Explaining the luxury tax, revenue sharing refunds, and the Yankees

(The following is a guest post from reader jerkface)

This offseason & the following offseason there will be a lot of talk about the $189 million payroll limit that the Yankees will try to get under by 2014 and the impact that it has on the moves the team will make.  A lot of people are unclear as to what this limit really means, so I thought I would write this to help educate fans on how the limit is calculated & how the current Yankee team is impacted by those calculations.

The CBA & Luxury Tax Calculations

The Collective Bargaining Agreement signed by the MLBPA & Ownership is what governs the interactions between players & management in Major League Baseball.  Last offseason a new CBA was signed which introduced new wrinkles into the luxury tax agreement that has the Yankees attempting to get under the limit for the first time in a decade.  Here are the basics:

  1. The luxury tax limit for 2013 is $178,000,000.  For 2014-2016 it is $189,000,000.
  2. There is a new revenue sharing refund program which forces teams who are in the 15 largest markets to refund their revenue sharing if they were eligible in increasing proportions until they refund 100% in 2016.  The Yankees pay around 27.5% of all revenue sharing each season, and would get some of that back thanks to the disqualification program.  The teams who are going to pay back as of now are the Athletics, Braves, Nationals, and Blue Jays.  They receive around 23% of all revenue sharing.
  3. The amount of refunded money the Yankees receives is based on how many consecutive years they have crossed the luxury tax threshold.  100% if they were not over the limit in the previous year. 75% if this year is the 2nd year they have gone over the limit. 50% if this year is the 3rd they have gone over the limit. 25% if this year is the 4th year they have gone over the limit. 0% if this year is the 5th (or more) year they have gone over the limit.  If the Yankees did not go over the luxury tax for 2014-2016 they would receive 11.65% of their revenue sharing back in 2014, 17.47% in 2015, and 23.3% in 2016.  This assumes the same teams above will continue to receive revenue sharing.
  4. The payroll value used to check against the luxury tax limit is not simply the sum of the team’s season contract values.  Payroll figures like those found on ESPN or COTS MLB Contracts are not the number that is used to determine payroll.  Payroll is the sum of: 1 year contract values of everyone on the 40 man roster, the annual average value of multi-year contracts including bonuses/player options/buy outs of non-player options, cash considerations from trades, single season salary escalators or bonuses (such as MVP bonuses/games played bonuses), any amount deductible or includible based on specific player events, and a 1/30th share of player benefits.
  5. Beginning in 2013, the amount of luxury tax a team pays will be changed to the following: 17.5% for first time offenders, 30% for second, 40% for third, 50% for fourth or more.  A team which did not go over in the previous year will reset to the 17.5% amount if they go over again.  This tax is only paid on the marginal overage, meaning if your payroll as calculated above is 190 you would pay tax on the $1 million not $190 million.
  6. The 1/30th share of player benefits is $10,799,590 for 2013, and will increase or stay the same for 2014.

 

How the Yankees will be looking at 2014

If you read and understand the above, you can see there is definitely incentive for the Yankees to get under the limit if their goal is to increase profits.  They will not only get the savings from simply reducing payroll, but also from paying reduced or no luxury tax and from potential revenue sharing rebates.

Unfortunately for the Yankees, the $189,000,000 goal will be difficult for the team to get under without some very shrewd maneuvering and getting a bingo on a minor league prospect or three.  The 2014 Yankee club, as viewed through a luxury tax lens, looks like the following:

Team must be at or under $189,000,000 for entire season costs

Alex Rodriguez -$27,500,000 (Average Annual Value of contract)

Mark Teixeira -$22,500,000 (Average Annual Value of Contract)

CC Sabathia -$23,875,000 (Average Annual Value of Contract [Original + Extension])

Player Benefits -$10,799,590 (Or more!)

 

Remaining budget room: $104,325,410

 

These are known costs, but there is 1 more cost that will definitely factor in to 2014.  It is variable.  If Derek Jeter accepts his player option for 2014 he will cost $15,500,000 (14 AAV+1.5 silver slugger bonus).  If Derek Jeter declines his option, he will count as $9,000,000 for 2014, due to the rules of the CBA.  Derek Jeter’s $8 million player option for 2014 counts as a guaranteed year and is included in the AAV calculation, which lowered the AAV of Jeter’s deal from $16mm to $14mm.  The Yankees will owe $2mm each in back pay for 2011, 2012, and 2013.  They will also owe $3mm for his buyout.

 

Without doing anything significant via trade, the Yankees 2014 operating budget will be either $88,825,410 or $95,325,410 depending on what Jeter does.  This does not include anyone in arbitration or minor leaguers on the 40 man roster.

 

Can the Yankees fit ~21 players under that salary amount while still competing for the playoffs?

