Welcome to the Big Leagues: Taxes on Multi-year Contracts

Tax News You Can Use | For Professional Advisors

January 13, 2025

Baseball player, Juan Soto, made headlines in December when he signed a 15-year contract with the New York Mets valued at over $750 million. With that contract comes a myriad of tax considerations. Although most of us can only dream of careers as professional athletes, the tax issues associated with multi-year contracts can impact taxpayers earning incomes from many other sources, including entrepreneurs who take back a note on the sale of a business, start-up employees who receive equity awards, corporate executives who elect to defer compensation, retirees receiving pensions or annuities, lottery winners and performers receiving royalties or residuals. With that in mind, let’s review the tax rules that apply to these kinds of multi-year contractual payments and the planning opportunities they present.

When is the Tax Due?

Virtually all individual taxpayers are cash-method taxpayers, meaning that items of income are taken into account only when received and deductions are available only in the year expenses are paid. This is likely good news for Mr. Soto, who will not need to report $750 million of income in a single year. Spreading the income over multiple years can lower taxes if it keeps the taxpayer from moving into a higher tax bracket. It also means that if they forfeit a later payment for some reason, the taxpayer has not already paid the tax on income they will never receive.

However, there are two situations where the taxpayer can elect to change the default rules, and in some cases this may result in a better outcome. The first is the installment sale of property other than marketable securities. If an entrepreneur sells a business in exchange for a series of payments, the seller takes part of the gain on the sale into income when they receive each payment. However, the tax code permits these taxpayers to elect to report all of the gain on the sale in the first year. Why would that be beneficial? If the taxpayer expects tax rates will be higher in later years, or if they expect to have more income from other sources in subsequent years, they may get better overall tax results by paying the tax all in year one.

Restricted stock awards (RSAs) that vest over time also offer an option to pay the tax upfront. Typically, the taxpayer recognizes income only if and when the RSAs vest. However, section 83(b) of the tax code gives taxpayers the choice to report all the income in the year the employer grants the RSA by filing an election. This may reduce overall taxes if the shares of stock are worth less now than they will be when the RSA vests. Start-up companies often grant RSAs to their employees with the expectation that the shares will grow in value significantly as time goes on. In that context, electing to pay the income tax upfront on the lower value may lower the tax bill. Taxpayers also incur tax at capital gains rates when shares acquired as RSAs are later liquidated. Note that restricted stock units (RSUs), where an employee does not receive actual shares, do not offer the same opportunity to elect when to pay tax on the income.

Bracket Management

Under Soto’s contract, he expects to receive $171.825 million in 2025, $46.875 million in 2026 and $42.5 million in 2027. He will be in the highest marginal tax bracket in all of those years, so a decision whether to defer receipts of income from other sources, or to accelerate deductions, will be based on whether it looks like rates for future years will rise or fall, based on expected legislative actions. For those with contracts more like base hits than home runs, the receipt of more income in one year than another can impact the taxpayer’s marginal tax bracket and the applicable tax rate, and it will make sense to bunch deductions in the year with the most income and push off discretionary receipts of other income until the years with the lowest projected receipts from the contract.

Taxpayers should consider deferring income from other sources when possible if they can identify in advance which years will have smaller contractual payments or lower tax rates. Some examples include waiting to sell capital assets with built-in gain and structuring other contracts such as an athlete’s endorsements or name/image/likeness licenses to make payments in later years. These taxpayers may want to save transactions such as Roth IRA conversions, which generate additional income, for those lower tax rate years. Those over age 59 ½ may want to take elective distributions from traditional retirement accounts in those lower tax years. Executives may want to use deferred compensation plans to have some of their income shifted to their retirement years, when they expect to have less wage income.

Conversely, taxpayers should consider bunching their deductions in the years where they will have the most income or be subject to the highest tax rate. This could include tax loss harvesting, prepaying deductible expenses such as real estate taxes, or purchasing depreciable assets. Many taxpayers in this situation contribute funds to cover several years’ worth of typical charitable contributions to a donor advised fund or a private foundation. Those taxpayers make the most of the charitable deduction in the year with the highest tax rates and can make grants from the donor advised fund or foundation in subsequent years to carry out their charitable giving plan. These techniques are also useful if rates are higher in some years because of legislative action.

State Income Taxes

While all U.S. citizens and residents are subject to federal income tax, state income taxes are determined by the taxpayer’s place of domicile as well as where they earn income. The states that do impose income taxes do not always define income subject to tax the same way, and the applicable rates can range from 1% to over 14%. For income that is not “source income” for a particular state, establishing tax domicile in a no- or lower-income-tax state can significantly reduce the overall tax paid by the taxpayer.

Gift and Estate Tax

Professional athletes, lottery winners and those who sell businesses often are inundated with requests for gifts following publicity surrounding their financial success. Under the federal gift tax rules, in 2025, a taxpayer can give up to $19,000 to as many people as they wish without incurring gift tax, and can do it every year (the cap is subject to annual inflation adjustments). The corollary is that gifts over the annual exclusion amount are subject to the gift tax , with the first $13.99 million using up the lifetime exemption and cumulative gifts in excess of that amount generating tax at a 40% rate. For this reason, it is important to consult with tax advisors before embarking on a giving spree. There are multiple types of gifts that have a lower gift tax impact than others, including gifts structured as Grantor Retained Annuity Trusts, Charitable Remainder and Lead Trusts, Qualified Personal Residence Trusts, bargain sales and net gifts, and gifts of assets subject to valuation discounts.

A tax-efficient estate plan is equally important, as the federal estate tax is currently imposed at a 40% rate on assets in excess of the lifetime gift and estate tax exemption (in 2025, $13.99 million per taxpayer) as well as the additional 40% generation-skipping transfer tax (GST) imposed on transfers to or for the benefit of grandchildren and more remote descendants. However, with advance planning, there are ways to reduce or defer taxes due at death. Expert estate planning advisors can design a plan that utilizes the unlimited marital and charitable deductions, certain valuation discounts, and the step-up in basis at death that reduces future capital gains taxes, for example, to reduce overall tax costs. This analysis should also include a review of the state-level death taxes that could be imposed on top of the federal tax.