Tax planning for cross-border endorsement payments to professional U.S. athletes.

• Author: Rubinger, Jeffrey L.

Since the 1930s, companies have used endorsements by high-profile athletes to increase their sales. As a result, top professional athletes routinely secure multi-million dollar endorsement deals for lending their names or images to products. In fact, the practice has become so competitive that more than 20 percent of the top 100 world's highest paid athletes have endorsement deals that significantly exceed their salaries and winnings. (1) These athletes primarily include professional golfers, tennis players, race car drivers, and track and field stars.

In a recent Tax Court case, Garcia v. Commissioner, 140 T.C. No. 6 (2013), the court reallocated the compensation received by professional golfer Sergio Garcia pursuant to an endorsement contract 65 percent to royalty income and 35 percent to personal services income. In doing so, the Tax Court rejected the allocation agreed to by the parties under the endorsement contract, which provided that 85 percent of the income was to be allocated to royalties and the remaining 15 percent to services. The allocation was critical because the Tax Court held that the royalties were exempt from U.S. withholding tax under the U.S.-Switzerland income tax treaty, while the compensation for services was taxable in the United States at graduated U.S. tax rates. (2)

In 2011, the Tax Court in Goosen v. Commissioner, 136 T.C. No. 27 (2011), held that income received under an endorsement contract by professional golfer Retief Goosen was properly allocated 50 percent to royalty income and 50 percent to services income. The Tax Court also held that a portion of the royalty income from "on-course" endorsement contracts was U.S.-source income effectively connected with a U.S. trade or business and, thus, subject to U.S. federal income tax at graduated tax rates. In addition, the Tax Court determined that the U.S.-source royalties from "off-course" endorsement contracts were subject to a 30 percent U.S. withholding tax because the taxpayer was not eligible for the benefits of the U.S.-U.K. Income Tax Treaty.

These cases illustrate that the most important factors the IRS and courts will consider in determining the appropriate tax treatment of income earned by a non-U.S. athlete under an endorsement contract are 1) the character of the income (i.e., services, royalties, or some other category); 2) the allocation of the income between the respective categories; and 3) the source of any royalty income. The character of the endorsement income depends on what the sponsor is actually paying for. If the endorsement contract indicates the sponsor is paying the taxpayer to make promotional appearances or to film commercials, for example, it is clear that a portion of the income should be classified as services. If the athlete is simply required to wear the sponsor's logo, and the endorsement income is unrelated to the athlete's performance in tournaments or other events, then a portion of the income should be classified as royalties.

Once the character of the income is determined, the income is allocated among the different income categories. As noted above, it is generally more advantageous for a non-U.S. taxpayer to allocate as much income as possible to royalties, as long as the taxpayer is eligible for the benefits of a U.S. income tax treaty that reduces or exempts the withholding tax on royalties. However, as illustrated in the Goosen and Garcia cases, in order to support an allocation that is weighted more heavily toward royalties, it is important to show that the athlete is being compensated primarily for the use of his or her name, reputation, and image, as opposed to tournament performance, ranking, or number of promotional appearances. Finally, to determine the source of any royalty income earned by the taxpayer, it is necessary to examine factors such as where the taxpayer's name and likeness are used, and where the products that the taxpayer is endorsing are sold.

Relevance to U.S. Athletes with Non-U.S. Endorsement Contracts

Given the number of high-profile, non-U.S. athletes that have signed lucrative endorsement contracts with U.S. companies and who are performing in the United States, the Garcia and Goosen cases are crucial in analyzing how the IRS and courts will attempt to allocate the endorsement income between royalties, services, or some other category of income, if relevant under an applicable U.S. income tax treaty. As discussed in this article, however, these cases also may be helpful in minimizing the worldwide income tax liability of professional U.S. athletes who have endorsement contracts with non-U.S. companies and who make appearances outside the United States.

It is becoming more common for professional U.S. athletes, NBA basketball players in particular, to sign multi-million dollar endorsement contracts with non-U.S. shoe companies in countries such as China. (3) The issue in such situations is whether it is possible for a U.S. athlete to defer paying U.S. federal income tax on any of the non-U.S. source income earned under such an endorsement contract. (4)

For example, assume a professional U.S. basketball player is considering signing a multi-million dollar endorsement contract with a Chinese shoe company. Instead of signing the contract directly, the taxpayer...