 

You can find the CBA at http://mlb.mlb.com/pa/pdf/cba_english.pdf

 

 

Born in Southwestern Ohio and currently residing on the Chesapeake Bay, Brien is a former editor-in-chief of IIATMS who now spends most of his time sitting on his deck watching his tomatoes ripen and consuming far more MLB Network programming than is safe for one's health or sanity.

22 thoughts on “Explaining the luxury tax, revenue sharing refunds, and the Yankees

  1. michael

    Thank you Jerkface. How do the milestone bonuses in Rodriguez' contract factor into the AAV? Are they assumed to be realized and factored into the AAV, or are they added to previous year's budgets, retroactively, as he accumulates HRs? Thx

    • jerkblog

      They are added to the budget in the year they are earned, so they do not affect the AAV of A-rod's contract but are supplemental. For example, A-rod is very close to the first milestone, we can assume he will hit it next year. If he gets it, for 2013 only A-rod will count as 33.5 million against the luxury tax limit. If he gets the bonus next year, you can assume he will be likely to hit his second bonus sometime between 2014-2016, so it will be something the Yankees must consider.

      Please note that articles referencing marketing contracts no longer being allowed due to circumvention of the luxury tax limit refer to their exclusion from AAV calculation. The CBA quite clearly states that special covenants will count for the years they are paid out.

      This is Jerkface btw

      • uyf1950

        Currently A-Rod has 647 HR's the 1st milestone incentive kicks in at 660 Mays HR total. Assuming he hits about 20 HR's in 2013 that would give him 667 to start the 2014 season. The next milestone incentive kicks in at 714 Babe's HR total. That means he would need 47 HR's to reach that milestone sometime during the 2014, 2015 and 2016 seasons to reach that milestone. He will be 40 years old midway through the 2015 season. With reduced playing time and factoring in injuries I'm not sure it's a foregone conclusion that A-Rod can or will reach the Babe's Home Run Total to cash in on his 2nd milestone.

        • jerkblog

          A-rod did OPS .900 out of the DH spot this year, so I think it will be very possible for him to reach the second milestone. The first is almost guaranteed, as I think we can all agree, and the second is less likely but still with great enough odds that the Yankees have to keep it in mind. They can ignore the others, it will be impossible almost unless A-rod turns it around completely.

          He only has to average 17 HRs a year to reach the 2nd milestone in 2016. That is very doable for a guy like A-rod.

          • uyf1950

            Normally I would agree with you about A-Rod and averaging just 17 HR's. But, A-Rod has not looked good at all the 2nd half of 2012 and the injuries keep piling up. Factor in, in 2014 he will be 39, in 2015 he'll be 40 and 2016 he will be 41 I think there is enough there to put the odds at less then 50/50 for reaching the 2nd milestone. At least that's my opinion. But you are correct the Yankees will at least have to keep it in the back of their minds. The good part is come the 2016 season as it stands right now the Yankees only have 3 players under contract (A-Rod, CC and Tex) for about $75MM AAV. Now of course that will probably change but it does give them some leeway.

  2. Rich7041

    Thanks JF. This makes it very clear (and somewhat depressing) about what we have to look forward to in the next 3-4 seasons. Cashman will have to earn his money if they're going to stay under that cap.

  3. Bill

    Nice write up. Just a couple of notes though. Oakland is exempt from the market disqualification program until their stadium situation is resolved. I'd imagine that would significantly reduce the potential size of the rebates.
    How much of their rebate share they receive is slightly different than how you described. They do get the full rebate in any year they are under the threshold, but f they are over the luxury tax threshold, their rebate is dependent on what tier they are assigned for the program. Because they've been over the threshold for several consecutive years, the Yankees will be starting out in tier 5 (lose 100% of their refund). If they go under for only one year, their tier drops only 2 levels, it doesn't completely reset.
    So if the Yankees are over in 2013, they lose their entire refund for 2013 and remain in tier 5. If they go under for 2014, they get their full refund for 2014, but if they go over again in 2015, they only reset to tier 3 (lose 50% of their refund). If they get under 2 consecutive years, they reset completely to tier 1 (get full refund).

    Also, I believe in CC's case, the AAV of the extension would be used (24.4M AAV) as the original contract is no longer in effect.
    Jeter's AAV would be slightly lower to account for the present value of the salary deferred without interest. If my math is correct, it would work out to 4/$55.61 – about $13.9M AAV, resulting in about $15.4M for 2014.
    As for the amount Jeter would count for if he declines his option, I believe Article XXIII, E. (5)(d)(ii) might apply. In the new CBA, it only applies for option years 2017 or later, but in the previous CBA (in effect when Jeter signed his contract) it applied for player option years 2012 or later. If this clause does still apply to Jeter's contract, the effect would be that his AAV for luxury tax purposes would be adjusted upwards about $1.55M/year from 2011-2013 (so $15.45M total). In this case, if Jeter declined the option, he would count for $4.26M ($50.61M present value of the $51M actually paid, less $46.35M ($15.45M x 3 years) actually taxed. If he did exercise the option, they would receive a refund of the tax paid on the extra $1.55M/year paid in 2011-2013. Since the years covered by this clause change in each CBA, I'm not sure if this original calculation is still in effect, or if the AAV is adjusted somehow to reflect the change in the new CBA.

