With Dwight Howard’s recent move to Houston it has become the new hot topic and catch phrase to talk about states without personal income tax. However, it is not as simple as sports networks and analysts would like you to believe. In 2012 the highest California tax bracket was 12.3%, which leads many non-tax professionals to guess that on a $88 million contract Dwight Howard would pay $10.8 million in state taxes if he chose to play for the Lakers. On the other hand, many people believe he would pay zero taxes if he signed a contract to play in Texas where there is no state income tax. If true, this could be a major consideration in deciding which team to choose. However, there are several major factors this does not take into account.
- Dwight Howard has been said to live in California. In order to get out from under the taxing jurisdiction of California he would have to make Texas his tax home. California does not easily relinquish this taxing right and it would take more than simply playing basketball games in Houston to for Dwight not to be taxable in California. As you will see, even if Dwight successfully moves his tax home to Texas there are still other considerations that close the gap.
- Personal services, such as playing basketball, are taxed in the state where they are earned. Every time Dwight plays a basketball game in a state that has personal income tax he will be required to file a state return for that state and pay tax. California has a very high tax rate, but any tax at all paid to other states lessens the benefit of living in Texas. If Dwight lived in California, when he paid these taxes to other states he would get a credit on his California return so that he would never pay higher than the California rate. This makes it an additional tax in Texas he would not have in California.
- California, similar to the IRS, has tax brackets and does not tax all income at the same rate. See our previous article, Tax Fact: The Misconception of Being “Pushed Into a Higher Tax Bracket,” for more information on how this system works. In short, for 2012 California taxpayers paid an effective tax rate of roughly 9.7% on the first $1 million of TAXABLE income. Which leads to the next point.
- The contract we read about Dwight signing is his gross income. It does not account for deductions or other tax items that factor into his final taxable income. The taxable income amount could be significantly less than his salary because of other situations. Review your own tax return and you will see that taxable income very rarely equals your salary. Therefore, when determining the tax effects of California you have to consider the effective tax rate and cannot simply multiply the highest tax rate by the amount of the contract.
Overall, clearly Dwight Howard will pay less in taxes if he becomes a resident of Texas and plays for the Rockets as opposed to living in California and playing for the Lakers. However, it is not as clear how wide this gap will be when you take into account all the factors. Also of note, had Dwight chosen to stay in Orlando he might not only have saved his image, but Florida, like Texas, is also a state without a personal income tax.
Do not take tax advice from sports professionals. Contact us at Hone Maxwell LLP with your tax questions and follow us on twitter @HMLLPTax or facebook at www.facebook.com/HoneMaxwellLLP for more tax tips and the latest updates on tax news.