Are The Capitals Getting 15 Mil Extra Cap for next 7 Years?

[NorthCoast]

How much of an impact on real cap dollars are front-loaded bonus laden contracts having?

This question came up in respects to the value of a front-loaded contract for Karlsson from SJ vs a non-front-loaded contract from Ott. It was an interesting deep dive and so I have expanded the research to look at the impact of these contracts on the capitals for the business forum.

How do Front-Loaded Contracts Impact Cap

1) Taxes. In most states salary that is considered "bonus" is taxed at a lower rate than normal income. In Washington DC, the first million of bonus is taxed at 25% vs. 37% for normal income tax.

2) Interest. Assuming that a player invests any advances (salary paid above cap hit), and receives a standard 7% return from the markets, then they will benefit from interest that they would not have received had the salary matched their yearly cap hit.

Should the extra money players receive from the above be considered additional cap dollars?

For sure this is a bit of an over simplification, but I though it was worth discussing because if a team took this practice to the extreme (every player paid in bonus with front-loaded structure) then it could have a pretty significant impact on actual cap dollars to spend.

Below I attempted to draw out the implication for the Caps based on the players that have these contracts in place. Using this method it would appear as if the caps will get an additional 14.6 million in cap over the next 7 years, or about 2.1 extra per year.

Capture — Postimage.org

I imagine that there are errors in the methodology so please feel free to provide feedback on the semantics, but regardless of the exact percentages, I can't imagine it not having an impact.

Thoughts?

Click to read more...

 

[yukoner88]

So..........penalize a team for having smart management of their cap hits?

 

[mouser]

1) Taxes. In most states salary that is considered "bonus" is taxed at a lower rate than normal income. In Washington DC, the first million of bonus is taxed at 25% vs. 37% for normal income tax.

Some comments:

- I think you're talking federal taxes here, not state taxes. My understanding is most states treat signing bonuses as regular income. So there would be no difference in state or local tax treatment.

- You can't apply 7% to the full amount of advances that are subject to withholding.

- Some of the amounts you're categorizing as advances are paid out through the year in salary, thus you're not going to get a full year of interest on them.

- Salary is subject to escrow, so the players aren't getting all their salary on the defined regular season schedule.

- Interest is taxable.

 

[LadyStanley]

San Jose's GM Doug Wilson usually gives "equal weight" contracts out, not front loaded. (IIRC he's given one non-equal contract, and that was increasing in value, by like $500k/year.)

So should EK65 re-sign, it may be a moot point.

 

[boredguy]

According to CapFriendly Evander Kane, Brent Burns, Martin Jones and Logan Couture's extension are all front loaded to various degrees. Doug Wilson may have been opposed to it before but he's fine with front loading now.

 

[DeltaSwede]

So..........penalize a team for having smart management of their cap hits?

The "Loungo" rule was made long after the Canucks and Roberto Luongo agreed to their contract - front loaded, good on the cap hit.

Canucks will potentially be penalized for something that was within the rules when it was drawn up.

 

[NorthCoast]

Some comments:

1. - I think you're talking federal taxes here, not state taxes. My understanding is most states treat signing bonuses as regular income. So there would be no difference in state or local tax treatment
2. - You can't apply 7% to the full amount of advances that are subject to withholding.
3. - Some of the amounts you're categorising as advances are paid out through the year in salary, thus you're not going to get a full year of interest on them.
4. - Salary is subject to escrow, so the players aren't getting all their salary on the defined regular season schedule.
5. - Interest is taxable.

Huge thanks for the great feedback and taking the time. Really appreciate it.

Took a quick one hour shot at it and definitely missed some of the tax details.

So based on your feedback and some more research, I am probably a year ahead in the interest earnings because of escrow, payment schedules, etc. And my bonus tax rate was off as you stated. Looking at a few states it looks like that add on another 10%, bringing the rate to 35%, which is pretty much the same as the standard tax rate for states with no separate income tax. However, most states charge some local income tax and so their is still a benefit of being paid in bonus vs standard income, especially if you live in say California or Ontario. (Ontario caps bonus out at 30% vs. 53% standard income tax).