    • jerkblog

      For CC's contract (and for any contract that is an extension) the original terms of the deal that were already counted for will be included in the new AAV calculation. The future years will be replaced by the extension.

      For Jeter, his salary is deferred without interest so it is counted in the year it is being deferred from as normal salary. That makes his salary 16 AAV without the option. The 2017 option section is separate from section D which explains the adjustment in luxury tax for a player opting out of a guaranteed year.

      (i) If a Player fails to exercise or chooses to nullify a Player
      Option Year that is deemed a Guaranteed Year pursuant to Sec-tion E(5)(a)(ii) above, the difference between the amount paid to
      the Player under his Contract (including any Option Buyout pay-ment) and the amount that has been attributed to Actual Club
      Payroll of a Club under that Contract shall be added to (or sub-tracted from) Actual Club Payroll in the Contract Year in which
      the Player Option Year falls.

      You're right about the rebate stuff, the article would have been a lot bigger had I included all of it. With one exception. The rules for the rebate tier state that the club will only move down 2 tiers if they are a CBT payor club.

      (C) A Club that is a CBT Payor Club in a given Contract
      Year but is not a CBT Payor Club for only the next Contract
      Year will have its assigned Tier reduced by two levels (but
      in no event to lower than Tier 1) in the next Contract Year
      in which it is a CBT Payor Club

      So as long as the Yankees do not pay the CBT in 2014 and 2015 they can become a CBT payor again in 2016 and receive 100 of their refund.

      • BrienJackson

        The relevant point on C.C. is that he never officially opted out of his first contract.

        • jerkblog

          Yes, exactly, so it counts as an extension of his original deal. This includes the 3 years he played, the signing bonus he received, and then the new terms of his extension.

  4. Bill

    Re CC: reading XXIII E. (5)(d)(i-ii) would seem to indicate that the AAV of the new contract (which replaced the old and started in 2012) would be used. No adjustments would need to be made because the taxed amount for 2009-2011 equaled the paid amount for that period. Bottom line, the total dollars taxed would have to equal the total dollars paid. In your calculation, to make it equal, they would have to revise upwards the amount already taxed in 2009-11. I don't see anything in the CBA that would indicate that they would revise upward past year luxury tax payrolls.

    Re Jeter: It's because the money is deferred without interest that present value is used. Per XXIII, E. (6) (b)(ii), if the money is deferred at a rate within one and one half percentage points of the imputed interest rate, it is included at it's stated dollar amount, otherwise present value is used. Jeter's, as you said, is 0% interest. The imputed interest rate in effect at the time would have been the Ocotober 2010 federal mid-term rate of 1.73%. Since 0% is not within 1.5% points of 1.73%, present value would need to be calculated. No big deal though, it's a very minor difference.
    The 2017 option stuff is a subsection of (d). If it does still apply to Jeter's contract under the new CBA (like I said, I'm not sure with the date change from 2012 to 2017 if it still does), it would change how much Jeter counted towards the 2011-2013 payrolls, which would directly impact the calculation of how much was taxable in 2014 if he opts out. I'm assuming your $9M figure comes from subtracting the amount that was taxed (14M AAV x 3, 42M) from the amount that will have been paid with the buyout (51M). My point is that extra clause, if still applicable to Jeter, would increase the amount taxed in 2011-2013 from $42M to $46.35M, which would reduce the difference from $9M to the $4.26M I mentioned (with my numbers factoring present value of the deferred payments).

    • Bill

      Yikes. That CC part should be XXIII, G (3), (i-ii)

  5. jerkblog

    The player option paragraph (d) is a subsection of (5) Player options, not a subsection (c) Club Option Years, which contains the sub-section (ii) Contracts Extending Into 2017 or Beyond.

    So the rules of it will apply to Jeter opting out of his player option, and the Yankees will be on the hook for adjusted amounts & the buyout in 2014.

    • Bill

      That's not the clause I'm referring to. There is a seperate, similar clause pertaining to player option years, directly under the clause you quoted above.

