Lakers center Dwight Howard is a free agent. He is considering offers from a number of teams including the LA Lakers and the Houston Rockets. At the moment the Rockets are considered the most likely bet despite the fact that they are offering $30 million less than the Lakers.
Why would anyone in their right mind turn down an additional $30 million?
The answer to that question was investigated by Tony Nitti at Forbes. He explains that the NBA allows the home team, in this case the Lakers, to offer a five year contract while competing teams can only offer a four year contract. On paper this would seem to give the Lakers a big advantage since they can offer Howard $118 million while the Rockets can only offer him a measly $88 million.
But the actual difference may not be as great as it appears. The final year of a five year contract is at the player’s option. This means, assuming Howard is healthy and playing well in four years, he would probably abandon the final year of his 5-year Laker contract and sign a new 4 year contract somewhere. That way he maximizes the lifespan and earning power of his career.
Assuming that’s the case, the total payout from LA over four years would work out to $91 million and the total payout from Houston about $88 million. The slight difference is because LA can offer larger annual raises than Houston. But once you consider the effect of state income tax, the benefit of signing with the Lakers disappears:
If Howard re-signs with the Lakers and relocates to California, as a resident of the state he will be subject to a 13.3% on all
of his income. Any income allocated outside the state and taxed in
another jurisdiction- for example, when the Lakers play the Phoenix
Suns – will generate a credit Howard can use against his California
income tax. But because California’s rate will always be higher than the
other state, Howard will still pay an effective rate of 13.3% on his
income…But what happens if Howard takes his talents to Texas? As a resident of a
state with no income tax, Howard’s earnings would only be taxed to the
extent he has duty days allocated outside of Texas.
There’s a bit of math involved in figuring out how many “duty days” Howard would have outside Texas and how much he might be taxed for those days. The bottom line is that total tax on the first four years of a contract with the Lakers would be in the neighborhood of $12 million. By contrast tax on a 4 year contract with the Rockets could be as little as $600k. Again, if we assume Howard will be looking for a new contract after four years either way, it turns out the Rockets are offering Howard about $8 million more than the Lakers. In effect, staying in high tax California would cost Howard $2 million a year compared to taking his talent to Texas.
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