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Monday, June 24th, 2013 at 11:51 am  |  no responses

Understanding The New Luxury Tax System

Learn about the CBA’s crucial financial terms right here.

by Leo Sepkowitz | @LeoSepkowitz

Salary Cap: For the ’12-13 season, the salary cap is a shade over $58 million. This number changes every season, and it’s slated to be $58.5 million for the ’13-14 season.

Cap Room: This is how far under the salary cap a team’s payroll is. The number dictates how much a team can spend on free agents who they don’t own the Bird Rights of. (Bird Rights grant teams the ability to go over the salary cap to re-sign their own guy.)

Tax Line: The tax line for the ’12-13 season is about $70.3 million. If a team’s payroll is over the tax line, they have to pay luxury taxes. So if a team is over the ~$58 million salary cap but under the $70.3 million tax line, they’re not in the luxury tax. This number usually increases slightly from year-to-year.

Luxury Tax: How much money teams are required to pay the League based on how far over the tax line they are. Under the old CBA, teams would pay $1 to the League in taxes for every $1 they were over the tax line. The CBA changed this system. Here’s a helpful chart to see what the changes are, courtesy of the NBAFAQ. This stuff will make more sense in a second.

Non-Repeater Tax: It’s good to be a non-repeater. This doesn’t come into play until the ’14-15 season. It will apply to teams that were under the luxury tax for at least one of the three previous seasons, but are over the tax line in ’14-15. In ’15-16 and beyond, it will also apply to teams that were under the luxury tax for zero, one or two of the previous four seasons. As you can see, these taxes are steeper than the $1-$1 ratio in the old CBA, but are much less harsh than Repeater Tax penalties (more on this soon).

Repeater Tax: It’s bad to be a repeater. This does not apply for the ’13-14 season. In ’14-15, it will apply to luxury tax payers that were also over the tax for each of the prior three years. In ’15-16 and beyond, it will apply to teams that paid the luxury tax in at least three of the previous four seasons. As you can see in the chart, Repeater Tax penalties are more serious than Non-Repeater Tax penalties.

Incremental Maximum: If a team is, say, $14 million over the tax line, it will pay taxes on that $14 million. But rather than multiplying the $14 million by the tax rate in its range ($2.50 for a non-repeater, $3.50 for a repeater in this case), the tax is incremental. For each $5 million over the tax, the penalty grows steeper.

Calculating Non-Repeater Taxes: First, subtract the tax line ($70.3 million this year) from a team’s payroll to find out how far over the tax line they are. For this example, let’s use an imaginary team—the Seattle SuperSonics—with an $84.3 million payroll. The Sonics would be $14M above the tax line, which means they have to pay taxes on “only” that $14 million.

Add up the two incremental maximums for the $0-4,999,999 and $5,000,000-9,999,999 ranges because they’re on the way to $14 million. $7.5M + $8.75M = $16.25M. Then, take the remaining $4M not covered in those ranges, and multiply it by the $10,000,000-14,999,999 non-repeater tax rate ($2.50 for every dollar over the tax), because that’s where the original $14 million falls. $4 million x 2.5 = $10 million. Add that to the incremental rates we calculated three sentences ago ($16.25 million), and you get the total luxury tax number: $26.25 million. So under the new CBA, a non-repeater $14 million over the tax line pays $26.25 million in taxes. Under the old CBA, they would have paid $14 million in taxes.

Calculating Repeater Taxes: We’ll use the same Sonics example here, except now let’s pretend that they’re Repeater Tax payers, meaning this is at least the year 2015, and the Sonics also paid the luxury tax the prior three seasons (or, if we’re in 2016, they’ve paid the tax in at least three of the prior four years). Again, they’re $14M over the luxury tax. Time to whip out the calculator once again, and use the same paragraph you read a minute ago, only with different numbers, since now we’re dealing with Repeater Taxes.

Add up the two incremental maximums for the $0-4,999,999 and $5,000,000-9,999,999 ranges because they’re on the way to $14 million. $12.5 million + $13.75 million = $26.25 million. Then, take the remaining $4 million not covered in those ranges, and multiply it by the $10,000,000-14,999,999 repeater tax rate ($3.50 for every dollar over the tax), because that’s where the original $14 million falls. $4 million x 3.5 = $14 million. Add that to the incremental rates we calculated three sentences ago ($26.25 million), and you get the total luxury tax number: $40.25 million. So under the new CBA, a repeater $14 million over the tax line pays $40.25 million in taxes. Under the old CBA, they would have paid $14 million in taxes.

Cap Holds: Cap holds aren’t directly related to the luxury tax, but they’re very important when it comes to calculating how much money each team has available to spend during the offseason. Here are three key types of cap holds.

1. If a team has a to-be free agent whose contract for the prior season was worth $7 million, for example, they don’t get the $7 million off their books immediately. To get the cap relief, the team must renounce the player and give up his Bird Rights, which allow the team to go over the salary cap to re-sign him. Until they renenounce the player, there is a cap hold for the player. The worth of the cap hold varies based on how long the player has been in the League and how much he was paid in the prior season, but it’s at least the value of his previous year’s salary.

2. If, for example, the Sonics had four players on their roster at one point during the offseason, their payroll wouldn’t only be the combined salaries of the four players. They automatically have cap holds worth the veteran minimum tacked onto their payroll until the roster is filled to 12 players, but, of course, they don’t actually sign any players to those contracts. So, in this example, the Sonics would have eight such cap holds. Similarly, a team with zero players under contract wouldn’t have a payroll of $0, and its available cap space wouldn’t be the full $58.5 million. For each roster spot available, the team is charged $480,180—the rookie minimum.

It’s worth noting that if a team has a cap hold for, say, an unrestricted free agent who they haven’t renounced, that counts as a used roster spot, even though the player isn’t under his old contract or a new one. Similarly, each first-round draft pick a team owns for the upcoming Draft counts as a used roster spot, even if the draft hasn’t happened yet. Speaking of…

3. There are cap holds for each first-round pick a team owns before the Draft. Essentially, the League is assuming the team will pay that first-round pick a certain amount, so money is added onto their payroll before the Draft actually happens and they negotiate real contracts with rookies. The rookie scale can be seen here.

h/t to Larry Coon for making the CBA understandable.

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