So in most of the US it would make a difference, but not a huge difference.

However, In Canada it Might be a HUGE Difference

Again, the original context was how much value to Karlsson would a front-loaded-bonus contract be (ie: Tavares) vs. a flat 11 mil per year.

So I applied my math, with corrections, to Tavares contract, and wow.

edit: note that the advance row is cumulative, so interest is only accumulating on the original advance.

I know that Tavares accountant will find all kinds of tax loopholes and such to bring the actual rates down regardless, but you can't help but wonder how much of the above played into the fact that the entire contract is pretty much a bonus payment. Also might explain why Canadian tax rates were likely not a factor for T.O. when trying to land Tavares. Teams in California can offer similar value, while teams in Florida wouldn't have much impact.

Again, hope someone can pick this apart and fix any errors. I don't care if i'm wrong so long as your right

 

[NorthCoast]

According to CapFriendly Evander Kane, Brent Burns, Martin Jones and Logan Couture's extension are all front loaded to various degrees. Doug Wilson may have been opposed to it before but he's fine with front loading now.

See my new post above. IF I am correct, the tax difference between Bonus vs. Normal salary in California could be 35% vs. 53%...I would ask for my $$$ in bonus as well.

 

[Burke the Legend]

So..........penalize a team for having smart management of their cap hits?

There's two main benefits of the cap:
1- cost certainty. Owners love this

2- parity. Fans in smaller marlet teams love it. Probably healthier for the league's overallpresentation.

Regardless of how clever the teams are being, teh net result of leveraging tax advantages like that is that it's chipping away at the principle concept of parity. I don't know what the breaking point is, but at a certain point maybe a block of owners from higher tax jurisdictions begin to raise the issue.

 

[Liebo]

According to CapFriendly Evander Kane, Brent Burns, Martin Jones and Logan Couture's extension are all front loaded to various degrees. Doug Wilson may have been opposed to it before but he's fine with front loading now.

Just to chime in on the Sharks in particular, the signing bonuses for three of those players--Kane, Burns, and Jones--may have more to do with the potential of a work stoppage at the end of the current CBA. More and more players, particularly those with more bargaining power, are seeing that the NHL may have some or all of the 2020-21 season wiped out. To protect themselves, they are asking for less of that season's payout as salary and more as a signing bonus. Consider:

Jones will earn a base of $6M this season and next, with a $750K bonus each year. In 20-21, his base drops to $4.5M with a $1.5M bonus.
Kane is more extreme. His base of $6M for each of the next two years drops to $3M in 20-21, with a $3M signing bonus. It appears in his case, that represented a bit of compromise, because that season is also his lowest total compensation, at $6M.
Burns, whose contract pays him a total (base + signing bonus) of $10M each season for the first four years of his deal, is getting $2M base and $8M bonus in 20-21. His total contract has $27M in base pay and $37M in signing bonuses.

To your point, though, all of those deals are front-loaded to an extent. That presents a risk as it relates to cap recapture, especially for Burns, but they can probably circumvent recapture by citing an injury and putting him on LTIR.

Now, as to the OP, there's a reason players love signing bonus-heavy contracts and teams are loathe to include them: buyouts. By my understanding, the savings a team gets from a buyout is based entirely on the base salary, not the cap hit. To use the contract Tavares just signed as an example, his cap hit is $11M, but every season after this, his base salary is just $910K. If (for some reason) Toronto ever wanted to buy out Tavares, they wouldn't calculate the savings on his $11M cap hit, just the $910K base salary. Saving $300K or $600K on an $11M cap hit is barely worth the trouble, making his contract buyout-proof. If the Dallas Stars wanted to buy out Jamie Benn, slated for a cap hit of $9.5M through 24-25, after the 19-20 season, they'd save a whopping $444K a year.

