The international athlete and entertainer: a summary of important U.S. tax considerations.

• Author: Bruno, Michael
• Position: Tax Law

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. person (1) 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) In 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, not-with-standing 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.

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