It may have been a late Christmas present, but it finally got delivered Friday evening when the Dodgers and Teoscar Hernandez came to terms with a contract that will bring back the widely loved slugger. The deal is reportedly 3 years and $66 million, with a signing bonus of $22 Million, and deferred money that is about the same as the Bonus. The deal also includes a club option for a 4th year for $15 Million dollars as well.
Deferrals
Adding deferrals to a player’s contract seems like a new idea, but it’s been happening for quite some time, I.E. Bobby Bonilla. The Dodgers do seem to have made it more of a common practice, however, than maybe what most of us have been accustomed to though.
Deferring money on players’ contracts has different layers of value. First, and most importantly, it can work to reduce the Average Annual Value of a player’s contract (AAV), which helps with the CBT (Competitive Balance Tax).
It’s an alphabet Soup of complications, that’s for sure!
In a nutshell, if the deferred money acquires a certain amount less interest than the Annual Federal Mid Term threshold, then whatever amount is below that threshold can be deferred. So, $70 Million per year can turn into only $45 or $50 Million counting towards the CBT (luxury tax).
That allows clubs like the Dodgers extra financial flexibility to acquire other players while also doing the least amount of damage in terms of CBT penalties.
The Player
So, now that we have all of that complicated business nonsense out of the way, you might be asking, why would a player want to defer money? Especially knowing that inflation is going to make their contract less valuable by the time they receive their money.
One reason is it allows clubs to pay more for an overall contract. So, for instance, if Shohei Ohtanis’s contract only counts $45-$50 million per year against the CBT, then that likely is all he would have gotten paid if not for the deferrals. So, because of the deferrals, the Dodgers were, in essence, able to give him back the difference in what they saved towards the CBT ($20-$25 Million per year). And when they added that total to the amount they were willing to pay towards the CBT ($40 to $45 Million per year), it equated to $70 million per year.
It’s a win/win in that scenario, because the player gets paid more, and clubs get a discount towards the CBT.
But, that’s not always the case.
In Teos’ case, the Dodgers, nor any other team were ever going to pay a 32-year-old $40 Million or so for 3 years, just to get their CBT number down to $22 Million. And, you can’t blame Teo for not wanting anything less than $22 million to be paid over the next 3 years, and not deferred where inflation takes its hit.
So, this was the conflict that took a minute to resolve, and in the end, both sides came together and met exactly in the middle. Teo got a signing bonus, which beats inflation altogether, and then the Dodgers got roughly the same amount in deferrals to help against the CBT.
This is what happens when two sides want to work together, but are also very smart in knowing there’s a way to make it exactly fair or equal. Congratulations to the Dodgers for completing yet another “Chess” level transaction, and equal congrats to Teo for negotiating such great terms as well.
In the end, it’s a Merry Christmas for all, well except for all the other teams in the MLB.
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Great breakdown of the Teoscar Hernández deal and about how they really did meet right in the middle. One additional reason why deferrals can work for both the team and the player is the state income tax consequences. California has among the highest (if not the highest) state income taxes in the country at 12.3% for people earning $720K or more. I don’t think that Ohtani is deferring his money so that he can save on taxes, he wants the money invested in other players, but it’s an extreme example that illustrates the point on tax benefits.
Ohtani is deferring $68m of his $70m salary. If he is living in California after retirement then he’ll pay $8m a year on the deferred money but he’ll probably be back in Japan thus avoiding the state tax altogether. If the Dodgers just paid him $46m per year, or roughly what the money is worth in present terms, then Ohtani would pay around $4.6m per year in taxes.
The team and the player have an extra 10% to work with on the player’s income tax side to find common ground by using deferrals. On top of that the Dodgers are getting “CBT luxury taxed” at an excessive rate so the team is motivated to use them as your article explains well. When Andrew Friedman talks about how deferrals can be used at the end of the negotiation, when sides are within 10% of each other, it’s easy to see how that’s the case.
That’s interesting, never thought of it like that. Each player has to pay taxes in each state they work in, so the way I understand it is, it’s not where you live, it’s where you made the money. So, even though he plays for the Dodgers, he’s making money in Colorado, and thus, has to pay Colorado taxes on that money earned while in that state.
That being said, even if he’s living in Japan, I would assume the deferred money being earned will have originated from California, thus those California state tax laws would apply. I could certainly be wrong, but that’s the way I understand that part of it.
Awesome you stopped by the website!