      "(ii) If a Player Option Year falls in the 2017 Contract Year or
      later, and the Base Salary (plus any attributed Signing Bonus,
      deferred compensation or annuity costs) in the Player Option
      Year (“Player Option Year Value”) is less than 80% of the Base
      Salary (plus any attributed Signing Bonus, deferred compensa-
      tion or annuity costs) in the Guaranteed Year with the smallest
      such figure before the first such Player Option Year (80% Figure),
      then the difference between the 80% Figure and the Player
      Option Year Value shall be allocated pro rata across the Guaranteed
      Years preceding the first such Player Option Year;
      provided, however, that if the 80% Figure is itself less than 75% of the
      Average Annual Value of the Contract (calculated as if the Player
      Option Year was not a Guaranteed Year), then the 80% Figure
      shall instead be 75% of the Average Annual Value calculation set
      out immediately above.

      If my math is correct, the 75% of the AAV calculated as if the Player Option Year was not a Guaranteed Year) would be higher than the 80% of the lowest year, so would be used in the calculation.
      The AAV calculated in that fashion would be 16.87M. ($51M total including the buyout, discounted to $50.61M present value/divided by 3 guaranteed years). 75% of that would be about $12.65M. The difference between that and the $8M original option value ($4.65M) would then be prorated over the guaranteed years, adding $1.55M/year, and making the 2011-2013 figure for luxury tax purposes $15.45M/year.
      That's if this clause still applies to Jeter. It seems it definitely would have under the last CBA, but I'm not sure if it would still apply now.

      • jerkblog

        This clause clearly does not apply, as Jeter's option is for 2014 which is NOT '2017 or later'. It is being counted as a guaranteed year following the Rules of section E (5) and the rules of (d) (i) will count if he opts out.

        • Bill

          I'm not disputing that it counts as a guaranteed year. The clause applies to player options treated as guaranteed years, just the calculation involves a starting point calculated as if if were a non guaranteed year.
          The reason I'm not sure this applies or not is because the same clause was included in the last CBA as applying to option years for 2012 and beyond. Jeter's contract was signed during the last CBA, and the first year of the contract occurred in the last CBA. At the very least this clause would seem to have applied to his 2011 luxury tax figure. I'm just not sure of those calculations carry over to the new CBA or if they are readjusted.

          • jerkblog

            Yea that is true, the clause was in the previous CBA, but because these are negotiated agreements that expire/are re-upped, then I'm pretty sure the new one takes precedence unless specifically included in the new CBA.

            What this means is that the Yankees could potentially receive a refund for 2012 if they were taxed at a higher amount in 2011 because of the previous rule. Not like it would do much good though given they are way over this year.

          • Bill

            That's entirely possible.
            I'm just not sure because luxury tax implications are calculated when the deal is signed, and there don't seem to be any provisions in the CBA allowing for recalculations of prior years based on changes in the CBA. Maybe that's just assumed. I don't know.
            From a Yankees standpoint, I'm hoping the contract isn't recalculated with the new CBA, as $4.6M would be much easier to swallow if he opts out and they still try to get under $189M for 2014.

          • jerkblog

            The luxury tax salary figures are submitted each year, so I think it is something that is re-calculated each year given the rules of the CBA for that year.

  6. jerkblog

    You're right about CC's contract, which is actually even worse. As his extension will count as 24.4mm against the tax instead of 23.875.

  7. Stephen

    I think I understand most of it Brien. But, could you ballpark the amount of money you think the Yankees could get back from revenue sharing. It has to be a couple hundred million right? (Sorry if that is a dumb question).

    • jerkblog

      No, sorry, it is much less than a couple hundred million. If you include everything (luxury tax, payroll, revenue sharing) they could save around 100 million potentially. here is what I wrote on another blog:

      They only receive rebates from the teams in the 15 biggest markets that receive revenue sharing. Of those teams, only 4 actually received revenue sharing (Athletics, Washington, Braves, & Blue Jays). After 2016 the revenue sharing rebate program will no longer exist. Those teams collect about 23% of the revenue sharing. The disqualification program only rebates 50% in 2014, 75% in 2015, and 100% in 2016, so they will not get back all of their amount. The Yankees paid 125 million between luxury tax AND revenue sharing in 2011, not just revenue sharing. They pay around 25-30 million in luxury tax per season so lets say they paid 27.5. This makes sense at the Yankees are generally around the 400 million mark in revenue and pay 25-28% of it into the RS pot. They receive some revenue sharing tax credits thanks to their stadium as well which decreases their RS pot.

      They would get from the rebate program: 11.35mm in 2014, 17.03mm in 2015, & 22.72mm in 2016. That is 51.1mm total for all three years..

      Because the limit is going up to 189, their luxury tax burden will actually decrease because 10 million less will be taxed per year. If they kept payroll the same they’d pay 46.5 million in luxury tax from 2014-2016. A savings of ~30 million.

      So best case is they would save 97.6 million over 3 years specifically from things they are forced to pay. Note: If any of the big 15 market teams drop off the revenue sharing payee list the Yankees rebates would decrease.

      Note: If Oakland doesn't get a new stadium, they will be exempt from the rebate program and the amount the Yankees could see returned will be around 40 million.

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