Of course, stars like Tavares and Benn aren't likely to face a buyout. But even lesser players are looking for contract security with signing bonuses. Ryan O'Reilly's contract is almost 87% signing bonus, and Milan Lucic's deal was over 50% signing bonus--and they were signed a few years ago. Heck, even Matt Martin's deal was 65% signing bonus.

So to the original point, players love signing bonuses, but I doubt it's because they get one big check each year, some interest income, and potential tax savings. Those are nice, but the signing bonus is leverage against a buyout, and guaranteed income in case of said buyout. And for that reason, teams aren't big fans of the signing bonus.

 

[NorthCoast]

Just to chime in on the Sharks in particular, the signing bonuses for three of those players--Kane, Burns, and Jones--may have more to do with the potential of a work stoppage at the end of the current CBA. More and more players, particularly those with more bargaining power, are seeing that the NHL may have some or all of the 2020-21 season wiped out. To protect themselves, they are asking for less of that season's payout as salary and more as a signing bonus. Consider:

Jones will earn a base of $6M this season and next, with a $750K bonus each year. In 20-21, his base drops to $4.5M with a $1.5M bonus.
Kane is more extreme. His base of $6M for each of the next two years drops to $3M in 20-21, with a $3M signing bonus. It appears in his case, that represented a bit of compromise, because that season is also his lowest total compensation, at $6M.
Burns, whose contract pays him a total (base + signing bonus) of $10M each season for the first four years of his deal, is getting $2M base and $8M bonus in 20-21. His total contract has $27M in base pay and $37M in signing bonuses.

To your point, though, all of those deals are front-loaded to an extent. That presents a risk as it relates to cap recapture, especially for Burns, but they can probably circumvent recapture by citing an injury and putting him on LTIR.

Now, as to the OP, there's a reason players love signing bonus-heavy contracts and teams are loathe to include them: buyouts. By my understanding, the savings a team gets from a buyout is based entirely on the base salary, not the cap hit. To use the contract Tavares just signed as an example, his cap hit is $11M, but every season after this, his base salary is just $910K. If (for some reason) Toronto ever wanted to buy out Tavares, they wouldn't calculate the savings on his $11M cap hit, just the $910K base salary. Saving $300K or $600K on an $11M cap hit is barely worth the trouble, making his contract buyout-proof. If the Dallas Stars wanted to buy out Jamie Benn, slated for a cap hit of $9.5M through 24-25, after the 19-20 season, they'd save a whopping $444K a year.

Of course, stars like Tavares and Benn aren't likely to face a buyout. But even lesser players are looking for contract security with signing bonuses. Ryan O'Reilly's contract is almost 87% signing bonus, and Milan Lucic's deal was over 50% signing bonus--and they were signed a few years ago. Heck, even Matt Martin's deal was 65% signing bonus.

So to the original point, players love signing bonuses, but I doubt it's because they get one big check each year, some interest income, and potential tax savings. Those are nice, but the signing bonus is leverage against a buyout, and guaranteed income in case of said buyout. And for that reason, teams aren't big fans of the signing bonus.

Great points. For sure the lockout protection is a big one at this time.

Apparently there is a tax angle, but not exactly the way I thought.

John Tavares Could Save Nearly $12 Million In Taxes On His New Contract

Whatever the reason(s), it's not being done for nothing, and it's definitely a big advantage for the larger clubs.

 

[mouser]

Great points. For sure the lockout protection is a big one at this time.

Apparently there is a tax angle, but not exactly the way I thought.

John Tavares Could Save Nearly $12 Million In Taxes On His New Contract

Whatever the reason(s), it's not being done for nothing, and it's definitely a big advantage for the larger clubs.

There are a number of different tax angles. The most important take away is anyone trying to compare different team markets by simply using the nominal tax rate is going to end up with a flawed conclusion.