clock menu more-arrow no yes mobile

Filed under:

On deferred money and the MLB luxury tax

Some info regarding how deferred money can reduce a team’s Competitive Balance Tax hit

Detroit Tigers v Los Angeles Angels Photo by John McCoy/Getty Images

The record contract between Shohei Ohtani and the Los Angeles Dodgers — reportedly 10 years, $700 million — has been widely reported to have extensive and unprecedented deferrals. This is due to the Competitive Balance Tax in the current Collective Bargaining Agreement — also referred to as the luxury tax — and the reported desire of Ohtani (and, of course, the team) to lessen the impact of the deal as it relates to the Dodgers’ potential CBT obligations.

This has led to some questions and discussions about how all of this works, and why a team would seemingly be able to get around the CBT by deferring money. Having dug around in this in order to post about this in the comments here on LSB, I figured I might as well make a full blown post about the issue.

To start with, let’s discuss the Collective Balance Tax. This is covered at length in the 2022-26 Collective Bargaining Agreement. The CBA as a whole is 442 pages, including Table of Contents and Appendices. Article XXIII of the CBA, which deals just with the Competitive Balance Tax, is 30 pages long.

XXIII(c) deals with “Determination of Actual Club Payroll.” Actual Club Payroll is defined in XXIII(c)(1) as consisting of four parts:

1 — a 1/30th share of Player Benefit Costs (defined in XXIII(d), but generally covering all the mandatory benefits all players receive and all teams must pay)

2 — a 1/30th share of the Pre-Arbitration Performance Bonus Program pool (which the CBA says is $1,666,666.67 per Club in each year from 2022-26)

3 — the sum of the yearly salaries attributable to players for the club that year

4 — “any other amount includible in or deductible from Actual Club Payroll,” which is a catch-all for other miscellaneous things that may not necessarily fall under #3

#1 and #2 are the same for every team, and #4 is going to generally be minimal. #3 — player salaries — is what is going to vary by team, and ultimately be the biggest determinant in whether a team is paying the CBT tax.

XXIII(E), entitled “Determination of Salary,” is what is used to set out how #3 is calculated. This, as one would expect, is fairly lengthy, running almost eight pages, and addressing issues such as how performance bonuses, option years, and the like are factored into that number.

There’s lots of interesting stuff in there, but what we care about is XXIII(E)(6), which deals with “Deferred Compensation.” Deferred compensation is defined in XXIII(E)(6)(a) as:

any Salary payable to a Player pursuant to a Uniform Player’s Contract in a Contract Year after the last championship season for which the Contract requires services as a baseball player to be rendered.

Okay, straightforward enough. If your contract for your 2023 salary provides for you to be paid some portion of that salary after the 2023 season is over, that portion is deferred compensation.

XXIII(E)(6)(b) deals with attribution of the deferred compensation. This section provides:

if the salary is deferred at an effective rate that is within one and one-half percentage points of the Imputed Loan Interest Rate for the first Contract Year covered by the Contract, then the Deferred Compensation shall be included at its stated value.

So that is straightforward enough. If you defer $10M of 2024 salary to a later date, but that $10M is accruing interest at a rate that is at the Imputed Loan Interest Rate, or within 1.5% either way, then for CBT purposes, that $10M in deferred salary is treated as if it were paid in 2024. It is $10M for CBT purposes, whether paid now or paid later.

What is the Imputed Loan Interest Rate, you may ask? As defined in XXIII(A)(4), Imputed Loan Interest Rate is “the annual ‘Federal mid-term rate’ as defined in Section 1274(d) of the Internal Revenue Code for the October preceding that Contract Year.” If we Google “Federal mid-term rate for October, 2023”, we see that the annual mid-term rate was 4.43%. Thus, if salary is being deferred at an interest rate between 2.93% and 5.93%, then for CBT purposes it is no different than if it isn’t being deferred, and deferring salary at those rates won’t help the team’s CBT situation. (Deferring at a higher rate than 5.93% would actually increase a team’s payroll for CBT purposes, rather than decreasing it, so teams presumably aren’t going to do that.)

So, now that we know that, what do we do if a contract has deferred compensation at a rate below that threshold? XXIII(E)(6)(b) goes on to say that, in that case:

the Deferred Compensation shall be included at its present value in the season to which it is attributed, said present value to be calculated by increasing any such payments by the Contract’s stated interest rate, if any, and then reducing such payments back to their present value by applying as a discount rate the Imputed Loan Interest Rate for the first Contract Year covered by the Contract.

To illustrate: let’s say that the Rangers sign J.D. Martinez to a 1 year, $20 million contract, with $10M to be deferred at 1% interest compounded annually until 2034. Under the CBA, you would figure in the amount of interest that would accrue over the next ten years — $1,046,220.00 — and add that to the $10,000,000 being deferred, which gives you $11,046,220. You would then calculate the present value of a $11,046,220 payment ten years from now, using a 4.43% discount rate. That comes up to a present value of just over $7 million.

Thus, for CBT payroll purposes, that 1 year, $20 million contract for Martinez would be treated as a 1 year, $17M (and some change) contract.

Which gets us to Ohtani and the Dodgers. Let us say, for discussion purposes, Ohtani’s $70M salary has $20M paid per year immediately, and the other $50M deferred for 20 years at 0% interest. Applying that 4.43% discount rate, for CBT purposes, that $50 million to be paid in 2044 is equivalent to just over $20M to be paid in 2024. And thus, for CBT purposes, Ohtani’s 2024 salary would be treated as a little over $40M, rather than $70M.

We will know more once the details come out in regards to the structure of the detail and the interest rate at which the salary is deferred, but I think it is clear that when the deal is calculated by MLB and the MLBPA, it will be much less than $700 million, with an AAV of much less than $70 million. Ohtani will be getting a lot less per year right now than he would with a traditional contract. But given that he’s making $40 million per year in endorsements, reportedly, deferring tens of millions in salary per year until after his playing days are over probably isn’t going to impact his lifestyle much.