In sports, success frequently brings significant monetary compensation. While this is a dream come true for most individuals, it is important to take the right steps to safeguard this hard-earned money. Most people assume that the biggest challenge is spending beyond one’s means. While this can cause many problems, it is not the only issue that athletes need to be aware of and plan for.
Your Off-Court or Off-Field Penalty: Taxes
There are several types of taxes that may impact you as an athlete if you play in the United States.
As you make more money, it is natural to want to give gifts to or support your loved ones. But be careful, as those gifts could generate a tax. According to the Internal Revenue Service (IRS), the gift tax is a tax on the transfer of property from one person to another when nothing, or less than full value, is received in return. Luckily, not all gifts are subject to the tax. Each person has an annual gift tax exclusion amount ($15,000 in 2020). This cap is the amount or value someone can give another person during the calendar year without the IRS assessing the gift tax. This amount is per person, meaning you can give up to $15,000 to as many people as you want in 2020. An easy way to avoid the gift tax is to make sure you are not giving a friend or loved one more than the annual exclusion amount each year.
Alternatively, if you want to make a larger gift, keep in mind that every US citizen has a lifetime estate and gift tax exclusion of $10 million adjusted for inflation ($11.58 million in 2020). However, this is the maximum aggregate amount you can give during your lifetime; it is not per person like the annual gift tax exclusion. Be aware that this exclusion amount is set to sunset back to $5 million (adjusted for inflation) on December 31, 2025, so if you wish to make large gifts, it is better to do so now while the exemption is high. Although you should file paperwork with the IRS, there should be no gift tax due as long as you have your exclusion. We can discuss your gifting desires and offer ways to make gifts, save taxes, and protect the gift recipient from wasting the money.
Depending on your team’s location, it is quite possible that you permanently reside in one state but play for a team in another state (or even country). Because you are earning income in one state (or country) but are residing in another, you may owe taxes in both jurisdictions. It is important that you work with an experienced tax professional to make sure that you are paying the right income taxes at the right time. The last thing you want is to owe more because of penalties and interest.
Although estate tax is not assessed until you die, it is vital to think about it now. As previously mentioned, the lifetime estate and gift tax exclusion is currently high but will sunset. Because no one has a crystal ball to determine when you are going to die and what the estate tax exclusion amount will be at that time, we always need to be mindful. Given your career as an athlete, your income potential is great and will most likely come in large lump sums. Invested properly, those large lump sums can grow even larger.
Guarding Your Money and Property
As a high-earning individual, your first line of defense is having the proper insurance. This includes homeowner’s, automobile, long-term care, disability, and life insurance. In the event money is needed to pay a claim or satisfy a judgment, these policies will be available first before looking to the rest of your money and property. You should periodically review these policies with an experienced insurance professional to ensure that you are adequately covered. As your income increases, so should the amount of your life insurance. As you acquire more accounts and property, you should also adjust your other policies’ value to reflect these increases.
As a further step, there are sophisticated asset protection planning tools we can use to provide you with more protection. A domestic asset protection trust (DAPT) is an irrevocable (unable to change) trust into which you (in your role as the grantor or trustmaker) permanently gift your accounts and property such as your home, cash, stocks, or other investments. Once transferred into the DAPT, the accounts and property are legally protected from future lawsuits, divorcing spouses, bankruptcies, and similar threats. The trustee (the person or entity you have chosen to manage, invest, and use the accounts and property) can then make distributions to you as the grantor, thereby allowing you to continue enjoying some benefits of the property in the trust. In most cases, the trustee must be an independent trustee (someone who is not related or subordinate to you or any other beneficiary and will not inherit anything from the trust) to preserve the trust’s asset protection nature. It is important to remember that DAPT laws can vary significantly by state. Residency requirements for the grantor or trustee of a DAPT vary from state to state, as does the required connection of the grantor with the DAPT state. It is crucial that you work with an experienced attorney when designing a DAPT to make sure that it is not considered a fraudulent transfer meant to defraud an existing creditor, which could land you in hot water.
Another valuable strategy, which protects the financial well-being of your loved ones, is an irrevocable life insurance trust (ILIT). An ILIT is an irrevocable trust created by transferring an existing life insurance policy into the trust or by the trust purchasing a new policy. Using your annual gift tax exclusion, you make cash gifts to the trust in order to pay the premiums on the insurance policy. Upon your death, the death benefit is paid to the trust, and the money is distributed according to the instructions you have left in the trust document. Not only does this strategy allow you to utilize your annual gift tax exclusion and remove the value of the life insurance policy and death benefit from your estate, but it also allows you to direct and protect the money you are leaving for your surviving loved ones. You can also use an ILIT to provide cash to your loved ones without increasing the value of your accounts and property that are subject to estate tax.
