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MLB Owners Seek Rule Change to Claim Tax Break

Major League Baseball (MLB) is pushing to let professional sports team owners benefit from the 20 percent “pass-through” deduction, a key provision of the 2017 tax law. This unwarranted change to proposed Treasury regulations to implement the law would come on top of several of the law’s other provisions that benefit this ultra-wealthy group, such as the cut in the top individual income tax rate and the $11 million increase in the amount of an estate that a couple can pass onto their heirs tax free.

The 2017 tax law gives a 20 percent deduction on certain “pass-through” income — income that the owners of businesses such as partnerships, S corporations, and sole proprietorships report on their individual tax returns, which previously was taxed at the same individual tax rates as their wage and salary income.

But not all pass-through businesses are eligible for the deduction. For high-income taxpayers, the law lists certain industries — such as law, health, and athletics — that are generally ineligible. For a business owner like a professional sports team owner, whether she can benefit from the deduction depends on the underlying business’s activities. If the team’s business involves performing athletic services, then the owner can’t claim the deduction.

The proposed Treasury regulations try to clarify how the law should apply to various businesses; as drafted, they limit sports team owners’ ability to benefit. MLB is asking Treasury to change those regulations, arguing that the players on the field comprise a “de minimis” — that is, a tiny or trivial amount — of a baseball team’s overall activity. Treasury should reject this argument. Whether the employee is a second baseman, a statistician, or a ticket salesperson, every activity of a sports team is fundamentally connected to the team’s performance of athletic services.

Team owners could try to game the rules to take advantage of the deduction even if Treasury refuses to make MLB’s requested change. For example, they might be able to separate a part of the team’s business (say, stadium maintenance) into a new entity whose income would be eligible for the deduction. Treasury added anti-abuse rules to the proposed regulations to prevent this kind of gaming, but creative team owners (and their tax planners) might be able to get around them.

The pass-through deduction could also prompt team owners to embrace contracting arrangements. Consider a team deciding whether to retain its 100-person maintenance department or replace these employees with an outside contractor firm to do the same work. Assuming the contractor firm’s owners can claim the pass-through deduction, the firm can charge the team a lower price, effectively sharing some of the tax savings with that team. These gaming strategies require businesses to take actions that have considerable real-world consequences — such as restructuring a line of business, shuffling assets into a separate entity, or laying off employees in favor of independent contractors — for no reason other than tax avoidance.

Finally, MLB’s request indicates the creative ways that business owners and their tax planners are thinking about how they might benefit from the new deduction. Such efforts shouldn’t surprise anyone; the laws’ “guardrails” — its provisions intended to limit the scope of the pass-through deduction and prevent gaming — invite such behavior because they reflect arbitrary decisions that the law’s drafters made about which activities are eligible for the deduction and which aren’t. For instance, the law includes a last-minute change that excluded high-income architects and engineers from the list of “professional services” that can’t receive the deduction. The law’s drafters provided no policy rationale for this change; they apparently simply chose to pick winners and losers among industries.

Beyond the guardrails, the deduction itself has little policy justification. And it’s sure to continue inviting abuse, undermining the integrity of the entire income tax.