A Quick Look at How State Income Tax Affects Huge Contracts

I noticed something interesting last week that remains timely in light of the ongoing free agency talk with Bryce Harper. The AP reported that Manny Machado’s $20 million signing bonus will not be subject to California income tax but will be taxed in Florida, Machado’s state of residence. Since Florida has no state income tax, this move should save the third baseman $2-3 million in local taxes.

The same report inadvertently answered a long-standing question of mine about Jon Lester’s contract. When Lester signed in 2014, his contract included a then-record $30 million signing bonus, only half of which was paid up front. The remainder was paid in installments between 2018-20 and I wondered why the money was listed as a signing bonus rather than salary. Taxes may have been the reason.

Yet as one question is answered, a new one is raised. If Machado and his agent were savvy enough to avoid taxes with a signing bonus, why did Machado sign in California at all? When I calculated the local tax rates of every MLB franchise last April, the Padres were tied for the highest. Their players pay approximately $106,000 in state and local taxes per $1 million earned. That means Machado will pay about $30 million in local taxes on his $280 million in salary.

Yet Machado was also heavily pursued by the White Sox, who pay one of the lowest taxes in baseball (~$62,600/per million). If Machado’s camp had gotten the White Sox to increase their offer slightly, maybe to $280 million over 10 years with the same signing-bonus structure, Machado would have ended up earning more in take-home pay in Chicago. And that’s despite the ostensibly “lower” total contract. Surely Machado’s agent should have been savvy enough to explain the situation.

Perhaps Machado genuinely preferred San Diego over Chicago, what with the beautiful weather and laid-back lifestyle. It’s been reported that Yonder Alonso and Jon Jay, signed by the White Sox to woo Machado, actually convinced him of how great San Diego was. But for a guy who said all along that he was going for the best financial package, I remain a little puzzled.

With Harper reportedly deciding between two California teams (Giants and Dodgers) and the Phillies, there may be more than just location that helps him make the choice.