 See I.R.C. §877A(a), modified by Rev. Proc. 2014-61.
Michael Bruno is an associate at Baker & McKenzie in Miami, where he focuses his practice on international and domestic tax planning for individuals and multinational businesses. He also advises athletes and entertainers on tax planning matters.
Steven Hadjilogiou is a partner at Baker & McKenzie in Miami, where he concentrates in the area of international tax planning for multinational businesses and individuals with respect to worldwide tax minimization, subpart F planning, treaty issues, general and international tax planning, and partnership taxation.
Robert H. Moore is a partner at Baker & McKenzie in Miami, where he has practiced international tax law for 11 years. He has represented numerous athletes and entertainers over the years, including cases before the U.S. Tax Court.
This column is submitted on behalf of the Tax Law Section, Cristin Conley Keane, chair, and Michael D. Miller and Benjamin Jablow, editors.