Next Player Up: Managing Your Money and Property If You Cannot
While you may currently manage your money and property yourself or with a professional’s help, have you considered what would happen if you were unable to continue managing your money and property? You may be injured on the job or afflicted with a condition that renders you incapacitated (unable to communicate or make decisions for yourself), or if you play for a team in a state or country other than where you permanently reside, you may be out of town and unavailable to handle necessary transactions.
A revocable living trust (RLT) is a trust you create during your lifetime and can change at any time prior to your incapacity or death. This planning tool enables you to name yourself as the current trustee (the person or entity charged with managing, investing, and handing out the money and property) and to designate a co-trustee or alternate trustee if you are unable to act as the trustee. An RLT also allows you to continue enjoying the money and property during your life and while you are incapacitated, as well as designate what will happen to that money and property upon your death, protecting it for your chosen recipients.
For this strategy to work as intended, however, any accounts or property meant to be owned by the trust must be properly funded into the trust. Funding the trust involves changing the ownership of the accounts or pieces of property from yourself as an individual to yourself as the trustee of the trust. If the trust does not own a particular account or property, the trust terms will not control what happens to it.
Lastly, not only does an RLT allow for continued management of your accounts and property if you become unable to act for yourself, a properly funded RLT also allows those accounts and property to avoid the probate process. This means that upon your incapacity or death, your financial matters can be handled privately by those you have chosen, and the details will be kept out of court records and the media. One caveat, however: an RLT will not protect your money and property from your creditors or judgments.
An additional tool that can help manage your money and property is a financial power of attorney. This document allows you to choose a trusted person (your agent) to handle your financial matters on your behalf. Your agent can handle a wide variety of transactions, from signing checks to opening a bank account, depending on the authority you give that person. If you wish your agent to act only in certain instances or transactions, then a limited financial power of attorney can be drafted for those circumstances. Alternatively, if you would like to grant your agent the authority to conduct all the financial transactions that you would be able to do yourself, then we can prepare a general financial power of attorney. Another consideration is when you want your agent to act. If you want to limit when your agent can act, a springing financial power of attorney allows your agent to step in only when a determination has been made that you are no longer able to handle your financial affairs. On the other hand, if you would like your agent to be able to act right away, an immediate financial power of attorney can be created. Even though your agent can act on your behalf as soon as the document is signed, it does not impact your ability to continue carrying on business for yourself. Your agent is just an additional person who has authority to act. This can be a useful tool if you routinely travel for work. Lastly, if you want your agent to be able to act when you are no longer able to handle your affairs, it is important that the financial power of attorney be durable. This means that the document and your agent’s authority will not be affected if you are later determined to be unable to make financial decisions for yourself. When the agent can act and what the agent can do are all things that can be customized to your unique situation.
Caring for Your Physical Well-Being If You Have Been Benched
Due to the risk of injury that comes with such a physically demanding occupation, having proper healthcare documents is crucial. These include a durable medical power of attorney, living will or advance directive, and a HIPAA authorization form.
A medical power of attorney allows you to name a trusted healthcare decision-maker to communicate your medical wishes in the event you are unable to do so. It is important that you name someone who will respect your wishes and carry them out when you are unable to communicate them to the appropriate medical professional. However, this person will only be able to make medical decisions on your behalf if you cannot. If you can make decisions and communicate them, you remain in control.
A living will or advance directive allows you to clearly convey your wishes regarding end-of-life decisions. Because these can be very sensitive topics, it is important that you carefully consider your wishes. This may take some soul-searching, but it is necessary that you know what you would like to have happen in certain situations so that your wishes can be properly documented and communicated to your chosen medical decision-maker. Absent specific instructions from you, your medical decision-maker is going to be left trying to figure out what you would have wanted. This can cause additional grief in a difficult situation, as well as potential fighting among your loved ones.
A HIPAA authorization form allows you to grant certain individuals access to your medical information (e.g., to get a status update on your condition or receive your test results) without giving those individuals the authority to make any decisions on your behalf. By at least providing the medical information to your loved ones, you can help quiet the anxieties and uncertainties that often arise during times of emergency. This can also help alleviate tensions between your medical decision-maker and the rest of your loved ones. Although only one person will be making the decisions, the rest of your loved ones will at least understand why those decisions were made.
Let Us Be Your Team Off the Court or Field
Proper estate planning is a must for everyone, but especially for you as an athlete. Not only do you have to address and manage tax, asset protection, and other financial concerns, you also need to protect yourself and your family in the event you are injured on the job. We welcome the opportunity to work with you and any other financial professionals on your team to help craft a winning game plan that will have you and your loved ones scoring for years to come. To accommodate your busy schedule, your Madison Estate Planning Attorneys are available for both phone call or virtual Zoom meetings.