The Grueling Truth - Where Legends Speak / Luxury Tax Implications for the 2019 Red Sox

Luxury Tax Implications for the 2019 Red Sox

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Red Sox Chairman Tom Werner, President Sam Kennedy and owner, John Henry and his wife, Linda Pizzuti Henry.

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Before Sunday’s game, NBC Sports Evan Drellich reported the Boston Red Sox are over the luxury tax threshold of $237M, which is the highest penalty bracket. This means that they will be taxed 62.5 percent on any dollar over $237M and will have their first-round pick dropped ten spots in the 2019 MLB Draft. Plus, they will lose about $500K in slot money.

While it does not hurt the organization’s competitiveness in a huge way, it does hurt the owners’ wallets. It is an evident commitment to winning and, as a fan, you cannot ask for much more than that. There are a few ensuing questions, however, that probably can only be answered with time. For example, does this mean they may go over again in the future?

According to Baseball Reference, the Red Sox have $211.7M committed to 2019 salaries with projected arbitration and options factored in. Chris Sale‘s $13.5M option will decidedly be picked up but they may stray from exercising Eduardo Nunez‘s $4M team option. If so, they can save some extra cash for other acquisitions.

Further, this $211.7M figures Rusney Castillo‘s $11.77M  into its calculations. While the team will still have to pay him, he will not count against the luxury tax. Presumably, he will stay off the 40-man and save the Sox some luxury tax breathing room. Consequently, the number drops to $196M ($211.7M – Nunez and Castillo).

Due to the inflation increase, the luxury tax will move  from $197M to $206M next year. That is just the first bracket. The Red Sox would actually be below the tax, however, there is almost zero chance they stay under. Boston has six looming free agents in Craig KimbrelDrew PomeranzJoe KellySteve PearceIan Kinsler and Nathan Eovaldi. Essentially, that is six roster spots they have to fill and it seems very unlikely they will get guys at the league minimum to fill all these voids.

Unless David Price heroically decides to opt out of his contract, there is almost no feasible way they will be able to get under. The focus probably shifts to if they will avoid the first and second surcharge.

As Evan Drellich kindly directed me on Twitter, the surcharge thresholds can be found within the Collective Bargaining Agreement. Before we delve into that, it is important to note the Red Sox will be second-time offenders. As a result, they will be taxed on the dollar even heavier. For example, first-time offenders, without getting into the first surcharge threshold, have to pay 20 percent tax on any dollar over $197M (the luxury tax threshold this year). Second-time offenders, however, will be taxed 30 percent on the dollar.

As mentioned, the Red Sox, as first-time offenders, are paying 62.5 percent on every dollar over $237M  because they are over the highest luxury tax threshold. If they stay the course next year and remain over it, they will be taxed 75 percent on any payroll over the highest threshold. This bracket’s threshold increases from $237M  this year to $246M the next. Is $246M the magic number they wish to stay under?

Meanwhile, the first surcharge threshold (the middle luxury tax bracket) was $217M this year and will increase to $226M in 2019. If the Red Sox stay between $226M-$246M next year, they will be taxed 42 percent on any payroll between those values. That is not as bad as 75 percent but a little more needs to be understood about these “surcharges.”

For example, let’s say the Red Sox next year run a payroll of $247M next year, which is a million above the second surcharge. From my understanding, this 75 percent penalty only applies to the difference between the club’s actual payroll and the second surcharge. So, if we take their hypothetical payroll ($247M) and subtract it by the second surcharge threshold ($246M), Boston will only be slapped with the tax on that million dollar difference. Instead of $1M, they would have to pay $1.75M, which means the penalty is $750K.

This can add up quickly if a team is well above their surcharge rates because these hypothetical 2019 Red Sox would have to pay 42 percent for every dollar between $226M-$246M. If that were the case, instead of the $20M they would normally pay, Boston would have to pay $28.4M. The first surcharge tax would give them a penalty of $8.4M, which is essentially what Drew Pomeranz is making this year.

Then, finally, we would have to add in the base tax for exceeding $206M, which would mean the Sox would be taxed 30 percent, as a second-time offender, for every dollar between $206M-$226M. That is $20M with a 30 percent tax, giving us a total of $26M. In other words, we have $6M more of penalties here.

In total, the Red Sox would have to pay the additional luxury tax of the following for its imaginary $247M payroll: ($1.75M+$6M+8.4M) $16.15M.

For most people, that’s more money than they’ll ever see in a lifetime. The Red Sox owners, however, are not most people. Unfortunately, I do not have information or the ability to figure out if this makes financial sense for the team. How much revenue does winning in Boston bring in? Between ticket sales, merchandise sales, television slots, etc. it is absolutely impossible to put a price on, probably.

While close to $20M in penalties is quite a bit, the real takeaway should be that exceeding these surcharge thresholds are a bit overblown. Sure, if a team is $10M over the highest-penalty bracket, then it is going to cost a significant amount of money. With that said, if the team is only $1M over, for a second time offender, it is only adding an additional ($1.75M-$1.42M) $330K in penalties.

The Boston Red Sox will exceed the luxury tax for the second straight year in 2019. The penalties will be steeper but there is not much of a difference (money wise, not prospect wise) between staying a couple million dollars below or a couple million dollars above the highest-penalty bracket. The same can be said for the middle bracket or even the base tax threshold (unless it makes you a multi-year offender).

The tax penalties will get even worse for third year offenders (50 percent base, 62 percent first surcharge and 95 percent second surcharge), which the Red Sox seem destined to become. It probably makes sense to reset the tax at some point but, with one of the best young cores in baseball, the next couple of years does not seem like a feasible time to do so.

Anyway, only the luxurious have the luxury of paying a luxury tax, so don’t worry too much about this.

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