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.

About Brien Jackson

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. 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

  2. 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. 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.

  4. 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).

  5. 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.

  6. 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. 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).