May 28th 2013
By Teresa Ambord
What tax rate do you pay for being cool? The IRS and the Tax Court disagree. Celebrities who have marketable personas can be paid a bundle by companies who want to be associated with them. Athletic stars with big personalities and untarnished images can make far more by lending those images to major companies than they can by actually performing well at their chosen sports.
But how is endorsement income taxed? This is where the IRS and the Tax Court have parted ways. The IRS discounts the importance of image, claiming such stars should be paying ordinary income tax rates, but the Tax Court, it seems, is no longer buying that line.
Take a look at two recent Tax Court cases – Garcia v. Commissioner and Goosen v. Commissioner. The conclusions of the court could have far-reaching implications in future cases for people who land fat endorsement contracts.
The most recent case is Sergio Garcia, also known as "El Nino." Forbes magazine refers to Garcia as a "fiery and skillful Spaniard." Way back in 1999, he came out of nowhere and gave Tiger Woods a run for his money, though in the end, he came in second. In the fourteen years since then, he still hasn't won a major championship. But that didn't stop golf giant TaylorMade from signing him to a seven-year contract that made him the poster boy for all things TaylorMade. The deal made him the only golfer ever to hold the title of "TaylorMade Global Icon."
As such, Garcia could only use TaylorMade products, plus he gave the company the right to use his image, likeness, signature, voice, and other symbols related to him. He was the centerpiece of TaylorMade's marketing strategy, but he was more than just a pretty face. He also had to actually perform as a golfer. He had to play in twenty or more events each year, make personal appearances, avoid legal trouble, and never touch performance-enhancing drugs. For that, he was paid handsomely.
Tee Off Time with the IRS
When it came time to file his nonresident tax returns, Garcia characterized his income according an amendment to his original contract (the original contract didn't seek to characterize the income) – 15 percent for personal services and 85 percent royalty income from endorsements. He used these percentages to pay his nonresident federal income tax. On the personal services income, he paid ordinary tax rates.
Royalty income received by a foreign athlete is taxed at 30 percent, assuming it isn't strongly connected to the athlete's personal services in the United States. However, because Garcia is a resident of Switzerland, he's able to escape US taxes on his royalty income altogether, thanks to the existence of a US–Switzerland tax treaty. That treaty maintains only the foreign athlete's country of residence may tax royalty income. And this is where the IRS disagreed.
According to the tax agency, 100 percent of Garcia's income should've been taxed at ordinary rates. Based on this assertion, for income relating to 2003, he was slapped with a tax deficiency for $930,248, and for 2004, another $789,518. And off to court they went.
Fortunately for Garcia, his case was influenced by another similar case that was settled in 2011, Goosen v. Commissioner. In Goosen's case, the Tax Court agreed with the golfer's characterization of his income as 50 percent royalties and 50 percent personal services.
Garcia v. Commissioner
When Garcia's case went to Tax Court, the verdict handed down in March wasn't quite as favorable as in Goosen's, but overall, it still represents a win for Garcia. Neither Garcia's claim – that his income was 85 percent royalties (not subject to any US tax thanks to the abovementioned treaty) and 15 percent personal service income (subject to ordinary US income tax) – nor the IRS claim that 100 percent of his income was personal service income, was accepted by the court.
Garcia sought to bolster his claim by pointing to the adverse relationship he had with TaylorMade regarding contract negotiations. That, he said, should solidify the accuracy of the 85/15 split. But his contention unraveled somewhat when TaylorMade's CEO said there wasn't much effort put into deciding the percentages. "It was irrelevant to me whether it was 15/85 or 50/50," he said.
That indifference may have told the court the percentages were more random than cemented in actual analysis. On the other hand, the court also didn't buy the IRS' claim, which stated TaylorMade only meant to compensate Garcia for his personal services.
In the end, the Tax Court adjusted the figures somewhat. Because Garcia's on-course success didn't justify the fees he was paid, the court recognized that a large part of his compensation had to be payment for use of his image. The court then characterized Garcia's income as 35 percent personal services income subject to ordinary income tax rates and 65 percent royalty income, in this case, not subject to US federal tax at all.
Retief Goosen Hits a Tax Birdie
When it comes to marketable images and cool, spotless personas, Retief Goosen topped the list among pro golfers, which explains why TaylorMade, Izod, and Titleist were willing to pay him a fortune to use his image. He licensed to them the right to use his name and likeness on golf equipment, golf apparel, and golf balls, respectively. He not only was required to play eleven more tournaments a year than Garcia and use TaylorMade products when doing so, he also agreed to make personal appearances and to assist in product testing and development. In return he was paid a flat fee, tournament bonuses, and ranking bonuses.
At tax time, he characterized his income as 50 percent endorsements and bonuses 50 percent for personal services, following what was in his written contract with TaylorMade. The IRS said, not so fast. They wanted 100 percent of his income to be classed as personal services, based on the assertion that the use of Goosen's name and likeness were de minimis compared to his personal services.
The Tax Court, however, upheld Goosen's claim. The court stated his position as a preeminent golfer afforded him immense popularity and gave him "value beyond his golf skills and abilities." The court also pointed to the fact that TaylorMade considered him its "brand ambassador," because the company wanted to be associated with his "cool and professional persona." Finally, the court relied on a report that states "an athlete's image is often more important than an athlete's performance on the course."
In these two high-profile cases, the Tax Court acknowledged that licensing your image in exchange for endorsement fees is, in fact, separate from being paid for your skills. And the percentage the court was willing to assign to royalty income rose between the two cases: first, 50 percent in Goosen and later, 65 percent in Garcia. The higher percentage for Garcia was due in part to the court's weighing of facts, including: while Goosen was merely a brand ambassador, Garcia was clearly seen as a bigger star, labeled TaylorMade's Global Icon. That and other considerations helped solidify the contention that TaylorMade was paying Garcia more for his image than for his personal services.
A Forbes analysis says even though Garcia didn't get everything he wanted, this could represent a win for future athletes who have worldwide endorsement income. One lesson learned from the court's decision: sometimes it's not as much about skill as it is about having a larger-than-life persona. In Garcia's case, his "coolness" factor paid off handsomely in tax advantages.